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Commodities: know the risks, use a major brokerage

Investing in commodities offers investors with a tough mind and a high tolerance to risk a chance to turn a mind-boggling profit or an equally mind-boggling loss.

Commodities include wheat and other grains, gold, silver, and other metals, pork bellies, cocoa, and numerous other products from all over the world.

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The commodities market is not just a big gamble. It serves a useful purpose for businesses that use these products. For example, when a mill buys wheat, it can lose its milling profit if the price of wheat drops before the flour is sold. To hedge such a buy, a mill will sell a future contract for an equal quantity of wheat. Thus, if the price of wheat declines, the mill makes up the loss with its profit from buying back the wheat futures contract at a lower price. Through hedging, commodities speculators assume the risk of future price moves, and the mill makes its normal profit on the milling.

Generally, individuals should avoid investing in commodities unless they have money they can afford to lose. Commodities trading is a "zero sum game." That is, for every gain there is a compensating loss. Typically, out of 100 commodities investors entering the market, 95 to 97 will lose their invested funds and the remaining few will collect the profits.

Before tackling any part of commodities, examine the free booklets offered by the Commodity Exchange, 4 World Trade Center, New York, NY 10048; Chicago Mercantile Exchange, 444 West Jackson Boulevard, Chicago, IL 60606; and ContiCommodity Service, 8150 North Central Expressway, Dallas, TX 75206. One of the best books on commodities trading is by Bruce Gould, "The Dow Jones-Irwin Guide to Commodities Trading" (at your bookstore -- probably by special order), or check your library.

A continuing problem for commodities investors is the need for additional cash to answer margin calls when prices move rapidly. Daily limits are established for each commodity. If the price moves up or down to the limit, trading stops for the day. In a precipitous drop, however, a commodity may open and drop the limit immediately, and trading stops with the market down the limit for the day. In some cases an investor is trapped in a series of limit moves and is unable to liquidate. These are the times for steel nerves -- and extra cash for margin calls.

Groups of small investors can pool resources for commodities investing through funds. The groups operate as partnerships. A sales charge of about 5 percent is typical. Further, if the commodities fund realizes a profit, individual partners must pay income tax on the profit even if the cash is not distributed.

Several funds are operating. To get more information, contact one of the major brokers. The names of prominent funds are Thomson McKinnon Futures Fund, McLean Futures Fund, Harvest Futures Fund, the Resource Fund, and others.

One caution: If you choose to invest in commodities futures, work with a specialist in one of the major brokerage firms. Speculating in commodities is risky enough; don't compound your risk by dealing with amateurs. And don't invest all of your available funds. Keep back from one-third to one-half for margin calls.

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