Saturday, November 04, 2006
Leveraging commodities with stocks
Leveraging commodities with stocks
Commodities are best defined as “An article of trade or commerce, especially an agricultural or mining product that can be processed and resold.” In this case I mean gold, silver, corn, beef, whatever is traded on US commodity markets.
The problem with commodities is that they are not traded as freely as stocks are and because of high minimums they are traded mostly by institutional investors and other professional investors. Commodity futures are often traded in 100,000 bushel lots, so for corn, this would require more than $200,000. Commodities are less leveraged than the foreign exchange markets and opening a futures account usually requires huge minimums so I will show you a way to profit on the rise and fall of commodity prices.
Commodity prices are set on markets all around the world, but the biggest market is the Chicago Board of Trade Futures market. Futures work by agreeing to purchase a commodity for a certain price on a certain date. When buying futures, an investor believes that the value of the commodity will be higher when you take delivery, allowing the investor to make an instant profit on the investment.
Gold and Silver futures make up most of the activity on the futures boards. Banks and governments alike turn to gold and silver bullion in order to protect their assets.
Since futures accounts require high minimum investments and also include numerous fees, trading certain stocks will allow an investor to invest in commodities by proxy without opening new brokerage accounts.
The best way to make a leveraged investment on gold is to buy stock in a company that is currently out of commission due to low gold prices. There are many gold mining companies where it costs them $500 an ounce to mine and haven’t been able to until recently after gold prices surged.
A gold company that operates at a cost of $300 an ounce will not go up as high when gold prices go up as a company that operates at a $500 cost. A $20 rise in gold will mean a much higher operating margin for the company that operates closest to current price in gold. If gold is $550 an ounce and a company operates at $500 per ounce then a $20 rise in gold would mean that profits rise 40% for the company.
News is a big player in commodities because of the supply and demand variables. Stocks usually have no real demand and a steady supply. Commodities are always in demand because they are used up and supply depends on how much is produced. There is never a set supply for ANY commodity. Bad weather could mean that corn yields are down 10%.