Commodities
Commodities like oil, copper, or wheat can barely be stored directly, so investors go through futures contracts. Their mechanics create costs that catch many beginners off guard.
Learning objective: After this lesson, you can explain why investing in commodities via futures carries its own, often underestimated costs.
The price of a commodity like oil, copper, or wheat starts out following ordinary supply and demand: if more gets produced or harvested than is needed, the price falls; if less suddenly becomes available, it rises. Commodity prices are especially sensitive to geopolitical shocks on the supply side: when a major producing region faces conflict, market participants expect fewer shipments, and the price typically rises even before deliveries actually drop. For agricultural commodities, a drought or a poor harvest in a key growing region can trigger the same effect.
You can hardly put a barrel of oil in your basement. Investors instead invest through futures contracts, meaning agreements to deliver at a future date.
These contracts expire and constantly have to be replaced with new ones. When the new contract costs more than the old one, that swap costs money every single time. Over the years, a commodity fund can lose money this way even though the commodity's price rose.
This effect is why many investors have bad experiences with commodity products. They bet on the right price and still lost.
Commodities also generate no income. Like gold, they depend purely on price. For most retail investors, they're not a necessary building block, especially since commodity companies are already included in any broad stock ETF.
A commodity index's return is made up of the spot-price change, the roll yield, and the interest earned on the collateral. Roll yield is positive in backwardation, when later contracts trade cheaper, and negative in contango, when they trade more expensively. Contango is the normal state for storable commodities, since storage costs and financing get priced in.
That creates an unpleasant property for investors: a long-term position in a broad commodity index can systematically lose value even if the spot price moves sideways. That's not a product flaw, it's a feature of futures-market structure.
In a portfolio context, commodities are sometimes cited as an inflation hedge, since their prices often rise during inflationary periods. The empirical evidence is mixed and depends heavily on the period examined and the index's composition. Energy-heavy indices behave differently from agriculture-heavy ones. A blanket claim about inflation protection isn't well supported.
Summary
- Commodities are held through futures contracts that constantly need renewing.
- In contango, every renewal costs money, even if the price stays flat.
- Commodity companies are already included in any broad stock ETF.
- Common mistake: treating commodities as a reliable inflation hedge — prices often swing more than stocks.
Did you get it?
What does contango mean?
Later futures contracts trade more expensively than earlier ones. Every renewal of the position then costs money.
Can a commodity fund lose money even as the commodity gets more expensive?
Yes. Negative roll yield can eat up the spot-price gain.
Are commodities a reliable inflation hedge?
The evidence is mixed and depends heavily on the time period and the index's composition.
Check your understanding
Sources and further reading
- Gorton and Rouwenhorst (NBER Working Paper No. 10595, "Facts and Fantasies about Commodity Futures") analyze commodity futures from 1959 to 2004 and find a positive correlation between commodity futures and inflation, alongside a negative correlation with equities and bonds. View source ↗