IF YOU choose to invest, you have numerous options of assets to invest in: stocks, corporate and government bonds and commodities.
Then you have a whole range of more exotic investment instruments, like options, futures, warrants, turbo’s, (synthetic) CDO’s or CMO’s, which I will not delve further in here.
Commodities can be distinguished in four categories: energy (oil, gas, electricity), metals (gold, copper, iron), livestock and meat (beef, pork bellies, live cattle) and agricultural products (rice, palm oil, corn, coffee, cocoa, cotton, sugar, orange juice).
It is believed that 6,000 years ago, traders in China already bought and sold rice futures, a contract to buy a predetermined quantity and quality of rice at a predetermined price somewhere in the future. These futures were used by farmers who want to hedge their risk.
Farmers want to ensure that what they sow today is still valuable when they reap. By paying a premium, they are ensured of a fixed price ahead of harvesting time.
Although they miss the potential upside of possibly higher prices, they also lose the risk of possible lower prices. Nowadays, most futures are bought and sold by traders and it is standard practice to settle the contract in cash, instead of actual physical delivery of rice.
One of the differences between stocks and commodities is that the average citizen won’t be directly impacted by the rise or fall of any company’s stock.
On the other hand, a rise in the price of commodities such as electricity or rice will be directly felt through reduced purchasing power.
On the other hand, a drop in the price of oil will be felt through a smaller government budget (which the government might counter with more taxes).
Commodities represent actual, physical products, while stocks represent ownerships – a part in the future cash flows of a company. Commodities are typically traded and held for a shorter duration, while stock can be held years, even decades.
So there are multiple differences, but what is the one, big fundamental difference? This difference is that commodities won’t ‘do’ anything, while stocks do.
Your gold won’t grow slowly from 100 to 200 grams and your rice investments will also not magically double. In fact, they might spoil!
This means that the only way to make money with commodities is to buy low and sell high, which everyone in the market is trying to do, so it is not exactly easy.
Many stocks, on the other hand, will pay you dividend, while you are holding the stock.
Even if you sell after a year for exactly the same price as you bought, you will have made a return on your investment.
Hence, stocks can "grow" in a way that commodities can’t. Stocks ‘work’ for you as the company they own tries to produce more cash flows.
So, commodities are standing still, their price determined by global forces of supply, demand and the occasional natural disaster.
Bonds – which generate interest payments – move very steady and predictably and at the end of the duration of the bond, you will get your money back. Stocks, finally can move at different speeds, depending on how well the company is doing.
Does this mean stocks are most risky and commodities are safe? No, not at all. Commodities are known to be quite volatile (think of what happened to the oil price), while the volatility of stocks can be reduced fairly easy by diversifying your investments.
I would therefore not advise commodity training for beginners. You are better of buying rice for consumption and stocks as investments.
Mark Reijman is co-founder and managing director of https://www.comparehero.my/ dedicated to increasing financial literacy and to help you save time and money by comparing all credit cards, personal loans and broadband plans in Malaysia.
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