How to Invest in Commodities in Canada
Did you know that it is possible to make money trading commodities like cocoa, pork bellies, sugar and gold?
Not only that, but it’s a type of investment that goes back millennia. The ancient Sumerians recorded future commodities trades on clay tablets more than 6,000 years ago. Commodity trading is still well and alive in the 21st century.
This article explores how commodities trading works, which commodities to invest in and how to get started. And don’t worry, it’s easy to get involved in commodities investment without a warehouse to stock a pile of lumber or barrels of crude oil.
What are commodities?
A commodity is simply a good, usually a raw material or primary agricultural product. It is fungible, which means that it is partially or fully replaceable. Essentially one ton of coal is equivalent to any other ton of coal.
Commodities are easily traded thanks to their intrinsic value as raw ingredients. Regardless of other economic factors, people will always need gasoline for their vehicles, corn to feed their livestock and copper for their electrical wiring.
Any investor can take advantage of this market, even those uninterested in purchasing commodities for their own use. The easiest way to get started is through an online brokerage that offers commodity ETFs or commodity futures and options.
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What is commodities trading?
Commodities can be directly traded in two ways. A buyer may turn to the spot market for immediate purchase and physical delivery. Investors are, on the other hand, much more likely to be involved in commodity futures. These are contracts that give the holder the right and the obligation to purchase a specified quantity of a commodity on a specific date.
For example, you might purchase and hold a futures contract for 100 barrels of oil at $60 per barrel for the third Friday of September of this year. You, or more likely, whomever, you sell the contract to, will ultimately have to purchase the 100 barrels of oil at that price regardless of how the market price evolves. You can make money on the price difference between the futures price and the real market price when you sell the contract.
How to invest in commodities in Canada?
Most investors trading commodities in Canada do so through futures contracts, ETFs and options. While you could theoretically claim the good, this is not usually the focus for investors. The idea behind commodity trading is that you buy a contract for a commodity today and sell that contract tomorrow to turn a profit. A possible exception is investors who wish to take physical possession of precious metals like gold.
Today the commodities trading market is largely online and open to all types of investors. Online brokerages allow you to buy lumber from someone in New Zealand or sell gold to someone in Japan. You can buy and sell the commodities without ever physically touching them. Essentially investors buy the rights to a resource.
In order to directly invest in commodities in Canada, you will need to open an account on a brokerage platform.
Alternatively, you could invest indirectly through commodity ETFs or even through stocks of companies closely tied to the price of commodities, like a mining company. ETFs and stocks represent a more typical way for individual investors to start trading commodities.
What are commodity stocks?
Commodity stocks refer to shares in a company whose share price correlates with commodity prices.
An example of commodity stocks is the shares of companies like Canada Natural Resources, which is traded on the Toronto Stock Exchange (TSX). As an oil and gas producer, you could buy their stock if you’re particularly bullish on these traditional fossil fuels. Should oil and gas prices rise, the company stock is very likely to rise along with them.
Alternatively, if you think that fossil fuels will drop in price long-term you may prefer to invest in lithium stocks instead. Lithium is crucial for manufacturing lithium-ion batteries that power electric cars and consumer electronics. At the time of publication, the two most valuable commodities stocks for lithium traded on Canada’s TSX are Orocobre and Lithium Americas.
What are the most traded commodities?
The most commonly traded commodities in Canada, mirror those in the rest of the world.
The most commonly traded commodities include:
|Commodity||Why it is popular|
|Brent Crude Oil||A critical energy resource. Petroleum is used to create gasoline, diesel, plastics and much more.|
|WTI Crude Oil||A critical energy resource. Petroleum is used to create gasoline, diesel, plastics and much more.|
|Natural Gas||A critical energy resource. Important heating source.|
|Gold||Hedge against the market, political and social uncertainty. Holds value.|
|Silver||Many industrial uses|
|Platinum||The automotive industry is dependent on platinum, notable for catalytic converter|
|Copper||Widely used in electrical equipment, construction and industry|
|Coffee||One of the most widely consumed beverages in the world|
|Corn||Staple food, feed for much livestock and biofuel|
|Soybeans||Staple food, feed for much livestock and biofuel|
What are the advantages and disadvantages of investing in commodities?
Commodity trading is not for everyone. How and if you should invest in commodities depends on your risk appetite, knowledge and investment strategy.
