Have you ever wondered how to invest in gold, oil, and other commodities? This guide covers everything you need to know before you invest your money.
Investing in commodities and commodity-producing companies is not like investing in other areas of the marketplace. Commodities themselves do not pay dividends or interest payments.
And even commodity producing companies that do pay dividends can’t be evaluated based on traditional concepts like PE ratios and free cash flow.
So how do you know when commodities are likely to give you good returns? And how do you know which ones to invest in at what times?
Read on to find out.
Each section of this guide is designed to give you all of the information you need to invest in a particular area of the commodities market.
So you can read them in order if you want. Or just begin with the area you are most interested in and jump to others when you are ready.
It’s up to you.
How To Invest In Gold: Key Things You Need To Know
Investing in gold is a good way to diversify your portfolio. But how to invest in gold and what should you know before investing? We did the work for you.
Over the past 17 years, the price of gold has nearly quadrupled. It began at less than $300 in January of 2000. It ended December 2016 at close to $1200. So it’s no surprise that many investors are interested in gold.
But why has the price of gold gone up so much? Has gold gone up too far too fast? Is it about to fall? Or can you make a lot more money by investing in gold?
Gold In The Era Of Sound Money
Once upon a time, you could exchange currency for a fixed amount of gold. Before 1933, anyone could trade a U.S. $20 bill for 1 oz. U.S. Double Eagle gold coin, for example. Savers had the right to withdraw ‘real money’ anytime they wanted.
In 1933, the U.S. government revoked the right of its residents to exchange their dollar bills for gold. But foreign citizens could still redeem them. So Americans could trade their dollars to residents of other countries in exchange for goods. These foreign dollar-holders could then trade them for gold. In this way, the dollar retained its value over time. Other countries had similar policies to maintain their currencies’ value.
During World War II, most countries spent their gold financing the war. So they couldn’t guarantee the value of their currencies anymore.
The one exception to this was the U.S. They came into the war at the end and spent way less compared to other countries. To help the world recover from the war, the U.S. agreed to redeem dollars for gold from any central bank. It did this at a rate of $35 per ounce.
As a result, many countries agreed to exchange their currencies into dollars at a fixed rate. This meant that most currencies had a stable value relative to gold.
In such a society, there was little need to invest in gold. Because gold has no yield. It pays no interest or dividends. And the law guaranteed the value of currencies.
The End Of The Era Of Sound Money
In 1971, President Nixon shocked the world by ending the convertibility of dollars into gold.
Many economists expected this to cause the U.S. Dollar to collapse in value. After all, that is what had happened in every country that had gone off the gold standard before.
But this time, it wasn’t just one country that was suspending redemptions. It was the entire world.
It would have been reasonable to expect that all currencies would have become worthless. But as we all know, this is not what happened.
So why didn’t it?
Why Currency Still Has Value
The gold-standard was created before banking and interest rates existed. And before the discovery of oil as a source of energy.
But times have changed. And today, three factors allow currencies to keep their value.
Each country has legal-tender laws that instruct courts not to recognise gold as a payment for debts. So gold cannot be lent out or borrowed at interest. And most businesses rely on loans to pay for their short-term operating costs. So merchants generally do not accept gold as payment for goods and services.
Most countries claim that gold is a ‘collectible’ and charge hefty capital gains taxes on it. This makes transactions in gold expensive and time-consuming. Using the local currency avoids this problem.
Saudi Arabia and other OPEC countries will not accept gold in exchange for oil. To get oil from these countries, a person has to have dollars. Since these countries produce a lot of the world’s oil, this makes the dollar somewhat valuable. And it makes other currencies valuable because the dollar backs them.
Why Investors Need Some Gold Instead Of Cash
So if currencies are maintaining some value, why do investors need gold?
There are three primary reasons why investors need to hold some gold instead of currency.
1. To avoid negative real interest rates
When interest rates are greater than the rate of inflation, currency is usually superior to gold. This is because you can put currency into a bank account and earn interest, while this is not possible with gold. But if the interest is less than inflation, then holding currency is a losing proposition. And gold usually rises at least at the rate of inflation. So it’s usually a better option in this case.
2. To avoid rising oil prices
If the price of oil is falling, currency is sometimes a better investment than gold. This is because oil is highly valued in the world. So you can trade it for anything. But if the price of oil is rising, then gold is usually superior to currency. You can’t print gold. It must be mined. And mining gold requires oil. So if the price of oil rises, the price of gold must rise with it.
3. Because global debt levels are high
When governments and businesses have low levels of debt, they can survive high-interest rates. But if they are deeply in debt, they need interest rates to keep falling. Otherwise, they can’t roll over their existing debts. If interest rates rise anyway, businesses go bankrupt and governments default on their debts.
For this reason, societies that have lots of debt always want central banks to keep interest rates low forever. But if inflation is high, then central banks need to raise interest rates to stop it.
This creates a catch-22 situation in which currencies mostly go down relative to gold. If the central bank raises rates, the economy crashes. Then the central bank gives in to political pressure and cuts rates again. As a result, gold rallies.
Or the central bank decides it is too politically unpopular to raise rates and never does so. Then gold rallies because the central bank didn’t raise rates.
In this kind of environment, gold is usually a better option than currency.
Gold In A Diversified Portfolio
The previous section gave several arguments for why gold can sometimes perform better than currency. Yet, you might wonder whether gold will perform better than stocks or bonds. Unlike currency, most stocks and bonds do pay more in income than the inflation rate.
So why not have a portfolio made up of these and forget about gold? The answer is that having some gold can protect your returns against negative events.
For example, a portfolio with a lot of treasuries in it may do well in a financial crash. It may even do better than gold in that circumstance. But if there is a lot of inflation instead, it will do poorly.
On the other hand, a portfolio of stocks may outperform gold during moderate inflation. But it will usually break even during high inflation and do poorly during a recession.
Another option is to diversify a portfolio with commodities like oil and copper. These tend to outperform both stocks and gold during times of high inflation. But they also fall hard during banking panics and recessions.
All these options are useful in a diversified portfolio. But gold is uniquely valuable because of its use as money throughout history.
Because of this use, it tends to provide stability in a variety of circumstances. When recessions happen, gold usually does better than commodities and stocks. When there’s high inflation, it tends to outperform both bonds and stocks. For this reason, gold can give your portfolio an added boost not easily obtained otherwise.
How To Invest In Gold: Gold-backed ETFs
So what is the best way to invest in gold?
It used to be difficult. Before 2005, retail investors who wanted gold had to buy small coins and bars. These products were sold at a premium and were difficult to liquidate.
If an investor needed cash and wanted to sell his gold coins, he often had to ship his gold off to a coin shop in a faraway town. Then he had to wait a week or two until the gold dealer receiver and inspected the package. After this, he needed to wait for the money to be wired into his bank account.
In 2005, this problem was overcome by the creation of gold-backed exchange traded funds. Gold-backed ETFs, such as the SPDR Gold Trust (GLD), buy gold in large quantities at a low cost. They then issue shares to investors.
If the share price rises faster than the price of gold, the fund trades its shares for gold. This decreases the price of the shares and increases the price of gold.
If the share price rises slower than the price of gold, it trades gold for shares. This increases the price of the shares and decreases the price of gold.
