Investing In Stocks Tied To Commodities

There is a rising demand for commodities in the world today. You can profit from this by investing in stocks that produce and sell these commodities. Here is what the demand landscape looks today and why it will only get bigger as time passes.

The two biggest factors in the increase in demand for commodities are China and India. No, they are not new countries. In fact, they are two of the oldest civilizations in the world. The thing that is changing is that they are rising economies with a rising middle class. These are two countries that hold almost half the world’s population, and they are getting richer.

That means they will need raw materials like copper, silver, natural gas, building materials and food in increasing measure. That will be good for mining stocks, agricultural stocks and energy stocks in the US. These are things that we can still export to other countries on the most part. Even if we don’t export these commodities, we have US-based companies that are producing these things and selling them to China and India.

Basics About the Worlds Demand for Commodities

Commodities and basic materials are very much in demand all around the world. The rapid growth of the emerging markets has sparked this rise and it is not expected to ever go back to where it was. That is why you need to understand the stock market basics for this demand of commodities around the globe.

You will want to invest in stocks that are somehow connected to the commodities trade. The rise of emerging markets is the catalyst for this. These economies are creating a middle class that is increasingly consuming more and more goods.

The agricultural sector should boom in the next few years, mostly driven by demand from China. I would invest in stocks that produce and export food. Actually, a lot of investment banks are buying up agricultural properties right now. As always, they are positioning themselves to profit from this boom.

The world is also going to need things like copper, iron and aluminum. These are raw materials that will be needed to produce the consumer goods that will increasingly be in demand. Find a list of stocks here.

Commodity ETFs

Another great way to invest in commodities in the stock market is via ETFs, or exchange traded funds. These are tied directly to prices in commodities markets like oil, gold and silver. There are ETFs for virtually all of these hard assets, including currencies.

There are ones that go long, go short, or even double long and double short. There are options for everyone.

Why I Like Natural Gas ETFs

There are a couple of things that I like about natural gas ETFs in particlar. I know the industry isn’t making tons of money right now, but they will. It’s the fuel of the future. More and more companies are building gas power plants and less coal fired plants. That is because it is cleaner and easier to get government approval.

The thing is, we are running out of crude oil. That is a known fact. Prices will soar and supply will be limited. That means more and more things will start to be powered by other fuel sources. I think natural gas will be one of them.

The other factor is the world’s concern about climate change and global warming. One of the biggest contributors to this is coal fired power plants. China is said to be building one new one every six weeks. As the world moves toward cleaning our atmosphere, we will see the increased use of natural gas for producing electricity.

Agriculture ETF – What You Need To Know

Many investors are seeking the ability to add commodity exposure to their portfolios. This can be difficult for most home-based investors to achieve through traditional methods. Since the advent of exchange-traded funds, anyone with a brokerage account can now easily jump into the commodities market. When it comes to trading commodities, there isn’t an easier method than by utilizing commodity ETFs.

Wheat Field

Why Agriculture?

In the economically tough times we live in today, inflation is a serious cause for concern for any investor’s portfolio. Inflation can quickly gobble up any gains made from dividends or capital gains. Inflation is often tracked by the CPI, or the consumer price index, which measures changes in the price level of household goods and services. Investors are often on the lookout for investments that can protect against an upward spike in CPI. Common investments that do this are gold and oil, but many investors are now looking into agriculture as a way to hedge against future inflation risk.

There are a few indicators and drivers of agriculture prices. Let’s look at them below.

Global Demand

As the world population continues to increase, demand for consumer products will continue to rise. The prices won’t be affected as long as the supply can keep up, but that is where the problem exists. Land is a limited resource. This will eventually put a hard limit on the amount of agriculture related products that can be produced. This is when the prices will really take off. But even short term, oil prices affect the cost of transporting goods to consumers, and there is strong indication that oil prices will continue to be volatile and high.

Natural Anomalies

Weather conditions tend to have a large impact on agriculture related goods. Tornadoes, hurricanes, wild-fires, floods, and severe droughts can cause short term spikes in agriculture commodities prices. Insects or plant diseases can wipe out entire crops, limiting supply. The fact that production of certain agriculture goods is concentrated in certain regions (for example: oranges in Florida and California, wheat and corn in the Midwest, cattle in Texas and Oklahoma) can be especially disruptive to the supply of these products.

