Investing in Commodities - Everything you need to know about the risks involved

Investing is all about risk management and monitoring of the risks involved in generating returns. Bellow is a short description of the common risks you might face when investing in commodities and some advices on how to minimise these risks.

Geopolitical risk

One of the innate risks of commodities is that the world’s natural resources are allocated in various continents and the jurisdiction over these commodities depends on governments, international companies, and many other entities.

Global disagreements over the control of natural resources and international miscommunications should be taken as a fact. Sometimes a host country will simply kick out foreign companies involved in the production and distribution of the country’s natural resources.

So what kind of activities should you take to secure yourself from this geopolitical uncertainty? One way to minimize it is to invest in experienced companies and economies of scale. For example, if you’re interested in investing in an international oil company, go with one with an established international track record.

A company like BP, for instance, has the scale, breadth, and experience in international markets to manage and minimize the geopolitical risk they face. A smaller company would be much more exposed in this kind of risks than a big one. In this occasion, size makes a difference.

Speculative risk

The commodities markets, just like the bond or stock markets, are dominated by traders whose primary interest is in making short term profits by speculating whether the price of a security will go up or go down.

A way to minimize your exposure to this risk is by constantly checking the pulse of the markets and trying to recognise as many as possible of the market participants, so to distinguish the commercial users from the speculators.

There are many online databases and reports that can give you an in depth analysis on the market participants, like the Commitment of Traders report, issued by the Commodity Futures Trading Commission (CFTC).

Frauds

Even though the Commodity Futures Trading Commission (CFTC) and other regulatory bodies do a great job on recognising market frauds and protecting investors from them, there is always the threat of fraud.

One way to prevent becoming a victim of a fraud is to be extremely scrupulous about where you are allocating your money. Make sure that you meticulously research the background of a firm before you invest your money.