How Can I Trade Commodities Without Actually Trading Commodities?

Commodities? Who wants to trade commodities? What do I know about pork bellies or pineapples? The truth is the price volatility and broad, constant demand can make this asset class a great choice for traders who are looking to diversify (always a good idea and something we highly recommend). When you’re looking for the next GameStop or hoping to jump on the Bitcoin wagon, it’s easy to overlook commodities – which is kind of weird when you consider that commodities like oil, gold, timber, sugar and cocoa are everywhere and you pretty much can’t live without them.

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Not long ago, commodities trading was limited to professional traders because it required a lot of money and at least as much skill. Commodity futures were established as contracts between buyers and sellers of certain goods and resulted in actual delivery of the commodity (here’s your 3 tons of corn!). Fortunately, as trading has become more democratized traders can now invest in commodity-based securities, funds and proxies. A proxy is one of a variety of asset classes whose behavior often correlates to commodity prices.  

An easy way to expose your investment portfolio to the commodity markets is to trade companies that deal directly in the relevant commodity. For instance, if you want exposure to gold, you could trade a gold mining company like Newmont (NEM). If you want exposure to oil, trade an oil company such as Exxon Mobil (XOM). Gaining exposure to commodities via the equities market is not without risk though because the stock price might not mirror the underlying commodity price. After all, there are a lot of other factors that go into a company’s stock price.

Another proxy for commodities are Exchange Traded Funds (ETFs). These are like mutual funds but there is no fund company between you and the investment. ETFs are securities that trade on stock exchanges and are regulated by the Securities and Exchange Commission (SEC). With an ETF, instead of owning the commodity itself, you own a security that is tied to the price or price index of that commodity. ETFs are liquid and easy to trade through on-line trading platforms, but some traders aren’t wild about them because they often don’t react to small changes in pricing of the underlying commodity.

Another way to trade commodities via the equities market is to trade infrastructure or service provider companies related to the commodity. Take plain old everyday water, for example. Recently, water trading has become a little more common in the United States, and options for investors who wish to speculate on future water prices are limited. But traders who expect increased water scarcity might want to think about investing in infrastructure companies like water transportation systems such as Maersk (AMKBY) or desalination technology like Hitachi Zosen (HIZOF). By investing in these companies early, traders can profit if their expectations are realized.

Commodity proxies can also be found in the foreign exchange markets. Take oil... If you want exposure to oil price changes without actually trading oil, the Canadian dollar might be an interesting investment. Canada exports a lot of oil to the United States, so when oil prices increase, the supply of USD relative to CAD is increased, causing the Canadian dollar to increase in value. Therefore, if an investor expects the price of oil to rise in the short term, an investment strategy could be to buy the Canadian dollar to attempt to profit from that price increase. However, currency valuations are affected by more than commodity prices so it’s always wise to be cautious. The chart below1 shows both the historical similarities in price movement and an uncoupling in price movement caused by the Russia-Ukraine crisis. This is a clear example of a disconnect between the movement of oil prices and the value of the Canadian dollar.

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The sweetheart of the commodity markets might be gold. Investors and traders like gold, particularly when there is a lot of volatility in the markets. Because gold is generally not as susceptible to fundamentals as some other assets, many investors see it as a “safe”. If there is geopolitical unrest, and the outlook for equities, currencies, and other commodities is uncertain, you can pretty much count on a rush to gold. 

If trading gold seems like something you want to explore, you might want to take a look at a foreign currency trade – the Swiss Franc – as a proxy for gold. Switzerland was one of the last developed countries to abandon the gold standard for bank reserves in 1999 and many forex investors have great faith that as uncertainty increases, so does the value of the franc. 

At QuantFu, we’re all about the democratization of financial markets that began in the stock market and has been expanding to all investment asset classes. Commodities have a long way to go compared to equities but there are still a number of different ways to get into commodities trading. From newer vehicles like ETFs, the stocks of commodity-related companies, or foreign currency trading trader access to the asset class is getting better all the time. Before jumping in, be sure to note that a proxy will never completely correlate with the underlying commodity. But with diligence and backtesting you can experiment with market condition correlations to make your commodity trading strategy stronger.


 1 From https://www.reuters.com/business/canadian-dollar-decouples-oil-adding-boc-inflation-headaches-2022-03-08/

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