Advancement In Technology

As technology becomes more and more advanced, production of many agriculture goods becomes more efficient and less costly. New tractors, new insecticides, new fertilizers, and new methods for producing these goods are coming out with increased frequency. Advanced technology has enabled the agriculture sector to create more goods with less time, money, and man power. However, technology advancements have also had a negative impact on production. With the boom in ethanol demand, the price of corn spiked, bringing along with it other agriculture related commodities prices. This is an example where new technology is competing for a commodity with the traditional consumers.

If you are an investor that is worried about inflation risk, acquiring more agriculture exposure within your portfolio will help you to mitigate the risk that inflation will have on your assets.

How to Trade Agriculture Goods

Trading agriculture goods the traditional way meant gaining access to a pit trader, or physically buying the commodity in question. Mutual funds that have positions in agriculture related goods lack transparency and are riddled with fees. ETFs allow you the ability to bypass brokers and pit traders altogether, as well as increase the transparency in your investments.

It is important to note that most ETFs involving agriculture utilize a futures-based trade strategy to realize the fund’s objectives. This gets rid of the often expensive and prohibitive necessity to physically own the agriculture commodities in question. For futures trading, the agriculture ETF purchases the front month futures contract on the NYMEX, for example. When the front month is within 2 weeks of expiration, they will ‘roll’ the contract into the next month (or sell the position from the front month and buy positions in the next month).

ETFs in agriculture can track different aspects of this commodity, such as:

  • Agribusiness
  • Livestock and Grains
  • Broad Agriculture

Agribusiness ETFs allow you to indirectly add agriculture commodity exposure to your portfolio. This is because of the fact that there is generally a positive correlation between the profitability of agriculture related businesses and the market prices of agriculture goods and commodities. A more direct method is to invest in livestock and grains ETFs. This targeted investing strategy allows you to gain exposure in futures trading of specific grains (such as wheat, corn, and rice), specific livestock, or both. For a more diversified approach, broad agriculture ETFs allow you to spread your holdings out throughout the sector. A list of the best agriculture ETF options will be provided at the end of this article.

There are several different methods for trading agriculture ETFs. These methods are discussed below.

Index Funds

Index ETFs are funds that track a specific index. For example, as the Rogers International Commodity Index Agriculture Total Return Index goes up or down, so do specific ETFs that track this index.

Leveraged Funds

Leveraging is one of the great tools that often comes with ETF investing. There are many funds that attempt to double, triple, or quadruple your return. They achieve this through margin investing. For example, the PDB Agriculture Double Long ETN (DAG) tracks the Deutsche Bank Liquid Commodity index – Optimum Yield Agriculture, but is leveraged 2x in an attempt to double your return. It is not uncommon to find a 2x agriculture ETF or 3x agriculture ETF among the different leveraged agriculture ETF options on the market.

Inverse Funds

What if you want to bet against the price of agriculture commodities and make money on it? There are two ways to go about doing this. You can short a agriculture index ETF, which would mean that as the index price decreases, you can sell the stock short and make a profit. There are also inverse ETFs available. These funds are basically doing the short selling for you, as they track the inverse of the index fund. Leveraging can also be applied to this investing strategy (for example, you could buy a fund that tracks the inverse of the agriculture index, but triples the return of the short position).

Trading ETF Options

Buying or selling call or put options for an agriculture ETF is another method for trading these funds. This is a great way to hedge against a future spike or severe drop in agriculture commodities price, since you don’t actually have to allocate money until the strike price has been met.

Editor’s note – leveraged investing, margin investing, and options investing include substantially increased risk. Be sure you do your homework and understand exactly how your are allocating your money.

Agriculture ETF List Of Options

Market Vectors Agribusiness ETF (MOO)

MOO tracks the price and yield performance of the DAXglobal Agribusiness Index. The fund invests at least 80% of total assets in equity securities of U.S. and foreign companies primarily engaged in the business of agriculture, which derive at least 50% of their total revenues from agribusiness. Such companies may include small- and medium-capitalization companies. This is an example of an Agribusiness ETF, and it is non-diversified.

