The idea seems simple enough at first: anyone can become a member of the merchant class, without ever having to physically even see their product.
Commodity futures originally developed as a way of making the market more stable, guaranteeing future prices (hence the name) for staples like wheat, corn and cattle.
Every futures contract required three pieces of information: the agreed upon type and grade of the product (corn, dried, off the cob), a quantity offered per contract (5000 bushels), and a delivery date (November 15th). At first, this contract would be retained, and on the designated date, the product would actually be sent to you from Chicago.
By the start of the last century, however, futures became an investment product in their own right, with a majority of futures trades taking place between speculators who only intended to profit from the commodity market, and never even wanted to take delivery.
There are currently 37 true commodities traded in Chicago and New York. These can be split into three categories: agricultural, energy, and trade metals. The price of gold or oil in the news? That’s a commodity. Steak suddenly costs much more than it should? Cattle futures are probably up.
Commodities, especially the precious metals, generally move opposite the stock market, for a variety of reasons including hedge funds managing risk, and investors seeking products that retain value and utility in unstable or inflationary economic conditions.
However, buying futures contracts themselves is NOT a viable long term investment. As we mentioned before, futures do expire, and have a delivery date. On that date, if you still have that position, you will have found that your entire investment has been spent on tons of, for example, perishable pork bellies, that you will need to find a way to deal with. Or worse yet, if you were short in a futures market, you will find the exchange coming after you to supply them with all that pork!
Of course, as we mentioned most modern futures investors are speculators, and never wanted all that bacon to begin with, so there is another way to resolve a futures contract: consummation.
Consummation requires making the opposite move than you initially made, ideally for a better price; i.e. if you bought the contract, selling it for a higher price, or if you sold short, buying to cover at a lower price. (Or, if the contract is about to expire, at any price. Remember the delivery date is final…)
For most individual investors, however, the short term nature of futures, combined with prohibitive share prices, with many contracts running over $100,000 per unit, make commodity funds a much better investment. In exchange for losing the close control afforded by direct participation in the commodity exchange, you can gain the peace of mind that your retirement fund won’t show up at your door in a line of cattle cars!