In this way, the shares of a gold-backed ETF always track the price of gold. This allows investors to get exposure to the gold price without the hassle of buying and selling small bars and coins.
How To Invest In Gold: Gold Mining Companies
Another option for investing in gold is to buy shares of gold-mining companies. These tend to give an investor leverage from the gold price.
For example, the gold price may go up by 10% while mining stocks increase by 50%. Or the gold price may fall by 10% while mining stocks go down by 50%. Whether the price of gold goes up or down, its gains or losses are usually magnified by mining stocks.
Gold-investors usually only invest in mining stocks if they’re willing to take a lot of risks. And then, they only devote a small part of their portfolio to it. Yet, it can give huge returns to those who are willing to give it a shot.
A good option for investing in gold miners is the Van Eck Vectors Gold Miners ETF (GDX). It contains a basket of stocks from the world’s largest and most successful gold miners.
Gold: Past Moves And Future Outlook
From the end of the gold-standard in 1971 until 1980, gold rose to more than 24 times the value it had been before the gold-standard ended. By then, the gold-value of the U.S. national debt had fallen to pre-WWII levels (http://pricedingold.com/us-federal-debt/). The U.S. had inflated away most of its debt to the rest of the world. It was free to start borrowing again.
Over the next 36 years, the following events shaped the price of gold:
- In 1980, the Federal Reserve instituted “shock therapy” to stop inflation. They raised the interest rate on overnight lending (the Federal Funds Rate) to 20%. This was the highest it’s ever been in history. Gold then topped out and began to fall as inflation got under control.
- Gold continued to fall for the next twenty years as interest rates remained high and inflation low. It bottomed at $250/ounce in 2001. Meanwhile, the debts of the U.S. government and other governments and businesses grew. And even though rates were high, they fell over time.
- By 2002, the gold-value of the U.S. national debt had risen to 650 kilotonnes. This is the highest it’s ever been. It’s more than twice what it was in 1971. Meanwhile, the Federal Funds Rate of 1.25% had fallen below the rate of inflation of 2.4%. This was the first time the real interest rate had been negative since the 70’s.
- From 2001–2011, oil rose to six times its previous value, from $20/barrel to $120/barrel. Meanwhile, gold rose to 7.6 times its previous value, from $250/oz. to $1900/oz.
- From 2001–2011, the gold-value of the U.S. national debt declined to 300 kilotonnes. This was the same level it had been in 1971.
- From 2011–2015, the Fed’s Quantitative Easing program came to an end. At the same time, new ‘shale oil’ technology started to increase the supply of oil. These events led to a falling oil price. Oil fell from $120/barrel to $30/barrel. During the same period, the inflation rate fell from 3.5% to 0%. Even though the interest rate was 0%, this still caused the “real interest rate” (the interest rate minus inflation) to rise from -3.5% to 0%.
- From 2011–2015, gold fell from a high of $1900/ounce to a little over $1,000/ounce. Meanwhile, the gold-value of the U.S. national debt rose from 300 kilotonnes to 500 kilotonnes.
- In 2016, the price of oil rose from $30/barrel to over $50/barrel. Inflation increased from 0% to 2.2%, and the interest-rate increased by only 0.5% This pushed the “real interest rate” into negative territory again at -1.5%.
- From late 2015 to the end of 2016, gold rose from $1070/ounce to a little under $1200/ounce. Over the course of 2016, this was an increase of 8%.
There is no question that gold has increased substantially over the past 15 years. Even after its recent pullback, it is still four times the value that it was in 2001. But does this mean that gold is still overbought and likely to fall some more?
Is The Gold Bull-market Over?
This set of historical facts implies that gold has room to grow. The Federal Funds Rate is only 0.5%. It’s not the 10% or more that we would expect if the bull-market were over. The gold-value of the U.S. national debt is 500 kilotonnes. It’s not the 50 kilotonnes we would expect at the end of a debt liquidation. Inflation is only 2%. It’s not the 10% or more we would expect at the end of a gold-buying mania.
Most of the historical indicators don’t imply that gold will stop rising.
In the past few years, the falling price of oil has definitely hurt gold. So has the falling rate of inflation. But those times appear to be over. Inflation has been rising again, and the Fed is now in a catch-22 situation. It must either raise interest rates and risk a recession or else allow inflation to rage. Either circumstance is bullish for gold.
Since its rapid price rise over the last 17 years, many investors have become interested in gold. But has gold moved too far too fast? Probably not. Gold is useful as part of a diversified portfolio. It will most likely help investors to achieve greater returns in the future.
Why Silver May Outperform Gold
With all the money-printing going on, it’s no surprise that the financial media pays a lot of attention to the price of gold. But silver is often overlooked. And this is a shame…because there are good reasons to believe that silver will be a better investment than gold in the future.
So what’s the point of owning silver? And how can you invest to take advantage of a possible silver mania in the future?
Silver: A Little History
While gold did “back” money in the recent past, the truth is that silver was the primary means of payment through most of human history.
Only very large purchases used gold. And even then, people traded gold for goods based on their silver value.
The reason why this changed is because of something that happened in the 16thcentury. During that time, the Royal Mint of England introduced a new ¼ oz. gold coin called the “Guinea”. This coin’s face value was equal to about 3.364 oz. of silver (20 shillings).
But outside of the country, a quarter ounce of gold was selling for less than this amount. As a result, merchants bought gold from abroad and had it minted into guineas. They then traded the guineas for silver coins and used the silver coins to buy more gold. In the long-run, this caused silver to flow out of the country and gold to flow in.
Isaac Newton tried to solve this problem as Master of The Mint by lowering the face value of the guinea. But he didn’t move fast enough to stop the flood of silver leaving the country. As a result, England eventually had to redefine the pound sterling as 7.3 grammes (about 0.2425 ounces) of gold.
Because England went on a gold-standard, every country in Europe had to also. Otherwise, they would end up with a bunch of extra silver from England.
From then on, people thought of gold as the primary “monetary metal” while silver had only a secondary role. But that may or may not be the way investors see the two metals in the future.
The Age Of Oil And The Decline Of Silver
For most of human history, gold and silver were both mined with human and animal labour. As a result, only the highest-grade ore could be mined efficiently. And because silver is only about 19 times more prevalent than gold in the earth’s crust, the market valued silver at no less than 1/15 to 1/20 the value of gold.
But all of this changed when petroleum-based mining processes were discovered. By replacing human beings with gasoline and diesel fuel, miners were able to extract lower-grade silver or gold ore that wouldn’t have been worth bothering with in the past.
Although this made both metals cheaper to mine, it had a disproportionate impact on silver.
As a result, the value of silver in terms of gold fell from about 1/15 oz. gold per ounce of silver in the 1800’s to 1/62 oz. gold per ounce of silver in the 1900’s.
Still, silver continued to be valuable because it took on a new role in the world.
Silver Today: An Industrial Metal
While silver is still not as valuable in gold terms as it once was, it has taken a new role in the world as an industrial metal. It is used in many products that we all often take for granted.
Here are some of the products that require silver.
- Electronics. Silver is used in circuit board switches, TV screens, telephones, microwave ovens, mobile phones, computers, and many other electronics devices. Overall, about 250 million ounces of silver are used each year in these applications…or about 24% of annual mining and scrap supply.
