What are raw materials?
Raw materials are objects that we obtain from nature and that serve as inputs in the production of derived products. For example, cotton is the basis for the textile industry, or petroleum for the polymer industry.
Classification of raw materials
As for the market segmentation of these products, they can be divided into two main groups, soft raw materials and hard raw materials, according to their characteristics.
- Soft raw materials. Practically refers to agricultural products, such as corn, cotton, wheat, sugar and soybeans. It also includes livestock products such as cattle and hogs.
- Hard raw materials. These are those related to industry, extraction and reserve assets such as gold, silver, oil, copper, nickel or natural gas, among others.
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In another approach, raw materials can be segmented into six main groups for greater clarity of the market to which they belong.
- Agricultural products with the highest demand and, therefore, the highest production, such as corn, cotton or wheat.
- Other agricultural products with high demand, but lower production compared to the agricultural product family, such as coffee, sugar, cotton, cocoa or orange juice.
- Usually live livestock lots such as pigs or cattle are traded.
- This includes the production of crude oil in its various qualities such as North Sea Brent or West Texas International, as well as its derivatives such as gasoline, diesel, boiler oil and natural gas,
- Precious metals. Mainly associated with jewelry and as reserves of value, gold, silver, platinum, palladium.
- Industrial metals. Associated with various industries such as manufacturing or construction, e.g. copper, nickel, tin, aluminum or steel.
Advantages of investing in commodities
Wide variety of options. There are many options to diversify in terms of products, while in terms of instruments there is the possibility of investing in stocks or ETFs, options or futures.
- They smooth volatility. These assets are usually not directly correlated to other assets or to each other, so, in the event of having positions in gold and cattle, and gold were to fall, this would not have to affect the cattle market. Thus, smoothing volatility in a portfolio.
- Inflation protection. Being inputs for production, regularly when inflation goes up, the price of commodities follows the same trend, so some commodities, such as gold, are also used as a store of value.
- Supporting economic growth. Emerging economies are the largest producers of raw materials, so by investing in them, we support the growth of trade in these raw materials and, therefore, global economic growth.
Disadvantages of investing in commodities
High volatility. Although the price of raw materials depends on supply and demand, both supply and demand are affected by external factors such as natural phenomena or political circ*mstances that abruptly alter the prices of raw materials.
Speculation. Unfortunately, the high volatility of commodity prices attracts those who seek short-term profits and based on the mass movements of these speculators, the price of these assets can be affected.
In contrast to equities. Although it is not a rule, the profitability of commodities usually goes in the opposite direction to the trends of the equity market, i.e., when the stock market shows a boom period, the commodities market usually shows a stagnation or drop in its yields and vice versa.
Damage to the environment. Despite legislation around the world on sustainable practices in livestock farming, agriculture, mining and extraction, procedures and mechanisms continue to be used to produce raw materials that have a high negative impact on the environment. The clearest example is the oil and crude oil refining industry.
Investing in raw materials has pros and cons, as well as risks and benefits, however, having them is always a good option that contributes to the diversification and good health of our portfolios.
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FAQs
Investing in commodities involves buying or trading raw materials like gold, oil, and agricultural products. Commodities can provide diversification to your portfolio and act as a hedge against inflation, but they also come with risks such as price volatility.
What are the disadvantages of investing in commodities? ›
The downsides to commodity investing are a lack of income, high volatility, and external risks. Lack of income: Investing in commodities doesn't generate yield income like a bond or a dividend-paying stock.
What is advantage and disadvantage of commodity trading? ›
This way, investors can easily diversify their investment portfolio and increase their profits. Moreover, commodities can generate great returns in the long term when people invest with prudence. However, there is a high degree of volatility in these markets that make it difficult to trade.
Is it a good idea to invest in commodities? ›
Investors can help reduce risk, hedge against inflation and diversify their portfolio by investing in commodities, such as gold, silver and copper. Investors are regularly searching for ways to maximize returns while minimizing risk. One often overlooked avenue for achieving this balance is investing in commodities.
What is it risky to invest in a commodity? ›
Risks of commodity investing
Commodity prices can be extremely volatile and the commodities industry can be significantly affected by world events, import controls, worldwide competition, government regulations, and economic conditions, all of which can have an impact on commodity prices.
What are 2 disadvantages of commodity money? ›
Overall, commodity money has both advantages and disadvantages. While it is more stable and reliable than fiat money, it can also be inflexible and costly to store and transport.
Why is commodities trading risky? ›
Commodities are considered risky investments because the supply and demand of these products are affected by events that are difficult to predict, such as weather, epidemics, and natural and human-made disasters.
Why commodities are better than stocks? ›
Usually, trading in the commodity market is suitable for a shorter time horizon since most transactions are executed through a futures contract. It's suitable for both short and long-term investment objectives. Individuals can park their funds for a day, a month, a year, or even 10 years.
Why become a commodity trader? ›
Commodity traders may work to secure a supply of raw material for a business or industry, to help to create liquidity in an international market, or to invest in a speculative capacity.
What is the benefit of commodity? ›
Commodities help in diversifying the investment portfolio. An investor can invest in raw materials in case you want to invest in stocks and bonds.
Gold. No matter what is going on in the market, investing in gold as a commodity always pays off. Gold is one of the world's oldest and best-known ways to make money. Even when the market fluctuates, gold still gives high returns.
Do commodities do well in a recession? ›
What happens to commodities in a recession? As a general rule, when economies slow, industrial outputs decline due to fewer infrastructure projects and house building, causing the demand for commodities to fall and prices to decline.
Can you make money investing in commodities? ›
While commodities can exhibit strong short-term gains, their short-term losses can also be sharp. Speculators often try to time these fluctuations, but long-term holders understand that the primary allure of these raw materials is their ability to provide diversification.
How much of my portfolio should be in commodities? ›
The diversification-based analysis gave a target between 4% to 9% allocation to commodities from a traditional 60/40 portfolio. Our inflation-based studies indicate 6.7% commodities allocation to attain inflation-hedging characteristics.
What is a disadvantage of investing in the commodities market? ›
The main disadvantage of commodity trading is that commodities are highly volatile as they are dependent on demand and supply factors. A slight change in supply due to geopolitical tensions or conflicts can adversely affect the prices of commodities. Hence investor caution is advised in commodity trading.
What is a problem with commodity money? ›
Commodity money has intrinsic value but risks large price fluctuations based on changing commodity prices. If silver coins are used, for instance, a large discovery of silver may cause the value of the silver currency to plunge, resulting in inflation.
What is the problem with commodities? ›
Commodity-dependent countries often grapple with issues like slow productivity, income volatility, overvalued exchange rates, and increased economic and political instability.
Which is better stock or commodity? ›
Investment goals - Equity investments generally yield better returns if you stay invested longer. This makes stocks a good option for investors with a long-term wealth-creation goal. However, investors looking for short-term gains can turn to the commodity market.
What are the risks of commodity trade finance? ›
The risk profile of commodities trading and trade finance has long been familiar. This is because there are inherent risks involved in trading with counterparties across distances and jurisdictions, with misdelivery and non-payment being two of the most obvious.
