Commodity Futures as an Investment Avenue

Commodity futures are globally recognized to be a part of every successful and diversified investment portfolio. The fact that the returns from most of the commodities in the last 53 years from 1951 to 2006 have been higher than the global inflation rate, establishes that investments in commodity are an effective hedge against inflation.

Some of the reasons that make investing in commodity futures an attractive preposition are described below:

Leverage :

Commodity Futures trading is done on margins. The investor only deposits a fraction of the value of the futures contract with the broker to cover the exchange specified margin requirements. This gives the investor greater leverage and thus the ability to generate higher returns.

Liquidity :

Unlike investment vehicles like real estate, investments in commodity futures offer high liquidity. It is equally easy to both buy and sell futures and an investor can easily liquidate his position whenever required. There is also another advantage of being able to use the profits from a trade elsewhere, without having to close the position.

Diversification :

Investments in commodity markets are an excellent means of portfolio diversification. For example, gold prices have historically shown a low correlation with most other asset prices (such as equities) and thus offer an excellent means for portfolio diversification.

Inflation Hedge :

As the commodity prices determine price levels and consequently inflation, investing in commodity futures can act as a hedge against inflation.

Physical Gold :

Physical Gold is a product by which retail and high net worth investors can take investment positions in dematerialized physical gold using the futures market. In this product, the investor can hold physical gold, in a safe deposit vault approved by the exchange, which is reflected in the investor's demat account. The main features of this are:

  • Liquidity
  • Assurance of purity
  • Transparency of rates
  • Safety

These features have attracted a large number of clients to the product since its introduction. Many brokers offer a full package of services associated with the Physical Gold contract, including acting as commission agent to take care of sales tax / VAT related issues.

Commodities traded in Commodity Exchanges :

Large numbers of commodity are traded on commodity exchanges in around the world. The commodities are classified on the basis of their use and consumption. Further classification is based on the characteristics of the commodity.

Some of the commodities traded on various futures exchanges are as follows:

Rough rice
Sunflower Oil
Orange Juice
Industrial Metals
Precious Metal
Crude Oil
Natural Gas

In order to understand the different types of commodity futures market, namely normal futures market and inverted futures market you need to know all the commodities which exist for trading and which commodity portfolio suits you the best.

In the next chapter we will learn about different types of futures markets namely normal futures market and inverted futures market.

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