26th July 2015
Today is Sunday, and i am too weak to go to church. Thankfully, my daddy bought some drugs for me that worked. I actually bought some the previous Friday, but i was later told by a doctor that they were fake. Lord save us from these people that sell fake drugs oo. Later in the evening, I regained my strength, and then picked up my book to read this:

Commodities as an Asset Class

Before we go into commodities as an asset class, let’s first define what an asset class is. An asset class is a group of securities with similar financial characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations.

The three main asset classes are equities, fixed income and cash equivalents, but alternative investments, real estate and commodities can be considered an asset class. Commodities as an asset class would have a homogeneous risk – return profile, meaning that various commodities within the commodity market gravitate towards the same risk- return profile. That is if there are low returns and high risk for a particular commodity, there would also be low returns and high risk for other commodities as well. It should be noted that although commodities have a homogeneous risk – return profile towards themselves, they have a heterogeneous risk-return profile towards other asset classes because of the low correlation between commodities and other asset classes. Commodities are priced based on the intersection of supply and demand on specific markets and by considering inventories. This means that commodities are priced based on the price consumers are willing to pay for the particular commodity and also what the sellers are willing to accept to let go of it;then when they reach an equilibrium, commodities can be traded.

 

Methods of investing in the commodity market

1) Purchasing the physical commodity in the spot market: This implies buying the commodity either directly or through an intermediary, but with an expectation of actual delivery.

2) Purchasing commodity futures: Futures are contracts entered into for the delivery of assets at an agreed price, at a later date. In commodity markets, investors can enter into a contract for a commodity by taking a long position (buying the asset) or taking a short position (selling the asset).

3) Purchasing commodity options: A commodity option gives the buyer or investor the right but not the obligation to buy or sell a certain quantity of a commodity at a particular price after a particular period of time. Commodity options can be traded in the secondary market, this then avails the investor the opportunity of selling the option before its maturity. This is an active strategy as opposed to a buy and hold strategy.

4) Purchasing stocks of commodity- related companies. This Is an indirect method of investing in commodities. It is similar to investing in an Real estate investment trust fund for example where not one person owns all the real estate properties being invested in. instead it is a pool of funds from various investors to finance the investment in real estate properties. You as an individual investor gets just a piece or a stake in the company that deals in the commodities, but you do not primarily own any commodity yourself.

5) Investing in commodity future indexes and commodity related notes: Commodity index tracks a basket of commodities to measure their performance, investing in such is an easy and passive way of investing in the commodity market.

Also commodity related notes are linked to major commodity indexes such as DJ-AIG, BCOM and the GSCI. They are issued by the investment bank, financial institutions or individual commodity producers that raise capital and invest it in indexes.

 

Recommended Reading 

Andrea Roncoroni., Gianluca Fusai., Mark Kummins., Handbook of multi commodity markets and products