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Commodity Investing - Answers to your 5 Key Questions Question 1: Why Invest in Commodities? Answer: Portfolio Diversification Commodities are a great way to provide additional diversity to a portfolio as they have historically had a direct negative correlation to stocks. History has shown that any bull market in stocks is met with a bear market in commodities and vice versa. The 20th century's longest bull market in commodities for example began in 1933, the year of the great depression. The second longest bull market in commodities started in 1966 when the DOW closed at 995.15 and lasted until the early 80's when the DOW was around 800. Always remember though, past performance is not indicative of future results. A possible explanation for this negative correlation is that regardless of the state of the economy (bear market in stocks, rampant inflation or downturn in the overall economy), commodities maintain demand long after the demand for consumer items weakens. In addition, the high price of commodities reduces the margins of companies that utilize commodities. For example, car companies use various metals, food companies use food commodities to produce their final product, building companies use copper/lumber/steel. While it is true that part of the cost is passed onto the consumer, part of the higher cost is taken directly from the bottom line. (There are exceptions of course, companies, such as oil companies, whose entire business is the production of certain commodities, pass on the entire increased cost to the consumer.) Another explanation for this negative correlation is inflation related. Assets do not benefit from rising inflation, particularly unexpected inflation, but commodities usually do. As demand for goods and services increases, the price of goods and services usually rises as well, as does the price of the commodities used to produce those goods and services. Because commodities prices usually rise when inflation is accelerating, investing in commodities may provide portfolios with a hedge against inflation. Futures and options trading involve substantial risk. The valuation of the futures markets fluctuate, and as a result, if trading futures and or writing options, clients may lose more than their original investment. >> Supply and Demand and the Cyclical Nature of Commodities Although short-term price fluctuations are very difficult to predict, the long term movement of commodities is ultimately based on the fundamentals of supply and demand. When supplies and inventories are plentiful, prices will be low; but once supplies and inventories become depleted and demand increases, prices will rise. This fluctuation of supply and demand will continue inevitably just as it has in the past. To put this into words that will help investors, all high prices in some commodity will at some point come down, and some commodity that is at a historical low price will at some point increase. At no point in history has the previous statement been proven untrue. This situation alone provides some wonderful insights as to how one might begin approaching commodities. In our opinion, a prudent investor looks for situations where this supply/demand balance is out of whack and makes a play in that market, just as they probably have in real estate or the stock market. The share price of a stock may go to $0, the price of a commodity will not. We must state, however, that when futures are traded on margin, one must "time" the market to some degree. The more margin someone is trading with (or less capital relative to the value for the positions being held) necessitates higher accuracy in the timing of the market. Futures and options trading involve substantial risk. The valuation of the futures markets fluctuate, and as a result, if trading futures and or writing options, clients may lose more than their original investment. >> Diversification Within the Asset Class - Stocks vs. Commodities Commodities consist of many markets, from interest rates to corn, from the Euro to coffee. At any given time, 10 markets may be in a bull market and 10 markets may be in a bear market. There is never a situation where there isn’t a trend in some market. The stock market has historically been a fantastic place to invest. There have, however, been times when the market has gone through extended periods of stagnation. After the market crash of the late 1920's and early 1930's it took 25 years for the stock market to make a new high; it took 16 years after 1966 for the market to achieve a new high (1982). Because most people play the stock market through some index vehicle or through mutual funds that compete against the indices, these stock market investors are subject to the same lack of performance from the equity portion of their portfolio. We are by no means suggesting that we are heading into a similar period in equities. What we are suggesting, as the graph below illustrates, is that if one can return a similar percentage by placing money in commodities while providing a hedge against a possible downturn in other portions of their portfolio, it would be a wise move. Trading on margin is more risky than when trading an asset equal to or less then the value of ones account. Most people trade commodities using margin whereas most people who trade stocks do not. Futures and options trading involve substantial risk. The valuation of the futures markets fluctuate, and as a result, if trading futures and or writing options, clients may lose more than their original investment. Question 2: How does one invest in commodities? Answer: Trade Futures Trading futures is the purest way of taking positions in commodities. Commodity futures can be traded by opening a futures trading account at an Introducing Brokerage, FCM (Futures Commission Merchant), or global banks/asset management companies that offers futures services to their clients. You can find a list of Introducing Brokerages and FCM's on the exchange web sites such as the Chicago Board of Trade (CBOT) and Chicago Mercantile Exchange (CME) sites. An option is a contractual agreement that gives the holder the right to buy (call option) or sell (put option) a fixed quantity of a commodity futures contract, at a fixed price, within a specified period of time. The purchasing of options allows a trader to take a position in a market by risking the value of the option. However because the majority of futures options (that are held to expiration) expire worthless, we do not consider them commodity "investments" but rather in additional tool in which to trade commodities. We do employ option selling "writing" strategies but for these purposes will not address that strategy. Futures options can be traded at the same place mentioned above. The risk for buying options is limited to the price of the premium paid, while selling (writing) options carry unlimited risk. - > Natural Resource Stocks