Consider the benefits and drawbacks of trading commodities below:
Pros of Commodity Trading
- A hedge against inflation
- A way to diversify an investment portfolio
- Commodities are a very liquid asset
- A variety of ways to invest: futures contracts, options, ETFs and stocks
Cons of Commodity Trading
- Some commodities are extremely volatile
- It can be a confusing market
- Exposure to economic and political fluctuations
What types of commodities exist?
Commodities can be broadly split into two types: hard and soft. Hard commodities are mined, drilled or otherwise extracted and include commodities like metals, coal and oil. Soft commodities are agricultural products like corn, live cattle and coffee.
Here are some commodities examples divided into hard (metal and energy) and soft (agriculture and livestock and meat):
|Commodity types||Commodity examples|
|Livestock and meat|
What are commodity futures?
In the commodity trading market, futures refer to commodity futures contracts.
These are agreements to buy or sell a specific amount of a commodity at a specific price on a chosen date.
Commodity futures are traded on numerous exchanges throughout the world. Perhaps the most famous in North America is the CME Group exchanges, which include the Chicago Mercantile Exchange, and the New York Mercantile Exchange. There are, however, many exchanges worldwide like Canada’s own Winnipeg Commodity Exchange.
For most investors in Canada, the best way to trade commodities futures is through an online brokerage. Platforms like Qtrade, Wealthsimple and Questrade allow individual investors to trade CFDs, ETFs, stocks and options.
How to trade commodity options?
Options give the right, but not the obligation, to buy a futures contract. Since they cost less than buying the futures contract, they pose less of financial risk. If the prices don’t move in the anticipated direction, you have less exposure.
Options are available through many online brokerages.
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What is a commodity ETF?
ETF stands for exchange-traded fund. They are collections of securities that are traded as if they were stocks. A commodity ETF is simply an ETF that focuses on one commodity. This could mean that the commodity is held as futures contracts or that it is physically held.
The chief advantage of commodity ETFs over commodity stocks and futures contracts is that commodity ETFs are diversified among different companies and contracts. ETFs usually have lower price fluctuation shares in an individual company.
What is the best commodity ETF in Canada?
The best commodity ETF for you will depend on your investment strategy and risk tolerance. Some popular ETFs include the following:
|ETF Name||Sector & Exposure|
|The iShares S&P/TSX Capped Energy Index ETF (XEG)||Oil and gas producers|
|Horizons Crude Oil ETF (HUC)||Brent Crude oil direct price|
|iShares S&P/TSX Global Gold Index ETF (XGD)||Gold miners|
|iShares Gold Bullion ETF (CGL, or CGL.C)||Direct gold bullion price|
|Global X Silver Miners ETF (ARCA:SIL)||Silver Miners, sellers and seekers|
|Sprott Physical Silver Trust ETF (PSLV)||Direct silver price|
|iShares Global Agriculture Index ETF (COW)||US Agricultural industry as a whole|
|Aberdeen Standard Physical Precious Metal Basket ETF (GLTR)||Direct precious metals prices|
Why do the prices of commodities fluctuate?
Commodities’ prices move as supply and demand shift. When supply increases and demand remains the same, the price will decrease because too much of a commodity is available. This means suppliers will have to compete on price in order to sell.
On the other hand, when demand increases and supply remains the same, prices will increase. Increased demand for that commodity means more scarcity, forcing buyers to compete with one another by paying more.
Commodity prices in Canada track worldwide prices. Poor wheat harvests in Europe and India are likely to drive world demand for North American wheat. In turn, this affects the commodities market, increasing the price of flour for a baker and the price of a consumer’s loaf of bread in Vancouver.
Investors can bet on price changes by investing in company shares, options, futures and commodity ETFs in Canada.
Is cryptocurrency a commodity?
Yes! The Canada Revenue Agency treats cryptocurrencies as if they were commodities. At least for tax purposes, cryptocurrency should be considered a commodity in Canada.
Outside of tax purposes, the answer is less clear-cut. Cryptocurrency is not a tangible asset, so it does not fit the traditional definitions of a commodity. Still, cryptocurrency can be a part of a diversified portfolio.
If you are interested in exploring cryptocurrencies as part of your investing strategy, you can begin by comparing the top crypto exchanges in Canada.
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