Commodity investments are those that provide you with exposure to these types of assets.
Commodity investments can be broadly classified into:
a)Energy related commodities such as coal, oil and gas
b)Metals and minerals such as copper, iron ore and nickel
c)Precious metals such as gold, silver and platinum
d)Agricultural commodities such as wheat, forestry and fertilizer
For each commodity sub-sector, Evy Hambro, chief investment officer of BlackRock’s Natural Resources Equity team, said price performance tends to be driven by different factors.
There are a number of different ways to gain access to commodities markets, but typically investors look at physical markets, futures markets and equity markets as a means to gain exposure.
The most direct exposure, according to Mr Hambro, is through owning the commodity directly i.e. owning the underlying physical material.
Typically, Mr Hambro said there was a significant cost associated with this type of exposure as commodities need to be stored, for example with gold in a bank or oil in a tanker.
In addition, he said physical commodities need to be insured from theft. Both of these costs can erode the potential returns for an investor.
Investors can also gain access through the futures market by buying a contract in a commodity for delivery at a later date.
Returns for investors in these markets, according to Mr Hambro, are influenced by the shape of the futures curve.
Depending on whether the market is in backwardation (prices in the futures market are lower than spot) or contango (prices in the futures market are higher than spot), your returns can be positive or negative (respectively).
Mr Hambro said: “Investing in a market where the futures curve is in contango means that you can to be impacted by a negative roll yield as the contract expires at a lower price to your original investment and you look to roll that contract through buying back into the futures market at a higher price.”
Investors can also gain access to commodity markets through physically backed ETFs, such as gold ETFs.
Physically backed ETFs provide investors with the opportunity to buy a share in a product that owns physical gold.
While this provides direct exposure to physical commodities, Mr Hambro warned it tends to be at a higher cost, there is limited availability and there are ethical concerns associated with those ETFs that take commodities where there is restricted supply and a population requirement such as agricultural commodities out of the market.
The fourth way to gain access to commodities markets is through the producers of those commodities.
As commodity prices are the main driver of earnings for commodity producers, Mr Hambro said a company’s earnings should improve during periods of increasing commodity prices.
Under these circumstances, Mr Hambro said an equity investment can provide operational leverage to the underlying commodity as they deliver margin growth into a rising commodity price environment.
Other performance drivers for commodity producers can be volume growth and resource discovery and the ability for the company to return an income to investors in the form of a dividend.
However, Mr Hambro said as the investment is made through equity markets it can be exposed to equity market risk.
