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How to invest long term in commodities

Monday, May 22, 2017 | Category : Commodities | 1 Comments
How to invest long term in commodities
While considering Commodities as a part of portfolio for investments, an investor should also understand the various types of Commodity Derivatives that are tradable in India.

Depending on the investment objective of the investor the commodity may be selected and the horizon or period of investment can be arrived at. Every commodity has its own independent fundamentals based on which the prices are impacted.


Commodities are broadly classified into:
1. Bullion
2. Base metals
3. Energy
4. Agriculture

1. Bullion
Bullion consists of Gold and Silver. Bullion are mainly considered as investment products. The objective behind long term investment in Gold and Silver should be mainly to hedge your financial portfolio against future economic uncertainties and/or inflation. For e.g. the uncertainties such as geo-political tensions, unstable governments, Economic policies, Global Economic slowdowns, etc. are likely to impact bullion prices positively. Similarly, high inflation rate is also likely to impact bullion prices positively. During these times, returns on other long term instruments like Bonds, equities and real estate are likely to underperform. The situations like economic uncertainties and high inflation tend to appear in cyclical phases. Therefore, ideally it is advised to allocate some part of an individuals portfolio (about 20%) towards Bullion for longer term portfolio protection and stability.

Under the bullion basket, besides gold there is Silver too, is a commodities which is referred to as investment substitute for gold, however it doesn’t typically work just as a safe haven commodities, mainly due to its industrial use and properties, however in India, silver is also looked as a precious metal and due to its scarcity in nature but a wider application of use such as Jewelry, coins, and Photography it does have a broader demand and with the supply being limited, the prospects of prices to rise in the long term cannot be ignored. An investor has an option to either buy Spot Gold/Silver from the physical markets in a systematic manner in small quantities, or may also buy future contracts on the derivatives platform and keep rolling over and accumulating as and when prices correct.

2. Base Metals
Base metals that are tradable in India on the Commodity Derivatives exchanges are Copper, Nickel, Zinc, Lead and Aluminum. Base metals are mainly considered as commercial metals and are used by manufacturing companies to produce secondary products. Individual investors too can consider it as longer term investment if they have a good knowledge on the long term fundamentals of those commodities.
Investors do tend to invest in companies manufacturing base metals if they have positive view on the demand for these metals to rise. Similarly, while investing in Base metals for longer term horizon, individuals should consider their average cost of production and the long term demand and supply for the said commodities. Closer the prices of the metal to the production cost higher are the chances of fetching smart returns in the longer term.

3. Energy
Energy instruments that are tradable in India on the Commodity Derivatives exchanges are Crude oil and Natural Gas. Similar to base metals, energy complex is also considered as a Industrial Commodity. Similar to Base metals, closer the price of the energy to the production cost higher are the chances of fetching smart returns in the longer term. But, unlike base metals, energy complex need significant in depth study and knowledge to arrive at its production cost. Energy complex is mainly suitable for short term investors.

Scenarios like Geopolitical tensions with energy producing countries, supply disruption due to weather ,etc. are likely to impact energy prices positively but these are factors which are not easy to predict and hence volatility in the prices due to such reason remain very high. The impacts of the scenarios depend upon the magnitude the occurrence but are ideally short term in nature. Energy, especially crude oil, is considered as the most essential commodity impacting the growth of the economy. When oil prices fall drastically due to various demand destructions, it becomes an opportunity for long term investors to start accumulating mini retail contracts and keep adding as when prices further correct, as the long term demand curve is always going to be upward trending.

4. Agriculture
Many agricultural commodities that are traded in India. For ex. Jeera, Cotton, Soya bean, Soya Oil, etc. Agricultural complex are mainly hedging instruments for farmers who are in to cropping the agricultural commodities. The prices of agricultural commodities tend to move as per the weather projections, sowing and harvesting data released by the government from time to time. Agricultural complex is mainly suitable for short term investors as the data released by the government are tend to change and involves high amount of speculation.

To summarize, long term investment in Gold and Silver is highly recommended to hedge against uncertainties and inflation. Investment in base metals near to their production costs could turn out as low risk and high reward strategy for long term investors. Whereas investment in Energy and Agricultural commodities are more suitable for short term investment objective.
 
To know more about Commodity investment click here
 


Ashish Shah | AVP - Commodities
He is a certified NSE (NCFM/NISM Certification) For: Derivatives Market, Capital Market, Currency Market & Commodities Market & he has also done MCCP (Mcx Certified Commodity Professional) & DICM – Diploma in Commodities Market (Wellingkar Institute, Mumbai). He is regularly featured on Chat Shows on moneycontrol.com, live interaction on CNBC TV18 & BTVi.

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