How to Invest in Commodities

February 27, 2013 at 16:25 PM EST

How to Invest in Commodities By Tony Daltorio, Contributing Writer, Money Morning One of things all investors should know for 2013 is how to invest in commodities, as the prices of many of these products head for huge gains. One of the reasons they will soar is because institutional investors have quickly abandoned them in the current risk on/risk off investment climate. There is right now roughly $424 billion invested in commodities, but that is a mere fraction of 1% of all global investment assets. When all that money comes pouring back in, those commodity-related investments will skyrocket. The few institutions that jumped into the market were disappointed because the commodities "super-cycle" did not generate spectacular gains for them in a year or two. Also, with inflation appearing to be nonexistent in the government-reported numbers, institutions are bailing on commodities. For example, the giant California state pension fund Calpers last month slashed its meager 1.5% allocation to commodities to a miniscule 0.6%. It moved the money into the already bloated U.S. bond market, adding to its overweight position. Just because institutions are short-sighted doesn't mean you should be. Keeping a percentage of your portfolio invested in commodities should help smooth out the effects of volatility. With more and more central banks pursuing easy-money policies, currencies will fall and commodities will be more valuable to investors. Also, keep in mind that emerging markets have not fallen off the Earth. They are still growing rapidly, and have a hunger for all sorts of commodities. How to Invest in Commodities wistiaEmbed = Wistia.embed("2cctej3y8g", { version: "v1", videoWidth: 590, videoHeight: 332, volumeControl: true, fullscreenButton: false, autoPlay: false, plugin: { "socialbar-v1": { buttons: "embed-email-googlePlus-facebook", tweetText: "" } } }); function gaFunc() { _gaq.push(['_trackEvent', 'Video','Play', 'SEO Video - how to invest in commodities - Excerpt']); wistiaEmbed.unbind("play", gaFunc); } wistiaEmbed.bind("play", gaFunc); wistiaEmbed.bind("end", function () { _gaq.push(['_trackEvent', 'Video','Complete', 'SEO Video - how to invest in commodities - Excerpt']); }); There are two broad categories of commodities: hard and soft. Hard commodities cover everything in the metals and energy areas including oil, natural gas, copper, nickel, gold and silver. Soft commodities include all the commodities that are edible including all of the grains, cattle, pork bellies, sugar, coffee, cocoa and orange juice. Cotton too is thought of as a soft commodity. There are three ways investors can gain exposure: To continue reading, please click here…

One of things all investors should know for 2013 is how to invest in commodities, as the prices of many of these products head for huge gains.

One of the reasons they will soar is because institutional investors have quickly abandoned them in the current risk on/risk off investment climate. There is right now roughly $424 billion invested in commodities, but that is a mere fraction of 1% of all global investment assets.

When all that money comes pouring back in, those commodity-related investments will skyrocket.

The few institutions that jumped into the market were disappointed because the commodities "super-cycle" did not generate spectacular gains for them in a year or two. Also, with inflation appearing to be nonexistent in the government-reported numbers, institutions are bailing on commodities.

For example, the giant California state pension fund Calpers last month slashed its meager 1.5% allocation to commodities to a miniscule 0.6%. It moved the money into the already bloated U.S. bond market, adding to its overweight position.

Just because institutions are short-sighted doesn't mean you should be. Keeping a percentage of your portfolio invested in commodities should help smooth out the effects of volatility.

With more and more central banks pursuing easy-money policies, currencies will fall and commodities will be more valuable to investors.

Also, keep in mind that emerging markets have not fallen off the Earth. They are still growing rapidly, and have a hunger for all sorts of commodities.

How to Invest in Commodities

There are two broad categories of commodities: hard and soft.

Hard commodities cover everything in the metals and energy areas including oil, natural gas, copper, nickel, gold and silver. Soft commodities include all the commodities that are edible including all of the grains, cattle, pork bellies, sugar, coffee, cocoa and orange juice. Cotton too is thought of as a soft commodity.

There are three ways investors can gain exposure:

buying the actual physical commodity (such a gold bar), purchasing futures contracts and investing in commodity stocks and exchange-traded funds (ETFs).

Futures contracts and options usually involve a high degree of risk because they are often short-term "bets" on price direction.

The safer play is to take a long-term approach through either individual commodity stocks or ETFs.

Investing in a commodity stock, such as the world's largest commodities company BHP Billiton (NYSE: BHP) involves the same process as buying any other stock. Macro-economic conditions, company management and balance sheet factors all come into play.

How to Invest in Commodity ETFs

The newest method of investing into commodities became part of the mainstream in recent years - exchange-traded funds.

Jim Rogers said that commodity ETFs offer individuals an easy-to-use method to profit from the combination of supply shortages in some commodities, rising demand in emerging markets, and easy monetary policies from the world's major central banks in the United States, Japan and Europe.

Some commodity ETFs allow investors to buy a basket of commodity-related stocks such as BHP.

An example of this type of ETF is the Market Vectors Hard Asset Producers ( NYSE: HAP). It is based on the index put together by Van Eck and Rogers and contains the largest mining and energy companies.

Others give investors exposure to an individual commodity or a basket of commodities through ownership of futures contracts. The PowerShares DB Agriculture Fund (NYSE: DBA), which invests in futures in all of the soft commodities from corn to cattle to coffee and cocoa, is an example of this type of ETF. The Teucrium Sugar Fund (NYSEArca: CANE) is an example of an ETF that owns futures on only one commodity - sugar, in this case.

Other ETFs actually own the physical commodity itself.

The biggest ETF of this kind is the SPDR Gold Shares (NYSE: GLD), which holds gold bullion in trust for shareholders. Another type of exchange traded vehicle is from the Sprott family and allows shareholders to actually take physical possession of precious metals. Sprott offers this for platinum and palladium, gold and silver - the Sprott Physical Silver Trust (NYSE: PSLV).

There are now a myriad of ways for the average investor to easily put some money into this third asset class. So now that you know how to invest in commodities, there is no excuse not to.

For more on how to invest in commodities, check out this latest report from Money Morning Global Resources Specialist Peter Krauth on one of his favorite picks for 2013.