Although commodities are a more sophisticated asset class, understanding different raw materials and their use can be done and utilised in achieving yield. The importance of diversification has come to light on the back of the global pandemic and long-term investors need to consider a wide variety of asset inclusions. Although investing in commodities is not as simple as picking your favourite stock, there are methods of accessing this asset class through different types of investments.
What are commodities?
A commodity is a basic good used in commerce, that is interchangeable with other goods of the same type. Commodities are used as a key ingredient in the production of other goods and services. The quality of the commodity can differ slightly, however its essentially uniform across producers resulting in a standard value. When commodities are traded on a formal exchange, they must meet specified minimum standards known as a basis grade.
Commodities are broken down into two categories. Hard and soft. Hard commodities require drilling activities such as mining to find. These include gold, copper and platinum and oil to name a few. Soft commodities refer to raw materials that do not require drilling and are grown or farmed. Some examples are wheat, maize, and coffee beans.
What causes commodity price changes?
Supply and demand trends of the commodity causes prices to change. When there is an oversupply of a certain commodity prices will decrease. This was seen in the oil market as a result of the lockdown and a decrease in economic activity. There was an oversupply of crude oil resulting in the commodity decrease. On the other hand, a shortage of a commodity or high demand will push the price up. This can happen on account of a drought reducing the supply of soft commodities and buyers increasing demand on fears of losing production inputs. The basic concept when trying to understand commodity prices fundamentally is to evaluate global trends. What products are in high demand and what inputs are required to manufacture these products?
The simple commodity formula when evaluating trends: Supply>Demand=Price Decrease Demand>Supply=Price Increase
Mega trends in emerging markets
Understanding global trends is key when looking to invest in commodities. Megatrends are powerful, transformative forces that can change the trajectory of the global economy by shifting the priorities of societies, driving innovation and redefining business models. Identifying the potential for structural change and investing in expected transformations early can be a key driver of successful commodity investing, by positioning a portfolio for long term growth potential.
Megatrends are long-term structural forces which evolve over time. In 2016, the 'emerging global wealth' megatrend primarily focused on China's rise. But since then, it has broadened to incorporate the emerging middle class in India, southeast Asia, and other developing economies. 'Rapid urbanisation' has similarly incorporated the advent of smart cities and on-demand business models along with infrastructure needed to support emerging megacities.
looking at investment opportunities in the commodity market means fundamentally understanding the evolving mega trends within the global economy. Trends result in demand of raw product, as an investor, investing in that raw product before the demand is at an all-time high is the strategy needed to generate healthy returns.
Urbanisation mega trends and commodities
Cities have been hubs for talent and job opportunities. In the last decade there has been a huge increase in city developments in emerging economies requiring significant infrastructure. As cities develop, they require telecommunication networks. This requires twisted copper wire as copper is generally the most common transmission used today.
Emerging cities account for a significant percentage of a countries population as jobs and opportunities attract citizens. Transportation needs to evolve which means increased demand for cars, trains, and busses as well as fuel. Raw inputs into the production of cars include platinum, steel, rubber, and aluminium. Exposure to fuel means investing in oil commodities while electric powered vehicles means batteries which utilise lithium and cobalt in the production process.
When analysing megatrends, investors need to link the demand to raw products that are required the manufacturing process. If there is an increased demand in electric vehicles, this might mean a decrease in demand for oil and an increase in demand for cobalt and lithium. When investing in commodities one must always look for trends and try to analyse which raw materials will be in greatest demand. Understanding emerging market trends can help greatly in doing so.
Investing in commodities
There are three ways for long term investors to gain exposure to the commodity market:
