Commodities or goods have lied at the core of trade and markets since the beginning of human civilization. In fact, many attribute commodities to have driven forward revolutions in the most fundamental areas of our history, be it agriculture or industrialization. Despite the appeal of most financial securities, commodity stocks remain a popular choice among investors seeking diversification and safety amid wider volatility and inflation. They are especially favorable in the market during periods of high inflation.

Many investors, particularly institutional investors such as pension funds commit a major portion of their capital to stocks with exposure to commodities. This allows for returns that are correlated to inflation but protected against the downside of financial markets.

Winning in the sphere of commodity stocks, however, requires knowledge and foresight. With this article, we aim to deliver exactly that and arm you with the know-how to excel in this domain of the market.

What Are Commodity Stocks?

Commodity stocks are essentially shares of companies that have their business performance and subsequently share price, directly correlated with the prices of certain commodities.

The reason these companies are directly in-tune with commodity prices is due to them being producers, explorers, or extractors of particular materials. Their profitability takes a boost when the spot prices of these goods rise, due to revenue surges and margin expansion.

Due to the intrinsic value of these stocks linked closely to actual commodities, they are a great way for investors to capture commodity appreciation, without actually holding the commodities directly. As such, investors ensure their inclusion in their portfolios for diversification.

How Do Commodity Stocks Work?

Having described what are commodity stocks, we now turn to explore how exactly they work. As mentioned above, they provide exposure to rising spot prices of commodities by delivering revenue growth and increased profit margins to these companies.

When an investor buys shares of such companies, they are acquiring a stake in businesses that are profiting off improving spot prices, and are thus setting themselves up to rise with the price of the commodity.

It is important to understand that the market price for a commodity typically rises when there is a surge in its demand, or when its supply is somehow compromised. In certain cases, this can take place during extraordinary circumstances such as war or a pandemic.

Stocks with exposure to commodities also take off during periods of high inflation, as the commodity itself becomes more expensive with general goods and services. This makes the commodity class of stocks an excellent hedge against inflation.

Example Of A Commodity Stock

We now turn to a real-life example of a commodity stock to contextualize the discussion made above and to enhance understanding.

Lithium Americas Corp (NYSE: LAC) is considered among the best commodity stocks as it provides strong exposure to the dynamic world of lithium. Because of its role in electric vehicles, energy storage, and consumer electronics, many call lithium the new ‘white gold’.

LAC being a lithium producer with operations in both Canada and Argentina is a sound example of a commodity stock. Understandably, its revenue and profits are sensitive to fluctuations in the market price of lithium.

When lithium prices rise, either due to surging demand, or macro inflation, LAC’s revenue would see a jump. Because production costs would not rise by the same degree, the company’s profits too would see a noticeable rise.

LAC, therefore, is a great way for investors to see their capital take off with the booming prices of lithium, without actually holding the lithium commodity in any capacity.

Pros And Cons Of Commodity Stocks

Those that invest in the commodity class of stocks typically face a wide range of both advantages and disadvantages.

The pros of commodity stock investment are listed below as follows:

• Hedge Against Inflation

  The commodity class of stock is one of the best hedges against inflation, as the rise of commodity spot price is often proportional to general inflation. This is the case even when demand and supply dynamics remain unchanged.

• Diversification

  Stocks of commodity companies offer superior diversification, given their low correlation with other financial securities such as bonds. As such, their inclusion can potentially reduce overall portfolio risk.

• Capital Appreciation

  The most compelling aspect of the commodity stock is its ability to grant exposure to commodity spot gains and position one’s capital to appreciate on this basis.

  Where the pros for commodity-based stocks are numerous, market participants must also keep in mind the cons of holding these in one’s security. These are as follows:

• Price Volatility

  Holding a stock tied closely to a commodity exposes the investor to the volatility of the spot market. Even during business booms, prices can behave unpredictably, potentially resulting in price swings.

• Company-Specific Risk

  It is important to note that when one invests in commodity-based stock, they are investing in a company that inherently holds risk.

