How to Buy Commodities

Commodities are raw materials such as grains, metals, oil and livestock. The exchange of these materials and products has evolved over time from unregulated merchant and supplier contracts, to forward contracts, to commodities derivatives. What this means is the trade of commodities has become increasingly refined with the advent of enhanced logistics, market regulation, massive amounts of product, and electronic means of recoding transactions. There are several ways to participate in the trade of commodities and several key aspects to consider when investing in commodities.

• Commodities are traded as 'futures contracts'
• Futures contracts may be purchased directly or indirectly
• Exchange Traded Funds (ETF's) and Brokers participate in commodities purchases
• Leveraged buying of commodities can increase risk significantly
• Futures commission merchants facilitate the trade of commodities futures
• Several commodities exchanges exist worldwide and in the U.S. are regulated

Indirect exchange of commodities

Indirect exchange of commodities may take place through the buying and/or selling of shares of managed funds that themselves trade in commodities via futures contracts. These funds are called exchange traded funds or ETF's and may have a 1-2% fee associated with the management of the fund.

Through the trade of ETF's, the risk of trading commodities directly can be reduced via (1) knowledgeable management and experience of the fund, (2) diversification of commodities contracts, (3) and indirect involvement in international trade (investopedia.com). ETF's may participate in purchasing of particular commodities or a broad range of commodities.

Additionally, the companies that produce commodities themselves can be traded via mutual funds and/or stocks. These funds and/or stocks are bought and sold through financial institutions that offer brokerage services and offer an alternative to direct exchange of commodities by partial ownership of the commodities producer that's assets include commodities.

Depending on market conditions this type of trade may be more or less risky and garner different yields than direct trade of commodities. Commodities can also be exchanged indirectly through a broker that is licensed in commodities trading. (investopedia.com)

Direct exchange of commodities

Direct exchange of commodities is performed through futures exchanges via futures commission merchants (investopedia.com). Within the United States, these merchants/brokers can be investigated prior to opening an account for registration with regulatory bodies such as the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA).

Since many commodities are traded as futures contracts, the actual physical exchange of the commodity does not have to occur as the commodities exchange can resell the physical contract and/or hold the underlying asset value through its market making capacities and/or financial affiliations.

There are several commodities exchanges around the World through which futures commission merchants operate. A few of which include the Chicago Mercantile Exchange (CME) which is now merged with the New York Mercantile Exchange (NYME), Tokyo Commodities Exchange (TOCOM) and Dubai Gold and Commodities Exchange (DGCX) (wikipedia.com) and each day, futures positions are settled and accounts with futures commission merchants are debited or credited to reflect daily changes in the price of futures contracts held. (nfa.futtures.org).

When the trader or broker of the contract decides to sell the contract and/or if the contract expiration date is reached, a final cash settlement will occur yielding either a gain or a loss. Since futures contracts are often bought using leverage i.e. margin that allows the buyer to purchase more with less, large fluctuations in commodities prices can having corresponding multiplied losses or gains to the value of the account through which the contract(s) are purchased.

Summary

Commodities trading involves the exchange of either commodities futures contracts, exchange traded funds (ETF) that themselves trade commodities futures contracts or companies that produce commodities. Levels of risk vary with the method by which commodities are exchanged i.e. direct or indirect, market conditions and the use of leverage in the exchange of shares and/or futures contracts. Commodities futures are exchanged through futures commission merchants who facilitate trade via the commodities exchange itself.

These financial intermediaries function as brokers, charge fees and/or commissions for their services and may be registered with commissions regulatory bodies. The practice of commodities trading may be participated in for a number of purposes including (1) market speculation (2) hedging of risk by commodities producers and (3) financial strategy by funds and/or financial institutions participating in the trade of commodities futures contracts.

Sources:

1. http://www.investopedia.com  (Investopedia)
2. http://en.wikipedia.org/ (Wikipedia)
3. http://www.nfa.futures.org/ (National Futures Association)