A Closer Look at Alternative Investments: Commodities

By Michael Williford, Spring 2016 Student Intern

Commodities are a subset of real asset investments, like real estate, which I discussed yesterday, and precious metal investments, which I’ll highlight tomorrow. Commodities include things like oranges, oil, animal products and foreign currency trading, just to name a few. Commodities are usually traded via futures contracts, which are agreements to buy or sell a specific quantity of a commodity at a specified price on a particular date in the future. You can read more at FINRA’s website, but essentially a futures contract is a bet an investor makes that the price of the contract purchased today will be lower than the price for which the commodities can be sold on the date the payment comes due. If that happens, the investor makes money. If the price of the contract is more than the price of the underlying commodities on the date specified in the contract, the investor loses money.

Specifically, commodities futures are regulated by the Commodities Futures Trading Commission (CFTC). Brokers selling commodity futures are required to register with the National Futures Association (NFA), an independent regulator for anyone who trades futures with the public. The NFA offers the public access to a database that allows investors to determine if the broker they are considering is the subject of any disciplinary actions. The system is called Background Affiliation Status Information Center, or BASIC. You can check up on a futures broker by utilizing the system here.

An investor may encounter commodities through a broker who manages a commodity pool. Brokers in charge of commodity pools raise money that is pooled together to trade commodity futures and options. The CFTC has issued warnings about commodity pools that encourage investors to be suspicious of sales pitches that lead investors to believe they can profit from news that’s already known to the public, such as promises the price of oil is going increase as a result of the hurricane you heard about on the news recently; by leading you to believe that other successful investors have already invested, by saying Warren Buffett has invested, for example, or; by promising that the value of a commodity is guaranteed to “double in the next three months!”

The bottom line is that commodities can be appealing to us regular folks, in part, because there is an actual good that is being traded. Unlike the derivatives market, which even the most sophisticated investors did not fully understand at the time of the housing market collapse, commodities are a direct bet on what the price of corn, for example, will be in 90 days. This can seem like an appealing bet the average investor stands a chance of winning. The commodities market, however, is susceptible to frauds perpetrated by unscrupulous bokes or salespeople who are unlicensed altogether. The FBI has even warned of the risks, so protect yourself by using the research tools available through FINRA, the NFA, and the CFTC.