Blog | Commodities

Have You Considered Commodities?

Why investing in gold, silver, oil or gas may (or may not) be your best option

Summary

• Commodities offer an alternative way to invest

• When investing, remember to create a hedge to minimize loss

• Before investing in commodities, be sure to educate yourself

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As the 2024 Summer Olympics are fast approaching, it’s easy for investors to think of some popular commodities: gold and silver. These precious metals are just a few items in the commodities class, alongside other natural resources like oil, gas and agriculture.

Going for the gold

Fun fact: The Olympic gold medals aren't solid gold, though they used to be. The medals are made of 92.5% silver that are simply gold plated, containing only 6 grams of pure gold. Still, they have significant value, with each gold medal worth about $937 at today's gold/silver value.

That makes an Olympian like Michael Phelps worth hundreds of thousands of dollars from his medals alone!

Why you should invest in commodities

Paper money is unstable. Since President Nixon took the dollar off the gold standard, paper currency is backed by nothing but a promise. No wonder the crypto craze is more exciting than ever!

That's why investing in commodities, like gold and silver, is a solid financial strategy. Gold and silver are finite resources. The government can't create more whenever they want to.

They are also true money, meaning they have intrinsic value and can be used to purchase other items that have value.

Gold has been valuable throughout history. The value of currencies used to be determined based on the amount of gold the government had stocked away. It's familiar, safe, and it will always be valuable.

Currency, on the other hand, isn't always valuable. For example, pull a $20 bill or Euro note from your wallet. Do you think that piece of paper you are holding is really worth $20? No, the paper itself is probably worth about one cent. The only way a currency has value is because people have confidence in the government issuing the currency and a shared agreement that the currency is worth something. As confidence wanes, so does its value.

As a hedge against a weakened currency and inflation, gold can be a good investment.

In fact, investors believe that everyone should have a little gold in their investment portfolio, as a hedge against future financial turmoil.

What is hedging?

When it comes to a garden, you build a hedge by planting shrubs close to one another to form a fence or a boundary. When it comes to investing, a hedge is like insurance. It is used to offset possible losses. It's like a financial fence for your investments and it’s available in most of the five major asset classes you could invest in.

For example, with every rental property they own, Robert and Kim Kiyosaki create a reserve account. This account ensures against unforeseen repairs and drops in income. The money is set aside to cover emergency expenses or a loss of rental income in case the tenants move out; it is a hedge against those losses.

They have a large commercial property with one tenant. If this tenant moves out before their lease expires, they are left with a gaping hole in their income, which they use to pay their mortgage. They would then be at risk of losing the property. The reserve account on this property is a hedge, or insurance, that if that happened, they could still pay the mortgage.

Types of hedges

Silver and gold are two examples of a hedge. The Kiyosakis buy gold and silver not because they think the price will continue to rise, but instead mainly as a hedge against the dollar losing its value. Historically, when the dollar declines in value, people look to real money, such as gold and silver. Generally, when the dollar goes down in value, the price of gold and silver goes up. Thus gold and silver are a hedge against the devaluing dollar. They buy gold and silver to offset possible loss of purchasing power of the dollar.

Stock options are another hedge that investors use. A stock option is the right, but not the obligation, to buy a stock (a call) or to sell a stock (a put) at an agreed-upon price within a certain time period or on a specific day.

A stock option is a hedge because, if you buy a call option, you are betting that the price of that stock is going up. The price of the option is a small fraction of what the actual stock would cost you to buy. For instance, the stock may be selling at $30 per share, but the option might cost only $1. If the price of the stock goes down $10, then you forfeit the cost of the option at $1 per share instead of losing $10 per share. The option is a hedge against possible losses. Of course, if the stock does go up, then you can use, or exercise, your option and buy the stock at the lower agreed-upon price. Stock options are a science all to themselves.

The other commodities

Of course, there are many commodities that you can invest in. They include:

• Agriculture (such as soybeans, wheat, milk, and cotton)

• Livestock (such as cattle and hogs)

• Energy (such as oil, natural gas, and ethanol)

• Precious metals (such as gold, silver, platinum, and palladium)

• Industrial metals (such as copper, lead, zinc, and tin)

Commodities, along with the other asset classes, are a science unto themselves, and a whole book could be (and has been!) written on each of them.

So, let’s keep it simple and just focus on the few commodities many people are talking about today.

Silver isn’t settling

Silver is also a smart investment. There might be some athletes who are disappointed with their silver medal at this year's games, but they shouldn't be! As a consumable commodity, silver is just as valuable as gold. It is used in the manufacture of things such as computers, cell phones, televisions, light bulbs, cars, mirrors, medicine, and water purification.

There's actually more gold in the world than silver. With the growth of emerging countries, the demand for silver should increase, even as the supply is dwindling. It stands to reason that the price of silver should increase as the demand increases.

Oil and gas can pay off, too

The price of oil and gas is a popular subject. Oil and gas prices affect so many parts of our lives — plastics, food production, gasoline for our cars, airplane tickets, heating your home, and more.

As an investment, it’s very important to differentiate between the types of oil and gas properties you can invest in. The four main categories are:

• Producing: Drilling wells that are currently producing oil and gas. These provide the smallest return of the four types because there is little risk involved.

• Proven developed: Oil and gas reserves are proven and drilling wells exist, however, they are not currently operating and producing. The returns are typically higher in a proven developed because the oil and gas are there and the wells are drilled. It’s simply a matter of getting into production.

• Proven undeveloped: Oil and gas reserves are proven to exist, but there are no wells on the property. These will yield a stronger return on your investment because of the time and expense of getting the oil and gas out of the ground.

• Exploratory: An area is being drilled to find oil and gas that has not yet been determined to exist. These provide both the highest risk and the highest potential for return.

Pros of commodities investing

As the headline of this article hinted, investing in commodities may be a great option — but it’s not necessarily the right option for everyone. Here are some of the pros and cons:

• Easy entry: For example, buying gold and silver coins is very easy to do. If you can buy a loaf of bread, then you can buy gold and silver. Buying other commodities has the same level of ease as paper assets.

• Increase in demand for raw material as economies grow: For example, with the growth of China and India, there is a greater demand for oil, gas, food, copper, and aluminum.

• A hedge against inflation and a falling currency: When currencies fall in value, commodities usually rise. And when investors lose confidence in currencies, they may run to commodities, especially gold.

• Tax advantages: Different commodities have varying degrees of tax advantages. Almost all are taxed at a lower rate than ordinary earned income or income from salaries and wages.

• Home-based business: A child can easily buy a couple of silver coins and follow daily charts and graphs to check the current price. Involve your children as much as possible as you invest. What a great way for them to get started!

Cons of commodities investing

• No cash flow: Most, not all, commodities do not cash flow. They are a capital-gains investment.

• No leverage: The average investor cannot borrow money to invest in commodities.

• Dependent on the economy: As an economy slows, there is a decreased demand for raw materials.

• Volatile: Commodities can be volatile with extreme ups and downs.

If you’re interested in commodities, as with any asset class, you’ll need to educate yourself. Maybe you don't have an Olympic medal lying around at home, but there are ways you can begin your own portfolio of gold and silver. Buying gold bullion coins or bars is a great place to start. You can also start collecting silver coins, which is not only a great financial investment, but can also be a lot of fun!

Thankfully, you can start small and learn from both successes and mistakes. And there is a wealth of information out there to help you learn — maybe you’ll find a group of like-minded people through the power of networking. Rich Dad offers many free investing classes and personal finance coaching too.

And the best news? You can start today!