How to Invest in Commodities UK

How do I invest in commodities UK?

Unlike shares and bonds, commodities weren’t necessarily designed with trading in mind. Commodities are physical objects with real uses in the economy, or could be consumer and agricultural goods, so it isn’t quite as simple as choosing one and purchasing shares from the stock market.

Commodities typically fall under one of five categories: industrial metals, precious metals, energy, grains, and livestock.

Below are three of the most common ways to get started when investing in commodities.

1. Direct investment

One way to invest in commodities is to purchase and store the physical asset itself. So, if you wanted to trade in gold, for example, you could purchase certain amounts of gold in the form of coins or, if in very large quantities, ingots.

However, physically purchasing commodities comes with the added issue of storage, since you will be responsible for your own investment. You must ensure that your commodity investment is stored safely and efficiently, which could be difficult depending on the asset class you choose to go for.

For example, unless you own a warehouse or storage facility, a large international transport vehicle, and a huge number of barrels, directly investing in crude oil could be a difficult endeavour.

Luckily, for most commodities, there are several firms that offer online dealing and safe storage, though be sure that any website you choose to use is legitimate before making any payments.

Additional costs

Another consideration when directly investing is additional buying and selling costs that may be at play, especially if you are using third-party sites. Since commodity trading firms typically buy from commodity companies on your behalf, there may be other costs involved with the process, which may reduce the value of any returns you make from the investment.

Plus, for UK investors, you may be required to pay VAT on commodities like silver and other precious metals. As such, many commodity investors use intermediaries in other countries to buy, hold, and sell certain assets on their behalf.

If you are thinking of using an intermediary, make sure you are certain that the intermediary you choose is not a scam. Since you will likely never see your investment if you choose this route, it could be risky.

2. Derivatives and call options

Before investing and trading as we know it today existed, commodities were used solely for manufacturing, merchandising, and consumption. Contracts would be drafted up between suppliers and buyers detailing how much of a commodity would be delivered and the price that would be paid on arrival.

When a buyer signed one of these contracts, they were essentially placing an order, which was called a forward contract. If the buyer wanted to cancel the order, they would need to sell the contract to another buyer.

If commodity prices had changed between the time of signing the contract and reselling it, the original buyer could find themselves with a profit or loss depending on the situation. As the financial world evolved, these practices found themselves a modern equivalent.

Forward contracts evolved into commodity futures, options, and swaps. Futures contracts like these do not work in quite the same way, but instead, take on the form of a “bet”.

In very simple terms, one party will predict the price of a commodity to rise, while another will predict the price to fall, with both agreeing to exchange money at a future date depending on who won the “bet”.

Alternatively, call options allow you to pay a fixed premium and take a position, predicting a “strike price” and expiry date. If the price of the commodity you selected is above the strike price on the expiry date, then you have won the “bet”, and will be paid the difference multiplied by the number of “options” bought.

Spread betting can also be used in a similar way to generate a profit when investing in commodities.

Due to the complex nature of the commodity market, always seek professional financial advice before deciding to invest in commodities through this method.

3. Indirect investment

Your last option when it comes to trading commodities is to invest indirectly, through exchange-traded funds (ETFs) or shares in commodity companies.

Commodity ETFs will use the funds it receives from investors to, in turn, invest in commodities. They usually come in two different types: physical and synthetic.

EFTs that invest in physical commodities like precious metals will likely buy and hold the commodity themselves, such as the SPDR Gold Shares ETF.

Synthetic ETFs will often elect to purchase derivatives and will not hold physical commodities.

Alternatively, you could invest in commodity production companies on the stock market. Commodity producers will perform well if commodity prices rise and perform poorly if commodity prices fall, meaning that buying shares in commodity companies can be similar to investing in the commodity itself.

Also consider: How to buy gold stocks and the best gold ETFs UK

What exactly are commodities?

Simply put, investing in commodities means that you are investing in physical assets rather than companies and shares. These physical assets are typically used either directly or indirectly to produce other products.

For example, you may choose to invest in precious metals, like gold and silver, or fuel sources, like crude oil and natural gas. Commodity investments tend to change in value depending on the specific supply, demand, and other industry conditions affecting related businesses.

Some commodities, like oil, are finite. This means they become more expensive to extract and buy as the supply depletes. But, this and the economic reliance on commodities also means that they tend to act independently from the fluctuations of the stock market, which could make commodities useful for diversifying your investment portfolio.

Commodity prices can fluctuate just like any other investment, so private investors should always seek financial advice and communicate with experienced traders before deciding to invest in physical commodities.

How have commodities performed historically?

Commodities are sometimes considered to be an inflation hedge, meaning that they can outperform the rising cost of living during periods of high inflation. However, as with any investment, positive returns are not guaranteed.

Because commodity prices tend to fluctuate independently from the stock market, commodity prices may not fall during a market downturn. However, this also means they may not rise during periods of strong economic growth either.

Unlike stocks and shares, commodities themselves do not really generate a profit unless someone else is willing to pay more for your commodity than what you paid for it originally. A gold coin could sit on your shelf for many years without any interest from other commodity investors.

As such, some commodity investments have provided positive returns during tough economic situations on the stock market, while others have been ineffective for years due to the holder never finding an appropriate buyer.

Pros and cons of trading commodities

As with all types of investing, commodity trading comes with its own set of potential benefits and drawbacks.

Investing in commodities FAQs

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.