Commodities trading could be a useful alternative to other asset classes, particularly in the current climate of rising inflation and global uncertainty.
Want to find out how to invest in commodities UK? Here’s what you need to know.
See also: Top Commodity Investment Platforms
5 easy steps to investing in commodities UK
- Choose a broker or platform that allows you to invest in commodities. You can find out more about the best investment apps right here.
- Open an account. Typically, this can be done online and will only take a few minutes to input your personal details.
- Deposit funds to your account. You’ll need to add money to your account to trade commodities. This can usually be done using a credit or debit card.
- Research your investments and decide how to buy. From direct investment to derivatives and call options, there are a few different ways to buy commodities. Find out more about these different options below.
- Start trading commodities. You’re ready to start buying and selling commodity investments!
Find out more details about how to trade commodities below.
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.
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.
Commodity trading can add some much-needed diversity to an investment portfolio, especially exchange-traded commodities which you do not typically have to manage yourself. EFTs tend to reflect the performance of the underlying commodity price rather than economic growth.
Commodities are considered to be an inflation hedge, meaning that they have the potential to grow in value at a faster rate than inflation. What this means is that your savings may not be eroded by the rising cost of living.
Of course, this will depend on the commodities market at the time and the specific commodity you choose to trade. You are never guaranteed returns from investing.
Investing in commodities can be complex. There are several different methods you could choose to use, but most of them will require professional financial advice to use efficiently to get the most out of your investments.
Commodities tend to be slightly more volatile than typical investments due to their involvement in the global economy, with some of the most commonly traded commodities frequently fluctuating in demand.
Investing in commodities FAQs
How much should you invest in commodities?
Just like any other investment, you should avoid putting all your eggs in one basket and limit the amount you are comfortable investing in the commodity market.
Commodity trading should only form part of your diversified portfolio, so make sure that you have an even spread across various methods and markets when investing. Private investors should seek independent advice before committing to commodity investing.
Are commodities a good investment?
Much like any investment, commodities should be traded at your own risk. Commodities may be worth adding to an already established portfolio for added diversification thanks to the fact that commodities tend to perform independently from stock markets.
However, it is probably worth avoiding putting all your eggs in one basket and investing solely in commodities.
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.