Commodity Futures

Warning! Investing in futures is very risky. Most traders lose money by investing in futures, due to the high leverage that they offer. I would recommend only investing in futures as a long-term rollover stategy, and not to make any trades based on short term views. Everytime you enter into a futures contract you should ask yourself what is the most you could lose. Along those lines, I would set a hard limit on what you can lose under the worst case scenario. If you can't follow a disciplined trading stategy, or would be tempted by the high leverage, then futures are probably not for you.

For more information on futures, see this Invest FAQ Article

Why buy futures instead of mining/oil companies?
Investing in natural resource companies carries certain risks:

  1. Political risks - 3rd world countries may impose natural resource taxes if commodities go up, or worse nationalize the mining companies.
  2. Global inflation, rising local currencies, rising energy prices may all impact the costs of mining wiping out much of the gain due to larger commodity prices.  For example many South African gold miners have seen their costs go up because of the rise of the Rand.
Therefore it is a recommended as part of a diversification strategy to invest part of a natural resources portfolio in pure commodities plays such as futures.  Many of the gold bugs recommend against using futures, warning of counter-party default risks with futures. Instead they recommend taking physical deliveries. My understanding of the futures market (as opposed to the forward transactions) is that the clearing corporation protects the buyer from default of the seller by requiring a margin deposit.  My view (this departs from many gold bugs) is that it's more effective to invest in silver by rolling over futures than by buying physical, since there are insurance and storage costs associated with owning physical, as well as opportunity cost of capital.

Futures for the small investor

Many future contract sizes are $100,000 and higher, and risky for the average investor due to the high leverage. There are some smaller future contracts available listed here.

Warning! Some of these futures are thinly traded, and the bid/ask spread can be large. It is advised to carefully select the limit price.

  1. CBOT A/C/E Mini N.Y. Silver, 1000 ounces (approx $5,000 contract value)
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  2. CBOT A/C/E Dow Jones AIG Commodity Index (approx ($38,000 contract value)
    product overview qoutes
  3. NYBOT Reuters CRB Index (approx $120,000 contract value)
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  4. NYMEX Palladium, 100 ounces (approx $21,000 contract value)
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The $38,000 contract value for the Dow Jones AIG is the lowest size of the available commodity index futures.  The index is balanced across 20 commodities, and rebalances every year to favor less expensive commodities, which improves perfomance, since commodities tend to revert back to the mean. In addition to the 17 CRB commodities, the Dow Jones AIG adds unleaded gasoline, soybean oil, zinc, nickle, and aluminum but does not have orange juice nor platinum and has a higher weighting towards energy.

The CRB Index is evenly balanced across 17 commodities, and remains balanced by using geometric averaging. These commodities are corn, soybeans, wheat, cattle, hogs, gold, silver, copper, cocoa, coffee, sugar, cotton, orange juice, platinum, crude oil, heating oil and natural gas. Its contract size is larger, which may be an advantage if you have a larger amount to invest, due to reduced commissions. It also tends to be more liquid than the Dow Jones AIG future contracts.

Managed Futures Funds

If you don't feel like buying and selling futures directly, then you may be interested in the Rogers Raw Materials fund, managed by Jim Rogers. This fund invests in a basket of 35 commodities from crude oil to azuki beans and silk.