- Brazing Alloys and Solders. Silver is mixed with other metals and used to hold together such products as shower and sink faucets, refrigerators and air conditioners. About 61 million ounces of silver are used for this purpose each year…or about 5.9% of mining and scrap supply.
- Photography. Film cameras use tiny silver crystals to produce negatives, which are then used to produce images. About 47 million ounces each year are used for this purpose…or about 4.5% of supply.
- Solar Panels. This is a growth industry that is using more of the global silver supply each year. Solar panels require silver because they have to be coated with a silver “paste” in order to collect energy. About 78 million ounces of silver are used for this each year or 7.5% of supply.
- As a Chemical Catalyst. Silver is used as a catalyst to produce ethylene oxide and formaldehyde. These two chemicals are needed to produce plastic. About 10 million ounces of silver are used for this each year or 1% of mining and scrap supply.
Because of this high demand for silver as an industrial metal, it tends to outperform gold during inflation…just like aluminium, cobalt, copper and other industrial metals do.
Silver Today: A Luxury Good And An Investment
Despite this high demand for silver as an industrial commodity, it is still also a luxury good enjoyed by wealthy people throughout the world.
Silver dinnerware is as popular as it ever was. And 60 million ounces of silver are used each year for this purpose. In addition, about 220 million ounces are annually made into jewellery.
This gives silver a ‘safe haven’ appeal that allows it to perform better during recessions as compared to traditional industrial metals.
Silver has also been rapidly gaining interest as an investment over the past 10 years or so.
Here’s the total demand for silver as coins or bars from 2006–2015. This includes retail coins and bars, ETFs, and institutional investment.
- 2006: -46.8 (-7.5% of mining output)
- 2007: -13.1 (-2% of mining output)
- 2008: 15.8 (2.4% of mining output)
- 2009: 144 (20.6% of mining output)
- 2010: 177.3 (22.1% of mining output)
- 2011: 131.9 (18.6% of mining output)
- 2012: 162.5 (21.9% of mining output)
- 2013: 93.2 (11.8% of mining output)
- 2014: 157.5 (17.8% of mining output)
- 2015: 162.4 (18.2% of mining output)
As gold gets more expensive, small investors who want to hold a physical precious metal find it difficult to find gold bars or coins in small enough denominations to suit their purposes. As a result, they turn to silver.
Now that you know some background information about silver, here’s why it’s poised to outperform gold.
Why Silver Will Beat Gold
Reason #1: Silver beats gold during precious metals bull-markets. And we’re probably in one now.
Silver is much more volatile than gold because of the small volume of trades conducted in it each day. As a result, it tends to underperform gold during bear markets and over-perform it during bull markets. For example, take a look at these two charts from the period 1972-present.
The top chart is the silver-gold ratio. It’s how many ounces of gold can be bought with one ounce of silver. When this ratio goes up, it means silver is outperforming gold. When it goes down, it means silver is underperforming gold.
The bottom, larger chart contains two lines. The reddish-black line is the price of silver in U.S. dollars. The black line is the price of gold in U.S. dollars.
The following events can be seen on the chart:
- During the last few years of the 1970’s bull market, silver outperformed gold tremendously. This is shown on the top chart as a huge spike in the silver-gold ratio.
- Then the long bear market in precious metals began in 1980. From 1980 to the late 1990’s, both gold and silver fell. But silver fell much more than gold.
- In the early 2000’s, both gold and silver gained in their dollar values. But silver gained more.
- After the 2008 financial crash, both gold and silver fell. But silver fell much more than gold.
- With the introduction of quantitative easing in 2009, both gold and silver went into a rally. But silver went up faster than gold.
- After the end of QE and the beginning of the shale-oil revolution in 2013, gold and silver fell because the cost of mining was declining. But silver fell faster than gold.
In each of these cases, silver outperformed gold during bull markets and under-performed it during bear markets.
Since oil prices are once again going up, we appear to be going back into a bull-market for precious metals. If this is the case, we can expect silver to outperform gold once again.
Reason #2: The silver-gold ratio is at low levels.
The average value of the silver-gold ratio over the course of the 20th and 21stcenturies has been around 0.016 oz. gold per 1 oz. silver.
Today, the ratio is 0.015 gold per 1 oz. silver. This is just below the average level. It appears that the silver-gold ratio has fallen into undervaluation during the shale-oil bear market. So we can expect it to go up again as precious metals rally.
Reason #3: Investment demand is increasing.
As stated earlier, there is a growing desire on the part of investors to hold silver in monetary form. Right now, only about 20% of silver output goes to this use. But if the price of gold continues to climb, this will only entice investors into holding more of their savings in the form of silver.
Of course, there is only so much silver to go around. And industrial firms will not want to give up a desperately needed metal to investors who are hoarding it to protect their wealth. But that just means these firms will have to pay higher prices. So now is the time to accumulate silver…before the bidding war begins.
Silver will do especially well if investment demand for gold reaches 100% of mining output. At that point, new gold jewellery will have to be produced entirely from scrap gold. But investors will want that scrap gold for themselves since all of the mining output will have been spoken for. Meanwhile, there will be plenty of investment-grade silver available as long as investors are willing to bid it away from industrial manufacturers. So silver will look like a great opportunity.
How To Invest In Silver
Suppose that you are convinced by these arguments that silver will outperform gold in the future. How can you go about preparing for that outcome?
The easiest way to get exposure to silver is to buy shares of an ETF backed by physical silver, such as the iShares Silver Trust (SLV). SLV moves in tandem with the price of silver. So if you own SLV, your returns should be similar to what they would be if you bought actual silver coins.
If you want to take on a little more risk for the possibility of greater returns, you can buy an ETF that invests in a basket of silver-mining companies.
Here are a few examples:
- Global X Silver Miners ETF (SIL)
- iShares MSCI Global Silver Miners Fund (SLVP)
- FactorShares PureFunds ISE Junior Silver ETF (SILJ)
Silver is poised to break out to new highs. So these are ways to take advantage now, before the price gets too high.
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How To Invest In Industrial And Precious Metals
In the early 2000’s, both industrial and precious metals prices boomed. As a result, the stocks of mining companies did very well. But the long bear market from 2013–2015 scared away many investors. Then, 2016 saw a resurgence of metals prices and a return to profitability among miners. As a result, many investors are wondering if this new rally in industrial and precious metals is going to continue. But how to invest industrial and precious metals? Here are some things to keep in mind.
The Prices Of Metals: Factors To Consider
The earnings of mining companies’ are heavily dependent on the price of the metals they produce. So before we even begin to consider whether to buy a stock in this sector? We first need to determine whether the prices of metals are likely to rise in the future.
So how can you know how the prices of metals will evolve? Here are a few factors that influence it.
When the economy is firing on all cylinders, demand for manufactured products heats up. People need new cars, appliances, new homes, etc. All these things consist partially of metals. So when growth is high, the prices of industrial metals usually increase. Precious metals are often used to make jewellery. Thus, they can also increase during times of growth. But because much of their demand comes from investors, this is less of a factor for them than it is for industrial metals.
- Negative real interest rates
Like all storable commodities, metal prices increase during times when the interest rate is lower than inflation. This is because producers tend to hoard underground metal reserves when holding cash is not profitable. And when purchasing power is declining faster than interest? Consumers go into debt to buy products instead of saving. Most consumer products are made from industrial metals. So, this action by consumers increases their demand and drives up their price. Because investors view precious metals as an alternative form of money, they have an advantage when real interest rates are negative.