There are a number of stocks that deal in commodities and many people look to these stocks as a way to invest in commodities. Such examples are oil companies such as Royal/Dutch Shell and Exxon Mobil; mining companies like Newmont Mining; food companies like Cargill and ConAgra. Such companies are subject to not only the price of the underlying commodities but also any of the various internal issues that effect companies, including management problems, accounting inconsistancies, and profitability questions. In fact a recent Yale university study (Gorton and Rouwenhorst, "Facts and Fantasies about Commodity Futures" p. 30) has found that "Over the 41 year period between 1962 and 2003 the cumulative performance of futures has been triple the cumulative performance of "matching" equities". It should be noted that Futures and options trading involve substantial risk. The valuation of the futures markets fluctuate, and as a result, if trading futures and or writing options, clients may lose more than their original investment. There are tradable commodity indices that can be traded as a futures contract which consist of different weightings of different commodities. One of the most commonly traded is the Goldman Sachs Commodity Index. There are also index funds in which investors can invest. Futures and options trading involve substantial risk. The valuation of the futures markets fluctuate, and as a result, if trading futures and or writing options, clients may lose more than their original investment. Question 3: What are the different types of futures accounts? Answer: Various - To meet your needs >> Self Directed Accounts The client makes their own trading decisions and places their own orders online or over the phone. Such clients receive low commission rates because of the lack of support they require. >> Broker Assisted Accounts The client and account executive discuss the best way to proceed, which market(s) to enter, appropriate risk, etc. No trades are placed without the full consent of the client. >> Managed Accounts The client gives legal discretion to the account executive to manage the account and trades are placed in whichever way he or she feels is best. >> CTA's (Commodity Trading Advisors) An individual or firm that advises others in the trading of futures and or futures options. CTA's often have a trading program or trading system that trades any number of strategies that the CTA has developed, which often have high minimum investment requirements. There are tradable commodity indices that can be traded as a futures contract which consist of different weightings of different commodities. One of the most commonly traded is the Goldman Sachs Commodity Index. There are also index funds in which investors can invest. Question 4: Why do people lose money in commodities? Answer: There are many reasons but "over leveraging" seems to be the most common. Commodity investors must be aware that commodity contracts can be bought and sold on very little margin. Say for example the current price of corn futures is $2.00 a bushel. A corn futures contract consists of 5,000 bushels and therefore the corn contract has a total current value of $2.00 X 5,000 or $10,000. If a trading account had a cash balance of $10,000 and went long (bought) a corn futures contract, there would be zero leverage. Because, theoretically, the price of a commodity cannot go to $0, the account could never lose its entire value. But, if an account had a value of $5,000 or 1/2 the value of the contract (50% margin) and took a position in corn (at $2.00 a bushel) the account would be wiped out if the price dropped to $1.00 a bushel (although the odds of that happening are unlikely as corn has never dropped to $1.00 a bushel). With $2,500, the price of corn would only have to drop 50 cents to $1.50/ bushel before the account would lose its value. The higher the leverage (or the less capital one is trading with relative to the value of the commodity being traded) the less a market has to move to greatly effect the value of an account. Aside from the potential of loss due to over leveraging, there are many other reasons why futures traders can lose money, including improper money management, lack of judgement, incorrect market analysis, etc. Please be advised that futures and options trading involve substantial risk. The valuation of the futures markets fluctuate, and as a result, if trading futures and or writing options, clients may lose more than their original investment. Question 5: What can we at Titan Commodities do for you? Answer: 1) Full Service Commodity Investment Accounts Titan Commodities will structure individualized portfolios of commodity futures based on the account size and the risk tolerance of a client. We select a basket of markets that fit your risk profile and then place you in the markets which we feel offer the best risk/reward. Clients are encouraged to be as involved as possible so they can gain a thorough understanding of the approach, however clients can take a hands- off approach and have their accounts traded for them. Our Minimum account size is $2,500 for such accounts although $5,000 to $10,000 is recommended. 2) Commodity Trading Advisors Investors can utilize their futures clearning accounts to access any number of managed futures managers, also known as commodity trading advisors (CTAs). Please inquire for more information on CTAs that we recommend. 3) Assisted Trading Accounts Have a trading professional monitor and assist you as you take positions in the markets. Not only are we willing to teach new traders/investors the ins and outs of the commodity markets, we will also provide advice on which markets to get into, where to get into them, when to take profits, how much to risk in each market, etc. 4) Self Directed Trading Accounts For those that want to cut out the middle man, we will set traders and investors up with either software- based or web-based trading platforms to place their orders online direct to the exchange floor. We challenge anybody to find an online commodity trading department that exceeds our combination of support, execution, and technology.Futures and options trading involve substantial risk. The valuation of the futures markets fluctuate, and as a result, if trading futures and or writing options, clients may lose more than their original investment.
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