Is it a good time to invest in commodities?

The simple answer: It’s always a good time to invest in commodities. The most obvious reason for this is that both short and long positions are allowed in the commodities futures markets. So, irrespective of whether the price of a commodity is rising or falling, you can make money on the movement, if you read it correctly.The big catch is that to make money, you must ‘read the commodity right’.

Understanding Commodities

Every commodity is determined by its own unique demand and supply dynamics. So, for instance, the price of oil – the most heavily traded commodity in the world – is determined by factors such as economic growth (both at the global level and in major developed and developing countries), the price of substitutes such as bio fuels, climate changes (a cold spell in North America and Canada can pull the price down) speculation, and production or stoppage thereof in the oil producing nations. The decisions and guidance of the Organisation of Petroleum Exporting Countries (OPEC) also pay an important role in driving the price of oil one way or the other.

The price of gold – another benchmark commodity - is impacted by very different factors and sometimes by the same factors but in a completely different manner. Like oil, growth and stability in major world economies impacts the price of gold too. However, ironically, unlike the price of oil, which increases with economic growth, the price of gold reacts negatively; it usually soars when there are economic down-cycles and falls when economic growth picks up.

Then again, while the short term supply of oil can be easily augmented, the supply of gold cannot. So, a spike in the demand for gold drives its price up much faster than a spike in the demand for oil. Usually, inflation and currency movements (especially of the US dollar) can drive the price of gold, while they are driven by the price of oil.

In a nutshell, tracking one commodity is a completely different ball game from tracking another. And, unlike stocks, there are no standard reporting formats (such as balance sheets and profit and loss accounts) or company and industry ratios (such as PE, EPS, Debt: Equity, etc) that can be applied and studied across commodities, in general, to arrive at conclusions about valuations and potential price movements.Each commodity is a unique animal that plays by its own rules. To succeed in commodity futures trading, you will need to study, in depth, each commodity that you choose to invest in.

 Knowing when to let go

While any time is a good time to invest in commodities futures, you must be very clear about when you need to disinvest. Your basic understanding of the commodities you invest in will guide you with respect to this too. So, for instance, agricultural products have very well defined seasons between sowing and harvesting. Taking a call at any point of time is determined by how the seasons are expected to pan out. Other commodities, like metals, which are more driven by industrial and real estate cycles, are likely to depend on economic growth and relevant policy announcements. Knowing what the triggers for various commodities are is the key. More importantly, being able to gauge if a trigger will have the anticipated impact, is what will guide you regarding whether you must stay invested or let go.