How to Invest in Commodities

[Editor's Note: As many of our readers are investors and professionals working in the commodity space, we are expanding the scope of our research beyond Asia. We've already featured some legendary commodity investors on the One Road Podcast such as Jim Rogers and presented at global mining conferences, but from today on you can expect more analysis of our favorite commodities.]

Commodities power and shape our world.

Raw materials such as oil, natural gas, aluminum, and gold make our economies tick.

Since the beginning of human history, gaining access to these has been the cause of conflict and cooperation among civilizations and peoples.

These days, commodity trades can take place in seconds without a barrel of oil or a bar of bullion in sight.

What investment theories must I, as an investor, know in order to fuel my journey on the road to prosperity?

I list four below. You may know the first three, but the fourth you'll likely have not heard of as it's a completely new theory we developed in-house.

1. Fundamental Analysis

Fundamental analysis relies on analyzing macro and regional news and trends in order to predict supply and demand.

Let’s say, for example, a trader purchases rice because the weather has been quite dry during the leading spring months, implying a smaller crop come harvest season and an impending constriction in supply.

Essentially, it’s about knowing the environment—and knowing it well.

2. Technical Analysis

Technical analysis is favored by traders who want to capture short-term movements in commodity prices.

It relies on the examination of the current price standing to predict future movements. This can consist of trading strategies such as range trading strategy and trading breakouts. Both strategies focus on the support and resistance zones, and ultimately identifying discrepancies against the commodity price—all using technical data.

But is this enough to inform low-risk investment decisions?

3. Self-fulfilling Prophecy

Think about clinical drug trials involving placebos—when people take a drug believing it will improve their health, they often feel better.

Or think of Shakespeare’s haunting message to Macbeth, to beware of his rival, the Thane of Fife. This prophecy leads to Macbeth acting against the Thane, and to Macbeth’s eventual death at the hands of his created enemy.

These are examples of self-fulfilling prophecies, predictions that directly or indirectly cause themselves to come true.

How does this relate to trading? Well, when it’s thought that a stock will deviate, investors act accordingly. They sell their positions or buy en masse, causing the stock to drop or rise significantly.

Now, what if you could marry the fundamental and technical theories, while not falling into the self-fulfilling prophecy trap?

4. Commodity Investment Cycle Theory

After spending 18 years discussing with the titans of the resource and commodity industry, I've developed my own in-house investment model, the Commodity Investment Cycle (CIC).

Its goal is to pinpoint where a given commodity is in the 'commodity cycle' in order to help investors make sound decisions.

And I call it a 'commodity cycle' because commodities follow what amounts to an economic 'business cycle'.

commodity-cycle 2.jpg

Remember, underlying principles of commodities trading are simple, in that the law of supply and demand drives all market prospects.

Here's the catch...

Supply is affected and manipulated by reserves and production potential, while demand is signaled by the price.

Further, raw material commodity production and extraction typically requires massive investments and infrastructure.

The Commodity Investment Cycle model attempts to incorporate these near-unique features of the commodity sector in a way that isn't being done by mainstream theories.

So how exactly do we predict commodity prices?

We analyze four core measurements:

a. Capital Expenditure (CAPEX) and long-term supply

b. Inventory break-down and short-term supply

c. Corporate decisions

d. Industry consensus

Interested in learning more? We publish our findings and conclusions in our model portfolio and research suite, The Commodity Cycle Portfolio.

The suite includes a monthly commodity that we're tracking and investing in, macro-level reports, and an interactive dashboard that can assist in your commodity investment endeavors.

Peter Pham