Commodities Seem Hot, But Investors Beware
Amateurs tend to be losers in this complex and risky arena
Global grain prices are at their highest levels in two years; gold has been on an updraft, sought out by jewelers, industrial companies, and investors; gasoline prices have also been heading northward. In short, this may seem an ideal moment to invest in commodities markets.
Nope, only for folks with the grittiest of temperaments and very deep pockets, financial experts say. Hillary Rodham Clinton did it and came away a winner in cattle futures trading. But her success is considered highly unusual. Studies show that 90 percent of amateur investors lose money on commodities transactions.
"It's a trader's market with very high monitoring costs and very rapid changes" in the economic cycle of the underlying assets, says John Markese, president of the American Association of Individual Investors (AAII), a small investors group in Chicago. "It is a market that is probably not suited to most smaller individual investors."
But what if you're persuaded you can beat the terrible odds and win wealth from grain, copper, cattle, pork bellies, soybeans, orange juice, gold, or stock options? You can open a commodities or futures account either through a firm that specializes in commodities transactions or from a regular investment house.
Be prepared for rigorous scrutiny of your financial standing. Usually, you will be asked about your annual salary and your net worth (total assets held, minus all debt obligations.) Commodities traders want to be certain you can meet financial commitments involved in a trade, including possible losses that could require you to quickly pony up substantial sums of money.
You can buy commodities individually - that is, take out a position in a basket of certain items, such as pork bellies. Or you can buy into a commodities fund, which is actually a limited partnership. In either case, your expenses will be higher than for a mutual fund. In the case of a brokerage account, fees typically run about 2 percent of your investment. You may also have to pay 10 to 20 percent of your earnings, if there are any. In the case of a fund, you will pay a 4 to 8 percent commission - a fairly high "load" compared with most mutual funds.
The 'long' and 'short' of it
To make money in commodities, you try to profit from price changes over time. To profit from rising prices on, say, bushels of wheat, you take out a "long position." This is a bet that your bushels will rise in value between the day you purchase your contract and some future date. You can profit from a falling market with a "short" position.
To obtain such a "futures contract," you usually buy on margin - that is, put down a small amount of money, such as only 10 percent of the value of the contract. If the value of your underlying basket of goods rises over time, you make a substantial profit on very little money down. You gain through leveraging.
Losses must be covered
But what if the value of your commodity tumbles when you want it to rise? Whoops! You will get a "margin call" from your broker that you must quickly advance him money to pay for your losses.
To limit trading losses, you can try strategies based on "options" regarding future occurrences. These are known as "calls" and "puts," and can be placed not only on commodities but also on stocks or other financial instruments.
Calls. The owner of a call option has the right to buy a stock, an index, or a futures contract at a designated price for a certain period of time. Say you think General Electric stock, now trading at around $80, will rise to $100 soon. You might get a call option for "GE at $90." If the stock moves to $95, you have the right to exercise your option and buy that stock at $90, even though it is worth $95. If the price of the stock does not move up, the investor will usually not exercise the option. Thus, the investor is out the money spent on the option, but not the (usually much larger) value of the security.
Puts. Here, you have the right to sell a stock, index, or futures contract at a certain price. You assume the price on the item will fall. But if the item does not fall in value, you once again need not exercise your option. So you lose only the cost of the option, not the actual worth of the securities.
The main regulatory body overseeing America's commodity and futures exchanges is the Commodity Futures Trading Commission (CFTC) in Washington. The main commodities and futures exchanges include the Chicago Mercantile Exchange, the Chicago Board of Trade, the Coffee, Sugar & Cocoa Exchange in New York, and New York Mercantile Exchange.
The man who probably did more than anyone to foster futures trading, Leo Melamed, has just written a fascinating new book, "Escape to the Futures" (John Wiley & Sons). He is a former chairman of the Chicago Mercantile Exchange.
To learn more about commodities trading, you might want to examine two newsletters: The Commodity Traders' Consumer Report tracks commodity advisory services for $225 annually (call 800-832-6065); Managed Account Reports, on futures funds, costs $345 a year (800-638-2525).
If you believe you have been personally injured by bad advice on a commodities deal, you can seek to retrieve your money through arbitration. Write to the CFTC at 3 Lafayette Centre, 1155 21st St., NW, Washington, DC 20581.