You can’t mine metal efficiently without burning diesel fuel. Recycling also expends a lot of energy in the process of removing impurities. So rising oil prices tend to restrict the supply of metals and drive up their prices. Falling oil prices have the opposite effect.
So if you think the price of oil is going up, growth is going to increase and interest rates are going to rise slower than inflation? Now might be a good time to invest in the industrial and precious metals sectors.
How To Invest In Industrial And Precious Metals
If you’re interested in investing in these sectors? The easiest way to do so is to buy shares of an ETF that contains a basket of mining stocks. This limits your risk. Because it guarantees that your portfolio is diversified across these sectors.
Here are a few funds that can help you gain exposure to mining companies.
- SPDR S&P Metals & Mining ETF (XME)
Invests in companies that mine steel, gold, aluminium, and others. Also provides exposure to some energy companies, such as coal miners.
- iShares MSCI Global Metals & Mining Producers ETF (PICK)
Invests in steel, aluminium, platinum and palladium producers, but excludes gold and silver miners.
- Van Eck Vectors Gold Miners ETF (GDX)
Invests only in gold mining companies.
- iShares MSCI Global Silver Miners ETF (SLV)
Invests only in silver mining companies.
Buying one or more of these index funds can allow you to allocate some of your portfolio to miners. But without the risk of holding stocks from only one or two individual companies. It can also save you a lot of time. Time that you would otherwise spend researching companies to build your own portfolio.
If you’re willing to spend a little more time doing research? You can also build your own portfolio out of individual stocks.
Here are a few key terms and metrics to look at when evaluating a mining stock.
Resources and Reserves
All mining companies have a certain amount of metal underneath the ground that they have a legal claim to. Owning this reserve is part of the value of owning a mining company’s shares. You can find out how many reserves the company owns by visiting the ‘investor relations’ section of the company’s website.
All mining companies have some cash on hand that increases the value of their shares. If you want to know the cost of owning the company’s reserves? You need to subtract this value from the market price of the shares. Mining companies also have cash that is owed to them and debt they owe to others. So you also have to take this into account.The price of the company apart from its cash is called its ‘enterprise value’.
To calculate it, follow these directions:
1. Look up the cash on hand, cash receivables, and cash liabilities on the company’s balance sheet.
2. Look up the market cap for the company.
3. Add the cash and receivables together.
4. Subtract step 3’s total from the market cap.
5. Add the cash liabilities to the number you got from step 4. This is the enterprise value of the company.
Divide the enterprise value by the company’s resources and reserves to find how much you pay to own each metric tonne of the company’s underground metal. If this company costs less per tonne than its competitors, this is an indication that it might be a good buy.
Every mining company has a certain average rate at which it has produced metal in the past. You can determine this rate by browsing through the company’s quarterly and annual reports.
If you are extremely bullish about the long-term price of the particular metal the company produces? Its production rate might not matter to you. You may even hope that it produces slowly so as to maximise your profit per tonne. But if the metal price has been going up and is approaching a plateau? You’re going to want them to get it out of the ground as quickly as possible.
The higher this rate is when compared to its peers? The more quickly you can convert the company’s metal into cash earnings.
Enterprise value/production rate
Divide the enterprise value by the production rate to find out how much the company’s shares are costing you per metric tonne of metal produced each year. If this number is lower than its peers, it may be undervalued.
Net present value
Net present value is a quick way to understand how much the company’s stock is worth compared to what it’s trading at. To calculate it, follow these steps.
1. Decide on the minimum rate of return you are willing to accept to take the risk of investing in a mining company. Is it 10%, 5%, 20%? This is your “discount rate”.
2. Multiply the production rate by the average price of the metal over the last few years.
3. Multiply the total from step 2 by the discount rate from step 1. This is the earnings of the company over and above the minimum you require.
4. Divide the total resources and reserves by the production rate. This is how many years it will take before the company runs out of reserves.
5. Multiply the total from step 3 by the total from step 4. Assuming it never finds any new reserves, this is how much earnings the company will make over and above what you require over the company’s lifespan.
6. Compare the enterprise value of the company to its net present value. Is it higher or lower? If it’s higher, then the company is trading at a premium to its NPV. In this case, it’s overpriced relative to your expectations. If the enterprise value is lower than the NPV, then it’s trading at a discount. In that case, it’s underpriced relative to your expectations. The greater the gap between EV and NPV, the more overpriced or underpriced it is.
7. Compare this company’s premium or discount to other mining companies. If it has a higher discount or less of a premium than its peers, its stock may outperform the sector in the future.
If you’re interested in building your own portfolio of mining stocks? Keep these terms and metrics in mind. It should make it easier.
One other option for investing in industrial or precious metals is to buy the metals themselves. This is especially useful if the cost of producing them is rising faster than their prices. As this causes the metals to outperform the shares of their producers.
You can do this by purchasing shares of an ETF that tracks the prices of industrial or precious metals. Here are some of the broader ones that track a basket of metals.
- Power Shares DB Base Metal Fund (DBB)
Invests in zinc, copper and aluminium futures.
- The Dow Jones-AIG Industrial Metals Total Return ETN (JJM)
Invests in aluminium, nickel, copper and zinc futures.
- E-TRACS UBS Bloomberg CMCI Industrial Metals ETN (UBS)
Invests in copper, aluminium, nickel, zinc, and lead futures.
- ETFS Physical Precious Metals Basket Shares ETF (GLTR)
Invests in physical gold, silver, platinum and palladium bullion.
Types Of Industrial And Precious Metals
There many different types of metals and mining companies you can invest in. Here is a list of the most popular.
These metals are primarily used in consumer products. They are rarely hoarded by investors. They are also much less expensive per tonne than precious metals and are usually not used in jewellery.
Aluminium is used in construction, packaging, and transportation. The iPath Dow-Jones Aluminum ETN (JJA) tracks its price.
Some miners that produce aluminium:
Nickel is mixed with iron and chromium to make stainless steel, which has a wide variety of uses in electronics, pulp & paper manufacturing, medical applications, and many others.
The iPath Dow Jones-UBS Nickel ETN (JJN) tracks its price.
Some miners known for producing nickel:
Copper wiring and plumbing is used in HVAC systems, home appliances, and telecommunications equipment.
The iPath Bloomberg Copper SubTR ETN (JJC) tracks its price.
Some ETFs that invest in copper miners:
- Global X Copper Miners ETF (COPX)
- First Trust ISE Global Copper ETF (CU)
Some individual copper companies:
- Jiangxi Copper Company Ltd. (JIXAY)
- Freeport-McMoRan Inc. (FCX)
- Lundin Mining Corp. (LUN.TO)
Zinc is used in a process called ‘Zinc Galvanizing’ that prevents iron or steel from rusting. It is also mixed with copper to make brass. Which is used for piping and other kinds of plumbing applications. As well as many other products used in everyday life.
The ETF Securities Zinc Fund (ZINC) tracks its price.
Zinc is often found with other metals. So there are no mining companies specifically for zinc.
Cobalt is mixed with other industrial metals to create alloys used in jet engines, turbine blades, high-speed drill bits, and many other products.