  Despite favorable spot conditions, the company still can face operational and managerial challenges which can potentially result in poor financial performance.

• Geo-Political And Regulatory Risk

  Commodities are usually highly sensitive to geo-political and regulatory factors, as each influences its production, extraction, or exploration. Often, trade restrictions can be devastating for the entire industry of a particular commodity.

Types Of Commodity Stocks

When choosing from a commodity stocks list, the first question to come up in the investor’s mind would be the type of commodity to that one wants to hold exposure. Described below are the most common types of commodity stocks:

• Energy Stocks

  These stocks are related to the production and distribution of oil, gas, and coal.

• Precious Metal Stocks

  These stocks are related to the production and distribution of gold, silver, and other precious metals.

• Industrial Metal Stocks

  These stocks are related to the production and distribution of metals such as copper, aluminum, and iron.

• Agriculture Stocks

  These stocks are related to the production and distribution of crops such as corn, wheat, and soybeans.

• Livestock Stocks

  These stocks are related to the production and distribution of meat products such as beef, pork, and poultry.

• Timber And Paper Stocks

  These stocks are related to the production and distribution of wood products such as lumber and paper.

How To Invest In Commodity Stocks?

Having explored the realities surrounding commodity-based stocks, the next logical domain to explore would be answering the question of how to buy commodity stocks. Fortunately, we have you sorted.

There are a number of channels one can turn to, in order to invest in the commodity class of stocks. These are mentioned in the list below:

• Direct Investment In Individual Stocks

  The most obvious way to invest in a commodity stock is to directly purchase such stock from the stock market, either directly or through a broker. This could be any stock of a company involved closely with a commodity.

• Investment Through ETFs

  Another route to take for investors seeking exposure to commodities through stocks is by investing in exchange-traded funds (ETFs). These represent investments in a basket of commodity-based stocks, with the risk being spread out and minimized.

• Investment Through Mutual Funds

  Similarly, investors can also commit their capital to mutual funds that have portfolios predominantly targeting commodity-based companies.

  These are professionally managed and can alter their asset allocation model based on shifting conditions.

What It Means For Individual Investors

The commodity class of stocks is extremely valuable to investors, as they provide exposure to a potentially advantageous commodity market without the need to purchase the commodity itself. It does this through investment in a company that profits off rising spot prices.

If an investor were to directly buy a commodity such as lithium, they would need operational expertise to acquire, produce, manage, market, and sell to an appropriate buyer while bearing the costs for doing so.

Investing in a company that already has the operational structure set up to profit off a particular commodity gives investors the opportunity to profit, without having to bear the direct burden. They also can invest small amounts of capital, and profit proportionately.

Similarly, they can simply pull out of their positions once the commodity no longer has growth potential, and can pivot to other commodities, based on their individual stock analysis.

Conclusion

The commodity class of stock is a great investment avenue available to market participants to take advantage of. They are a core driver of financial growth, by tapping into the demand of a wide range of physical materials.

They allow exposure to a booming commodity market without having to bear the burden of directly holding these materials. In addition to being excellent portfolio diversifiers and inflation hedges, they offer capital appreciation that is not correlated to other financial securities.

For the prudent investor, the inclusion of commodity stocks, either directly or through mutual funds or ETFs would be a no-brainer, given the wide range of compelling advantages they offer.

FAQs

What Do Higher Commodity Prices Mean For Stocks?

Higher commodity prices generally mean higher input costs for companies, which can lead to lower profits and lower stock prices. However, companies that produce commodities may see their stock prices rise.

What Are The Best Commodity Stocks?

It is difficult to identify the “best” commodity stocks as it depends on market conditions and individual investor goals. However, some popular names include ExxonMobil (XOM), Lithium Americas Corp (LAC), and BHP Group (BHP).

What Are The 4 Types Of Stocks?

The four types of stocks are growth stocks, income stocks, value stocks, and commodity stocks. Each offers unique advantages and holds appeals to distinct investment approaches.