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Please provide any method for investing in commodities.

Please identify the advantages/disadvantages for each method.

Please identify if a particular investing method only applies to certain commodities (e.g. possessing physical gold and silver is practical but not as practical for other commodities like oil, corn, and wheat).

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Here's a start at a high level:

  • Actual ownership.
    • Pros: You actually take delivery and possess the item.
    • Cons: Transaction costs are higher, there may not be a liquid market, you need cash and you need to secure the stuff somewhere.
  • Ownership through a trust, Mutual Fund or ETF. (Example: GLD, CEF)
    • Pros: You don't need to take delivery, transaction costs are lower, you can buy on margin.
    • Cons: It is a "paper" product, many of these funds are ETNs, which carry credit risks, and you are subject to risk of the brokerage or trust/ETF operator failing or otherwise not meeting obligations.
  • Indirect exposure via equities. (ie. Buy an oil/gold company)
    • Pros: You get exposure to equity price changes without owning the commodity. You yield a premium from well-managed companies, and often get dividends.
    • Cons: Conversely, you can lose money due to a companies management being poor, irrespective of commodity prices. (ie. BP) You can offset that risk with ETFs or mutual funds (ie. VMW)
  • Futures and options.
    • Pros: You can make alot of money and use leverage to maximize your investment.
    • Cons: You are forced to look at the commodity's price over relatively short periods of time. You can easily lose everything and more. These markets are volatile.

I have a few friends who have made a killing on GLD, and write options to make money off of the investment without incurring the capital gains penalties for selling. That's a little out of my comfort zone though.

  • Also remember that you don't need a stamped official-looking bullion bar to invest in copper. Just collect pre-1982 pennies and any nickels. – mbhunter Feb 27 '11 at 17:50
  • That's the list I was thinking of also. I thought someone may know of some other exotic instrument. Also, it seems the ETFs do such a lackluster job tracking the underlying commodity. I know this has been discussed elsewhere. I'm wondering if you should list that as a "Con" under the ETF section. – Muro Feb 28 '11 at 3:36
  • Note the difference between funds which invest in the physical commodities (mostly for gold, silver, platinum and palladium) and funds which invest in commodities futures and options contracts. The former do a better job of tracking the commodity's price in all markets, but only work if it's easy to store the commodities. – user296 Feb 28 '11 at 15:43
  • Note also that investing in futures leaves you vulnerable to contango in certain rising markets. I'm assuming you can't take the delivery of a few thousand barrels of West Texas crude. That means that if the price of a futures contract on oil that's expiring now is less than the price of a futures contract for 12 months out, you can't just store the oil for 12 months to capture that gain. – user296 Feb 28 '11 at 15:46
  • @fennec - can you give examples of funds that invest in physical commodities versus the ones that invest in futures and options? Thanks. – Muro Mar 1 '11 at 4:30

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