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The argument for avoiding commodity investments continuously outweighs any argument which encourages investing in commodities. Commodities are raw materials such as crude oil, natural gas, precious metals, and other natural resources, which people invest in and trade through the stock market. Investing in commodities is dangerous for multiple reasons, and this raw material should be dealt with wisely. The commodities market is a hard one to understand, and some of the risks involved include high commodity prices, long term returns, and unpredictable supply and demand.
Long-term returns aren't guaranteed.
Unlike other stocks and bonds options, the long term return on commodity share prices is volatile. Unless you plan on investing and flipping these shares in a short term capacity, you may not profit much on commodities. Long-term, some commodities will skyrocket, which is great—but others will absolutely tank. Just look at crude oil prices to see how up and down the market can get.
No Interest or Dividends
Commodity futures don’t pay dividends or interest. It is important to understand the difference between capital gains and dividend income when investing in the market, and this is a huge benefit most stocks and bonds will pay out. This means that the only return you’ll see from your shares or futures contract will be the capital gains made from the investment. This can be seen as a downside to investing in commodities for many people because interest and dividends provide a lot of extra benefits for investors.
Hard to Understand
Investing in commodities can be dangerous because they are hard to understand. A great place to start is by looking at the commodity index; take oil and gas for example, and see 1) what price the exchange traded at, and, 2) what the investment return for specific oil companies was. This level of detail makes commodities so much more difficult to understand than other investments, and increases potential risk for your investment. You should never invest in something unless you know what you’re getting into.
Another risk that comes with investing in commodities is that the value of commodities can change in an instant based on what the population decides at any given moment. Some people call this the bandwagon effect. As a result, if the population decides that gold is no longer valuable, your investment is no longer valuable. People can leave a commodity behind and choose another material if they wish. It appears that society is trying to veer away from oil in order to find more sustainable resources for the future. Though this may take us a long time, it’s important to note this when choosing your investments, as oil and gas will be severely affected by this shift.
There is also a geopolitical risk of investing in commodities because when commodities are located all over the world, they are under the control of different governments and companies. We go to war over commodities for this reason. Whether it is access to oil or something else, you never know when your commodity may be taken from you because of an international dilemma or dispute.
Fraud is a risk of investing that can happen, whether it be commodities or something else. You may not always be sure that the people you are investing your money with are reputable. You have to be sure with commodities that whoever is managing your investment is trustworthy. Using a mutual fund for commodities, called commodity funds, may be a good option if you are still considering this venture.
Supply and Demand Risk
Investing in commodities can be dangerous because when dealing with raw materials, supply and demand is unpredictable. Though everyone knows the stock market is a risky game to play, with constant ebbs and flows, commodities can be an even bigger risk. You have to worry about things like social conflict, natural disasters, and epidemics affecting your investment. All sorts of things can affect the short term and long term supply of your commodity, so this investment may not be a good one to bet on.
Commodity share prices are high—this is a known fact. When the share prices are high and you aren’t seeing a good return on these shares, you’re wasting your money. Some people may have better buying and selling strategies in order to meet their financial goals off commodities. They must, or else these stocks would not continue to be around. However, unless you become very knowledgeable about the market, this is a trade you may want to shy away from.
Bad Hedge over Time
Hedging is a sort of safety net or insurance policy strategy that investors use to reduce risk in other investments. While many people used to use commodities they thought would be steady investments as hedging devices, it turns out that commodities provide bad hedge over time. Commodities are becoming risky, and you cannot depend on raw materials to provide a good return anymore. It’s better to diversify your portfolio with low risk investments for your money in order to ensure your investments are safer in the long run.
Lastly, commodities are a risky sale. Everyone has now caught on to the fact that commodity investing may not be the right way to go, so if you buy them now and decide to sell later, you may not be able to sell as easily as you think. You may end up having to settle for a price that is much lower than what you hoped for. In the end, you could walk away from the commodity game at a total loss.
Before deciding to invest in commodities, make sure you do your research. Understand the risks and every piece of the puzzle. Much like investing in a typical manner, don’t buy into commodities until you’re sure you've learned exactly how to invest in commodities and are confident about where you're putting your money. Investing in commodities is dangerous, but it is possible to do really well in this game if you go into it with the right mindset and the right strategies in place.