There is no ETF that tracks its price.
Some companies that mine cobalt:
- eCobalt Solutions Inc. (ECO.F)
- Global Cobalt Corp. (GLBCF)
Lead is used in batteries, rolled extrusions, wire, pipe, pigments, and ammunition.
The iPath Dow Jones-UBS Lead ETN (LD) tracks its price.
You can often find lead along with nickel, copper, and other base metals. There are no particular companies that mine lead exclusively. But investors can gain exposure to the lead price through buying general base-metal mining companies.
Steel is produced from iron ore. The companies that produce it should properly be called ‘iron miners’ or ‘steel manufacturers’ instead of ‘steel miners’. It is used mainly in construction. But it also has value to the transportation, energy, packaging, and appliance sectors.
There is no ETF that tracks the price of steel.
But there’s an ETFs that invests in a basket of steel companies:
Market Vectors Steel ETF (SLX)
Some companies that produce steel:
- Rio Tinto Plc. (RIO)
- Vale S.A. (VALE5.SA)
- Tenaris S.A. (TS)
- Reliance Steel & Aluminium Company (RS)
These metals are:
- Very expensive on a per tonne basis
- Often hoarded by investors in physical form as an alternative form of money
- Widely used in jewellery
- Sometimes used in industrial products
But a small part of mining output goes to this use when compared to industrial metals.
People used gold as money in large transactions for thousands of years. It’s primary use today is as an investment.
Over half of all gold mining output each year is made into bullion and hoarded by coin and bar collectors, central banks, and exchange-traded funds. Most of the other half is made into 22k jewellery and sold in emerging markets. Where it is often used as collateral for loans and other kinds of financial transactions.
Industrial uses make up a small part of gold mining output each year when compared to other precious metals. Because of this, gold is less sensitive to inflationary booms than they are. As a result, it tends to underperform them as an investment during inflation. But, it usually outperforms them during economic slowdowns. This “safe haven” appeal to gold is one of it’s most popular attributes as an investment.
These ETFs invest in physical gold bullion directly:
- SPDR Gold Shares (GLD)
- Sprott Physical Gold Trust ETF (PHYS)
Some ETFs that invest in a basket of gold mining companies:
- Van Eck Vectors Gold Miners ETF (GDX)
- iShares MSCI Global Gold Miners ETF (RING)
Some individual gold mining companies:
- Barrick Gold Corp. (ABX)
- Newmont Mining Corp. (NEM)
- GoldCorp (GG)
- Franco-Nevada Corp. (FNV)
- Randgold Resources Lmtd. (GOLD)
People used silver as money in small transactions for thousands of years. But today, about half of silver mining output goes into industrial uses such as cell phones, solar panels, and batteries. The other half into jewellery or it’s turned into bullion and hoarded by ETFs and private collectors.
Some ETFs that invest in silver bullion:
- Silver Trust (SLV)
- Physical Silver Shares (SIVR)
Some ETFs that invest in a basket of silver mining companies:
- Global X Silver Miners ETF (SIL)
- iShares MSCI Global Silver Miners ETF (SLVP)
Some individual silver mining companies:
- Silver Wheaton Corp. (SLW)
- Fresnillo PLC (FRES)
- First Majestic Silver Corp. (AG)
Platinum is the rarest of the precious metals. Because of its rarity, nobody used it as money. About 2/3 of platinum output today goes into catalytic converters for automobiles. Most of the other third is turns into jewellery. Because of its heaviness, people often consider jewellery made from platinum to be more ‘masculine’. Therefore you can find it often in men’s jewellery pieces.
ETFs that invest in platinum bullion:
- ETFS Platinum Trust (PPLT)
Since platinum miners usually also mine for palladium, we will list them in the section below.
Like platinum, palladium’s rarity has prevented people from using it as money. About half of palladium output goes into catalytic converters for cars. Most of the other half is mixed with gold to produce ‘white gold’, a popular alloy in jewellery.
ETFs that invest in physical palladium bullion:
- ETFS Physical Palladium (PALL)
Companies that mine for platinum and palladium:
- Atlatsa Resources (ATL)
- Eastern Platinum Limited (ELR)
- Impala Platinum Holdings Lmtd. (IMPUY)
- Ivanhoe Mines (IVN)
- Platinum Group Metals (PLG)
- Polymet Mining Corp. (PLM)
- Stillwater Mining Company (SWC)
The Long-term Outlook For Industrial And Precious Metals
Both industrial and precious metals went through a long-term bull market from 2001–2008. After the financial crash, however, industrial metals plunged while precious metals stayed flat.
With the start of quantitative easing in 2009, industrial and precious metals once again rallied. But after QE began to slow down in 2011, metals went into a protracted decline. The falling oil price due to the shale oil revolution didn’t help either.
In 2016, industrial metals had their best year since 2011 as the SPDR S&P Metals and Mining ETF (XME) appreciated by a whopping 106%. Gold miners also did well, with the Van Eck Market Vectors Gold Miners ETF (GDX) posting a 68% gain.
Is this the start of a new bull market or just a fake-out?
The answer is that the future performance of industrial metals probably depends upon how much inflation continues to pick up.
And that, in turn, depends upon the actions of central banks all over the world. If central banks raise interest rates quickly to stop inflation, the industrial metals sector faces a severe beating. But gold may benefit from such a scenario. But other precious metals may suffer as they have some industrial uses as well. So the overall result will be negative for metals in general.
Yet, it may be that central banks raise interest rates more slowly and that they are ‘behind the curve’ as inflation picks up faster than they realise. If this happens, we can expect the industrial and precious metals sectors to do very well in the future.
So, while there are high risks to investing in this sector, there are also extreme rewards. Allocating a small amount of your portfolio to industrial and precious metals can give your portfolio an added boost it wouldn’t otherwise attain. But if you are especially risk-averse? You probably don’t want to have a significant allocation to this sector.
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Fundamentals of Investing in Oil And Gas Markets
The oil and gas market has gone through a terrible beating over the past six years. So, is this a buying opportunity? Or is there more pain to come in the oil & gas industry? And how can you know which oil and gas companies are the best to invest in? By understanding the fundamentals of investing in oil and gas you can improve your portfolio.
The success or failure of oil and gas companies
If you’ve learned how to evaluate companies in other areas? You’ve probably looked at things like P/E Ratios, Free Cash Flow, or Dividend Yields. These things can sometimes matter for oil companies. But they are usually less important than they are for companies in other sectors.
But don’t worry. No one can know exactly what the price of oil is going to be five or ten years from now. But there are some factors that you can use to make reasonable guesses on what direction it is heading.
Factors that influence oil & gas prices
The most important factor influencing the prices of energy products is probably economic growth. As technological advancements make workers more productive, the economy grows. This leads to higher incomes.
These incomes get spent on products that need energy to be produced. Some of these incomes also get spent on gasoline. As workers take vacations, go on joy rides, or consume more energy. As a result, demand for oil and gas rises.
At the same time, producers aren’t necessarily able to find new oil fields right away. The price can rise for many years before companies are able to produce enough to meet new demand.
This is why we often see rising oil prices during times of high GDP growth.
So, if you think the economy is about to start doing better than it has recently? This might be a good time to invest in the oil and natural gas sectors.
