In the past, we’ve explored the ins and outs of trading commodities, as well as trading the stocks of companies whose business centers around commodity trading. So the question becomes, which is the better investment opportunity? Should you be trading directly in commodities, or is it a better idea to trade the stocks of companies who deal with such activities? Let’s first set some context by defining a commodity-based industry.
What is a commodity-based industry?
Commodity-based industries are those where the products or services being offered are practically identical. Typically, incumbent companies will trade primarily based on price since products can easily be substituted between competitors. Essentially, commodity-based industries are defined by whether these businesses are able to differentiate its offering in some way. In this case, these companies are unable to since commodity by definition is a good that is the same no matter where you get it. After all, this is the very nature of a commodity-based industry.
Which is the better path – direct or indirect?
Now let’s get back to our main question – should you be trading directly in commodities or in the businesses that trade commodities? Here are three main things you should take into consideration when making your decision.
1) The nature in which commodities versus companies are traded.
First, you must consider the way in which each one is traded. Trading directly in commodities typically involves the use of derivatives. These investment vehicles require lots of speculation and can be tricky to maneuver for novice investors. On the other hand, investing in companies is slightly more straightforward since you can utilize simple buy and hold strategies. This approach tends to be the better place to start for novice investors.
2) Macroeconomic factors that affect the industry.
Generally, macroeconomic factors will affect the price of an entire commodity, regardless of who holds it. In the case of a commodity-based company, its stock price is also subject to individual business risks, as well as the macroeconomic factors previously mentioned. However, it should be noted that these individual business risks can be reduced through diversification. The solution is to trade ETFs that are based around a particular commodity. For instance, you can purchase a gold ETF which will be comprised of many gold-based businesses. Or, you may find an oil ETF which is comprised of companies dealing directly in oil-based transactions and activities.
3) The liquidity of the respective markets where each is traded.
Between the two investment paths, the liquidity of each isn’t a huge concern. Trading on popular markets for each investment vehicle will help to ensure a steady supply of buyers and sellers. For direct commodity trading you will want to stick with the major commodity markets. These are mentioned in our
article about the basics of trading commodities. The same goes for trading commodity-based businesses. As long as you stick with popular stock markets, then you shouldn’t have an issue when it comes to the liquidity of your investment.
Ultimately, it’s up to you as to whether you want to directly trade commodities, or leave the commodity trading up to the businesses. It all depends on your knowledge of the commodity markets, as well as your skill level and experience as an investor. Trading commodities is generally recommended for those who are more advanced when it comes to trading, but that doesn’t mean you should rule it out for you.
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