PowerShares Global Agriculture (PAGG)

Since 2008, PAGG tracks the NASDAQ OMX Global Agriculture index. The fund invests at least 90% of assets in the securities and ADRs and GDRs based on the securities that comprise the underlying index. PAGG invests at least 80% of total assets in securities of companies involved in the agriculture industry and farming related activities. The index is designed to measure the overall performance of globally traded securities of the largest and most liquid companies involved in the agriculture industry. PAGG is another example of an Agribusiness ETF, and the fund is non-diversified.

iPath Dow Jones UBS Livestock T (COW)

COW tracks the Dow Jones-UBS Livestock Total Return Sub-Index. The note is designed to reflect the performance of livestock. The index is composed of two futures contracts, lean hogs and live cattle.

E-TRACS UBS Bloomberg CMCI Livestock ETN (UBC)

Also founded in 2008, UBC  tracks the price and performance yield of the UBS Bloomberg CMCI Livestock Total Return index. The fund is designed to be representative of the entire liquid forward curve of each commodity. The index measures the collateralized returns from a basket of livestock future contracts. It is comprised of the two livestock futures contracts included in the CMCI two five different target maturities for each individual commodity. Both COW and UBC are examples of Livestock ETFs.

iPath Dow Jones UBS Grains Tota (JJG)

Founded in 2007, JJG tracks the Dow Jones-UBS Grains Total Return Sub-Index. The note is designed to reflect the performance of grains. The index is composed of three futures contracts, corn, soybeans and wheat.

ELEMENTS MLCX Grains Index ETN (GRU)

Founded in 2008, GRU tracks the MLCX Grains Total Return Index. The index is designed to reflect the performance of a fully collateralized investment in the four exchange-traded futures contracts on four physical commodities: corn, soybeans, soy meal and wheat. JJG and GRU are examples of Grain ETFs.

PowerShares DB Agriculture Fund (DBA)

DBA, founded in 2007, tracks the price and yield performance of the Deutsche Bank Liquid Commodity Index – Optimum Yield Agriculture Excess Return. The index is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities of€“ corn, wheat, soy beans and sugar. The index is intended to reflect the performance of the agricultural sector, and is a Broad Agriculture ETF.

iPath Dow Jones UBS Agriculture (JJA)

JJA tracks the Dow Jones-UBS Agriculture Total Return Sub-Index. The note is designed to reflect the performance of agricultural commodities. The index is composed of seven futures contracts: soybeans, corn, wheat, cotton, soybean oil, coffee and sugar. DBA and JJA are examples of Broad Agriculture ETFs.

DB Agriculture Short ETN DB Agr (AGA)

AGA tracks the price and yield performance of the Deutsche Bank Liquid Commodity index – Optimum Yield Agriculture. The fund is a senior unsecured obligation that allows investors to take a short or leveraged view on the performance of the agriculture sector. The index is composed of roughly equal percentages of corn, wheat, soybean, and sugar futures contracts. AGA is an example of an inverse broad agriculture ETF.

DB Agriculture Double Long ETN (DAG)

DAG tracks the price and yield performance of the Deutsche Bank Liquid Commodity index – Optimum Yield Agriculture. The fund is a senior unsecured obligation that allows investors to take a leveraged 2x view on the performance of the agriculture sector. The index is composed of roughly equal percentages of corn, wheat, soybean, and sugar futures contracts.

In Conclusion

Adding commodity exposure through ETF investing to your portfolio is a great way to add diversity, as well as inflation protection. With the many advantages of ETF trading (intraday investing, low cost, transparency of assets), you can increase your bottom line with respects to investment results. Agriculture ETFs are an attractive asset to include for these reasons. Hopefully, the list provided above will be a good starting point for you as you delve into agriculture funds investing. Good luck and happy investing!

Disclosure

I have no positions in any ETFs mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: Please remember to do your own research prior to making any investment decisions. This article is not a recommendation to buy or sell any securities or stocks, and is the opinion of the author.