Low (or negative) real interest rates
Another factor that often leads to rising oil prices is low or negative real interest rates. Sometimes, this factor can even supersede the effect of low growth and a weak economy.
After the financial crash of 2008, oil fell from $140/bbl (barrel) to $40/bbl in just a few months. Governments all over the world started cutting short-term interest rates and doing quantitative easing. As a result, oil rallied from $40/bbl back up to $120/bbl over the course of the next two years. Despite the fact that the economy was extremely weak during this time.
When interest rates are low, consumers do not want to save as much. So, they drive more and buy more products that are produced using energy. At the same time, oil companies do not want to produce a lot if interest rates are low. This is because cash in hand depreciates while oil in the ground does not. So, low or negative real interest rates increase demand and restrict supply. And as a result, they drive up the price.
If you think that real interest rates are about to go down, then you might want to invest in oil and gas companies.
Another factor affecting the price of oil? Technology that lowers the cost of production. Example: some minor upstart oil company finds a cheaper way to extract oil out of the ground. It will have an incentive to dig more oil and as a result, the supply of oil will increase.
This will lower the price. But now the company is taking more market share from the bigger oil companies. It will still turn a greater profit all the while that the oil price is falling.
Yet, the industry as a whole, will decline as the price of oil falls.
What does that mean in the long-run? The fall in oil prices caused by the new technology will lead to greater incomes elsewhere. And the cycle will begin again. But this can take years.
If you think recent technological advances in energy production have run their course? It might be a good time to invest in oil and gas companies.
3 Ways To Invest In Oil And Gas
1. Commodity-backed ETFs
Are you interested in investing in the oil and gas sectors? Then you don’t have to invest in oil & gas companies. You can also invest in oil and gas directly, through oil and natural-gas backed ETFs.
The most popular oil and natural-gas backed ETFs are:
- United States Oil Fund (USO)
- United States Natural Gas Fund (UNG)
These ETFs attempt to track the price of oil or natural gas. To do this, they buy the nearest-dated futures contracts in the commodity that they want to track. And when the contracts are two weeks from expiring? They sell them and use the cash to buy the next to nearest contract.
But the number of contracts they buy depends on:
- Their share price
- How it relates to the nearest-dated contract.
If the share price rises faster than the futures contract? They issue new shares and use the cash to buy more futures contracts. If the share price rises slower than the contract? They sell some of their contracts and buy back their shares. In this way, these ETFs are usually able to track the price of oil or natural gas.
This can be useful. Because sometimes the price of producing oil rises faster than oil itself. For example, this happened from 2002–2003. When this happens, investing in oil will outperform investing in oil companies. In other times, the price of oil rises at about the same rate as the cost of production. In these cases, it’s better to invest in oil companies that pay dividends. Because they perform better than investing in oil itself.
There are also cases where the price of oil is falling, but the cost of production is falling faster. In such cases, holding oil stocks instead of oil will mitigate your losses.
The bottom line is that it’s a good idea to have some investments in each. That way, you can watch market developments to make portfolio adjustments when necessary.
2. Oil and gas company index funds
The easiest way to invest in oil and gas companies is to buy an index-fund that tracks the entire sector. The most popular of these is the Energy Select Sector SPDR ETF (XLE). It contains a basket of the biggest oil companies around. Such as Exxon Mobil (XOM), Chevron (CVX), Schlumberger Ltd. (SLB), and ConocoPhillips (COP.)
But there are other oil and gas company ETFs as well, and some of them have outperformed XLE at different times.
Here are just a few of them:
- Vanguard Energy ETF (VDE)
- iShares S&P Global Energy ETF (IXC)
- JPMorgan Alerian MLP ETN (AMJ)
- ALPS Alerian MLP ETF (AMLP)
- First Trust ISE-Revere Natural Gas ETF (FCG)
Oil and gas sector index funds provide a simple way to get exposure to energy stocks. But without spending a lot of time doing research. For many investors, this is the best way to invest in oil and gas stocks.
3. Picking individual stocks
Do you have more time to spare? Then you could build a portfolio by selecting individual stocks. If you’re highly skilled at doing this? You can get greater returns than you would from just investing in an index fund. It can also be more satisfying to know that your portfolio returns are coming from stocks you picked.
But this method is also riskier. So, it’s up to you to decide which way you want to go.
If you decide that you want to build a portfolio out of individual stocks, here are a few things to keep in mind.
Unlike the products of most businesses, oil is a limited resource. Oil companies only have a certain amount of oil in the ground. When that oil gets close to running out? The company will have to wind down and sell off its assets unless it can find more reserves. So, the first thing you want to find out when looking at an oil company is the amount of reserves it owns.
These come in three categories:
There’s a 90% chance for the company to dig out oil in usable form.
There’s a greater than 50% but less than 90% chance to get the oil.
There’s a greater than 10% but less than 50% chance to get the oil.
Possible reserves are unlikely to be obtainable. So, it’s usually best to focus only on the proven and probable reserves.
You can often find this information on the company’s website in the ‘10K’ annual report. There are also a lot of financial websites that keep copies of 10K reports.
Other Factors To Look Out For
Barrels of oil equivalent
It can be confusing to see the various types of oil and gas products the company produces. So, companies also state their reserves in the form of ‘barrels of oil equivalent’.
This is based on a calculation of the amount of energy each product produces. You can even simplify your analysis. By treating the company as if it has nothing but crude oil in the ground equal to the barrels of oil equivalent.
But keep in mind that sometimes certain oil or gas products have higher prices than crude oil. Even though their energy equivalent may be the same. So, this simplified method isn’t foolproof.
The enterprise value of a company is the cost of buying the entire company. Plus any debts it owes and minus any cash it has on hand or is owed to it. This is the cost of buying all the company’s physical assets. Including the oil reserves it has under the ground.
To find the enterprise value of a company, first look up the company’s market cap. Second, subtract the company’s cash on hand and any money owed to it from this number. Third, add the debts of the company. You can find this information on the company’s balance sheet.
Now you know the enterprise value of the company.
Once you know the enterprise value of the company and its reserve? You can determine how much you are paying for each barrel of oil the company owns underneath the ground:
- Add the provable and probable reserves together
- Divide them by the enterprise value
If the enterprise value/reserves are less than its peers? This is a sign that the company may be undervalued. As an investor, you may get greater returns by investing in this company.
But there may be some legitimate reason why other investors are not willing to pay a higher price for the stock. So, this doesn’t guarantee that the stock is undervalued. Yet, it’s a good place to start when evaluating it.
It’s all well and good if a company’s underground oil is cheap. But if interest rates are high or if you think the price of oil will go down sometime in the future? Then you need that company to get the oil out of the ground quickly. This where the production rate comes in. You can find this number in company reports. Usually, it’s listed as MBD or ‘million barrels per day’.
Enterprise value/production rate
If you divide the enterprise value by the production rate? You get an idea about how much you’re paying vs. the speed at which the company is producing oil. If this number is lower than its peers? It may mean that the stock is undervalued and stands to outperform its peers in the future.
You can find this in the company’s reports. It’s the total ‘net present value’ of the company’s proven reserve after discounting by 10%. This number is calculated using a forecast of future oil prices. The number is based on an average of its price over the past few years. It also factors in the production cost and a forecast of future production rate. This is based on the declining productivity of oil wells.
If an oil company’s market cap is equal to its PV10? It means that an investor can expect to make 10%/year from buying the company’s shares. This will only hold true if the oil price stays within the same range that it has been trading in over the past few years.
So, like other metrics, this one isn’t foolproof either.
Probably the best way to use this metric is to compare a company’s discount or premium over PV10 to its peers. Let’s say that an oil company’s PV10 is $80 billion and its enterprise value is $120 billion. It might be tempting to conclude that this company is overvalued because its EV is higher than its PV10. But maybe the oil price has been falling recently and is about to go back up.
Let’s say that a similar oil company has an enterprise value of $100 billion and a PV10 of $75 billion. This second company’s premium is only $25 billion whereas the first one’s is $40 billion. So this is a much stronger argument that the first company is overvalued.
If you’re the kind of investor who likes a more ‘hands on’ approach to building a portfolio? These metrics can help you to pick individual stocks that would suit you better than an index fund.
The Oil And Gas Sector: Past Moves And Future Outlook
The oil and gas sector has had its ups and downs over the years. From 2001–2008, the Energy Select Sector SPDR ETF (XLE) outperformed the S&P 500 as a whole. This was a period of high inflation and rising oil and gas prices.
Yet, when the financial crash happened, this sector took a huge hit. But this was to be expected, given what happened to the market as a whole.
The XLE recovered. But it did so more slowly than the market as a whole. In the beginning of this period, the cost of oil and gas was rising as interest rates were cut and QE was enacted. But production costs rose faster than the prices of oil and gas. This prevented the sector from capitalising on this event. And at the end of this period? Oil and gas prices were flat and producers were barely able to keep costs low enough to stay profitable.
Despite the struggles of the sector, the XLE did manage to carve out a new high in the beginning of 2014.
Mid-2014 to early-2016
The XLE fell as the falling oil price finally overcame the ability of producers to cut costs.
The price of oil and gas bottomed in early 2016. And since that time, the XLE has once again started to outperform the S&P 500.
So where is the sector going in the future?
If inflation continues to pick up over the short-run? We can expect that the oil and gas sector will continue to outperform other sectors of the economy.
But inflation often encourages central banks to raise interest rates. If interest rates are raised too high, it may cause another recession. And it may be difficult for the oil and gas sector to bounce back, compared to other sectors of the economy.
Still, a recession will likely lead to another round of QE and another rapid rise in oil and gas prices. So, investors should be able to reduce their losses. How? By allocating some of their portfolio to energy commodity-backed ETFs. Such as United States Oil Fund (USO) and United States Natural Gas (UNG).
Another strategy is to allocate some funds to energy companies. This should give greater returns if inflation rises faster than interest rates.
So, the outlook for oil and gas investments as a part of a diversified portfolio looks positive.
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How To Invest In Agriculture, Cattle And Meat
If you’re used to investing in traditional financial assets like stocks or bonds, putting your money into cattle, coffee, sugar, or other consumable commodities might seem strange.
But investing in these assets is not just for farmers. It can actually lead to very high profits for anyone during certain circumstances.
So here is a guide to investing in cattle, meat, and agriculture.
Why you should invest in non-energy, non-metal storable commodities.
There is essentially one very good reason to consider investing in agricultural or meat products nowadays: negative real interest rates.
From 1980 to 2001, a person who deposited cash into a savings account got paid by the bank for the use of his or her funds. And this payment was always higher than the rate of inflation.
But beginning in 2001, central banks all over the world started lowering their interest rates to less than the rate of inflation. This meant that there was no longer any reason to hold cash in a portfolio.
As a result, there has been a worldwide ‘flight to yield’ as investors try to pile into more risky assets like long-term bonds and stocks. These have still produced some income, however low.
But all this has done is lowered the yield of those assets, making them no longer serve the purpose investors wanted them to serve.
In response to this problem, more and more investors every day are putting their money into ‘real goods’ like gold, silver, oil, and industrial metals.
If you’ve read the other sections of this guide, you know all about that already.
However, with all of this money moving into metals and energy, other investors may have overlooked things like cattle and sugar. So taking some of your portfolio and putting it into these unorthodox assets may pay off.
Here is a list of some of these under-the-radar commodity investments.
No matter what happens to the economy, we all have to eat. And unless we’re vegetarians or vegans, a lot of the meals we eat include beef.
But in order for beef companies to deliver that food to us each and every day, somebody has to raise steers (castrated male cows) and heifers (female cows that have not given birth) from calfhood to adulthood.
When a farmer wants to hedge his cattle to lock in the sale price, he or she often goes to the futures market to sell a contract for ‘live cattle’. Basically, this means cattle that are a full-weight of 800–1200 pounds (363–544 kg) per head.
In the meantime, these animals have to be housed. And that requires land. But when interest rates are low, mortgages and rents are cheap.
As a result, farmers are perfectly willing to keep these animals locked up for years without sending them to the slaughterhouse.
Because of this, low or negative interest rates lead to a scarcity of beef and rising beef prices.
From 2009 to 2015, for example, live cattle prices increased from $100/lb. To $170/lb., a 70% return on investment. This is during the ‘QE’ era in which the Federal Reserve was printing an unprecedented amount of money.
By contrast, metals and oil actually fell during the later years of this time period as technological innovations made it easier to extract oil.
While ‘live cattle’ are the full-weight of 800–1200 pounds (363–544 kg), feeder cattle are smaller. Some buyers prefer to get feeder cattle and fatten them up rather than buying them at full-weight.
Regardless, feeder cattle go up in value over the long-run for the same reasons that live cattle do. From 2009–2015, the price of feeder cattle rose from $100/lb. to $240/lb.
While beef is a large part of the diet of people in the developed world, pork is also popular. And it is sometimes substituted by consumers when beef prices are high. So investing in some lean hogs can help to diversify a cattle and meat portfolio.
This is especially useful for the times when regulators discover disease has spread through beef markets. During these times, live cattle prices will fall in value but lean hogs will often rise simultaneously.
From 2009 to 2014, the price of lean hogs rose from $60/lb. To $130/lb.
Corn is another staple part of the diet of the developed world. In addition to being eaten as a side-dish in meals, corn is also used to make tortillas, cornflakes, popcorn, and many other dishes.
Like other commodities, corn increases in price when interest rates are low or negative. From 2009–2013, it climbed from $3.75 per bushel to a peak of $8.125 per bushel. This is a gain of more than 100%.
However, corn’s bull-market did not outlive precious and industrial metals the way that cattle and hogs did. It fell at the same time they did, as quantitative easing began to slow down in 2013.
Soybean oil is used to make margarine, along with many cooking oils. It’s also an essential ingredient in mayonnaise. In addition, soybeans are used for animal feed and biodiesel fuel
From 2009–2012, the price of soybeans rose from $8.75 per bushel to $17.50 per bushel, a gain of 100%.
Wheat is a fundamental part of the diet of people in developed countries. It is used in everything from bread, to cereal, to whisky and beer.
There are three different types of wheat contractstraded on two different exchanges. The first is ‘Chicago Wheat’ or ‘Soft Red Winter Wheat’. It is planted in the winter months and is traded on the Chicago Mercantile Exchange (CME).
The second one is called ‘Kansas Wheat’ or ‘Hard Red Winter Wheat’. It is also planted and grows in the winter months. And it’s also traded on the Chicago Mercantile Exchange (CME).
The third type of wheat contract is called ‘Minneapolis Wheat’ or ‘Hard Red Spring Wheat’. Unlike the other two, this particular kind of wheat is planted and grows in spring. It is traded on the Minneapolis Grain Exchange (MGEX).
In the QE era, the Chicago Wheat contract underperformed against its agricultural peers, rising only by 75%. But the Hard Red Spring Wheat contract increased 100% and the Kansas contract appreciated by 114.7%.
Thanks to the compounding effects of global economic growth over the past sixty years, the world is now consuming 450 million tons of rice each year. That’s 143 pounds (65 kg) of rice per person. 90% of this rice is consumed in Asia, where it is included in almost every meal.
Rice didn’t do as well as other agricultural commodities during the QE era. Its bull-market started late, in 2010. And it peaked a year or two earlier than most other commodities, in 2011. Overall, it only rose by around 33% over the period 2009–2014.
Still, it may be useful to put a small amount of a commodity portfolio into rice for diversification purposes. But not too much.
Cocoa beans come from a tree species called Theobroma Cacao. Their most obvious use is chocolate.
Like rice, cocoa bucked the trend of rising commodity prices during the QE era. It had extreme volatility and finished up only 41.6% by the end of 2015. At one point during this time period, it was even down 8.33%.
About 9,300 tonnes of coffee are consumed each year.
It is sold on the Intercontinental Exchange (ICE) using two different contracts. The first contract is for the ‘arabica’ beans that you find in Starbucks and other brands of gourmet coffee. It is called ‘Coffee C’ and is abbreviated ‘KC’.
The second is for the ‘robusta beans’ you find in traditional brands like Maxwell House or Folgers. It’s called simply ‘Robusta Coffee’ and is abbreviated ‘RC’.
During the QE era, the arabica contract rose from $1.20/lb. To $3.00/lb., a gain of 180%.
Like gold, silver, and many other commodities, coffee peaked in 2011 and began falling again as inflation started to get under control.
While the rest of the commodities on this list serve as food for the global population, this is one agricultural commodity that is worn instead of eaten. But it’s just as important for human well-being.
From 2009–2011, cotton rose from $0.60/lb. to $2.20/lb., a gain of 160%.
Human beings consume 173 million tonnes of sugar each year, or about 53 pounds (24 kg) per person.
Sugar is traded on the Intercontinental Exchange (ICE).
From 2009–2011, it rose from 12 cents per pound to 36 cents per pound, an increase of 200%.
The Outlook For Livestock, Meat And Agricultural Commodities Today
Since 2011, cattle, lean hogs and agricultural commodities have all declined substantially as inflation has subsided. Some of them have even gone back to the previous levels they were before the bull-market began.
So is this a buying opportunity or are further declines just around the corner?
The answer is that it depends on what happens to the global economy in the next few years. If central banks continue to raise interest rates while inflation stays under control, this will increase real interest rates and continue to drive down commodity prices.
However, we have seen in the past that the global economy seems to be unable to withstand positive real rates. The last time they were raised into positive territory was in 2008. And we all know what happened that year.
So if inflation continues to pick up, central banks will be under pressure to keep interest rates low and let inflation rage. This will lower real rates and push up commodity prices.
On the other hand, if central banks are brave enough to raise interest rates anyway, it will probably cause another recession. This will force them to reverse course and lower interest rates again. This will cause commodity prices to increase as well.
So either way, the outlook for commodities looks positive.
But of course, it’s possible that somehow the global economy could grow quickly enough to survive interest-rate increases. Maybe there will be some new technological innovation that will increase productivity and allow debtors to pay off their debts.
So investing in meat & agriculture commodities is not a ‘sure thing’. These assets don’t pay dividends or interest. So you can’t make money on them unless their prices go up. For that reason, they are risky.
But taking a small part of your portfolio and investing in these commodities with it can help protect your portfolio if inflation gets much higher or if governments restart QE.
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How To Invest In Agriculture, Livestock And Meat Commodities
So let’s say that you are convinced enough to put some of your money into these assets. How do you go about doing it?
Getting a futures account
The first and most obvious way to invest in these commodities is to get a futures account and start buying contracts directly. However, you can’t get an account with a futures broker unless you pass some pretty strict capital and income requirements.
In addition, futures accounts are just not made to work for long-term investors. They use leverage, which increases both returns and losses. If you’re a long-term investor, you probably want less volatility, not more. So using leverage to buy futures is probably a bad idea for you.
Luckily, there is another option.
Exchange-traded funds or notes
The second way to invest in agriculture and livestock commodities is to buy shares of ETFs or ETNs that track their prices. Here is a list of some of the most popular ones.
- iPath Bloomberg Livestock Subindex Total Return ETN (COW). Tracks a basket of 60% live cattle and 40% lean hogs.
- UBS ETRACKS CMCI Livestock Total Return ETN (UBC). Tracks 60% live cattle and 40% lean hogs.
- PowerShares/DB Agricultural ETF (DBA). Tracks a diversified basket of agricultural commodities.
- Barclays iPath Grains Total Return ETN (JJG). Tracks 39.16% soybeans, 39.14% corn and 21.7% wheat.
- Teucrium Corn ETP (CORN). Gives exposure to just the corn price.
- Barclays iPath Sugar ETN (SGG). Tracks the price of sugar.
- Barclays iPath Cotton ETN (BAL). Tracks the price of cotton.
- Barclays iPath Coffee ETN (JO). Gives exposure to the price of coffee.
- UBS Bloomberg Food ETN (FUD). Tracks a diversified basket of both meat and agriculture commodities. But does not include cotton.
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Meat and Agriculture Companies?
If you’ve read other parts of this guide, you’re used to the idea of investing in commodity-producing companies. This can often give an investor increased gains when compared to investing in the commodity itself. For example, investing in gold or silver mining companies can often give greater returns than investing in gold or silver itself.
With meat and agriculture, however, this is not possible. There are essentially no publicly-traded companies that produce beef, pork, coffee, sugar, etc. There are only companies that package products produced by independent farmers. But these companies are consumers of meat and agriculture commodities, not producers.
If you’re used to investing in stocks and bonds, putting money into things like cattle, hogs, sugar, and coffee might seem strange. But these assets have had phenomenal returns during times where inflation was high and interest rates were low.
Although they are risky, putting a small amount of your portfolio into this asset class can give your portfolio an added boost it otherwise wouldn’t have.
Investing in commodities and commodity-producing companies is not like investing in other sectors of the marketplace. Commodities themselves do not pay interest or dividends. And even commodity-producing companies can’t be judged very well based on the metrics used in other sectors.
PE ratios, dividend yields, free-cash flow, and many other models that try to explain the value of stocks simply don’t have meaning when applied to companies that produce limited natural resources.
But there are other ways of figuring out when it is best to invest in commodities and when it is better to walk away. You can get a pretty good idea when the price of commodities are going to go up by paying attention to interest rates, growth, and energy costs.
You can also understand commodity-producing stocks by paying attention to such things as reserves, production rates, enterprise value, and net present value.
So, follow the strategies outlined in this guide. And you’ll be well on your way to understanding how to invest in commodities successfully.