• Wednesday, May 29, 2024
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Diversify with the commodities market: High reward, not without risk

Diversify with the commodities market: High reward, not without risk

Market Momentum: Agricultural products soared to $89.29 billion in 2023, energy commodities skyrocketed to $171.5 billion, and industrial metals climbed to $115.5 billion. Despite Precious Metals experiencing a slight dip to $27.13 billion, these dynamic shifts underscore the vast opportunities within the commodity market, driven by evolving investor sentiments and global economic trends.

In the world of investing, the commodities market has long stood as a bastion of potential high rewards, drawing in seasoned traders and newcomers alike with promises of substantial returns.

Yet beneath its glittering allure lies a landscape fraught with volatility and risk, where fortunes can be made or lost in the blink of an eye. As investors increasingly seek to diversify their portfolios in search of greater gains, the commodities market emerges as both a tantalising opportunity and treacherous terrain.

The commodities market has a rich history, dating back centuries to the trade of basic goods such as grains, livestock, and metals. Today, it encompasses a vast array of assets, including energy resources like crude oil and natural gas, precious metals such as gold and silver, agricultural products like wheat and coffee, and even digital commodities like cryptocurrencies.

“As investors increasingly seek to diversify their portfolios in search of greater gains, the commodities market emerges as both a tantalising opportunity and treacherous terrain.”


In recent years, the commodities market has witnessed significant fluctuations, driven by a myriad of factors, including geopolitical tensions, supply and demand dynamics, and macroeconomic trends.

For instance, the COVID-19 pandemic sent shockwaves through the market, causing oil prices to plummet to historic lows as global demand plummeted amidst lockdowns and travel restrictions. According to a 2020 World Bank report, the pandemic is only the latest in a long history of shocks to commodity markets.

A Special Focus looks at the nature of commodity price shocks on 27 commodities during 1970–2019. It finds that highly persistent (“permanent”) and short-lived (“transitory”) shocks have contributed almost equally to commodity price variation, although with a wide variety across commodities.

Permanent shocks account for most of the agricultural commodity price variability, while transitory shocks are more relevant in industrial commodity prices. The varied duration of such shocks points to a need for policy flexibility.

While metal and agricultural commodities have recouped their losses from the COVID-19 pandemic and are expected to make modest gains in 2021, energy prices, despite some recovery, are expected to stabilise below pre-pandemic levels next year, the World Bank said.

Oil prices fell dramatically in the early stages of COVID-19 and have only partially regained pre-pandemic price levels, while metal prices declined relatively modestly and have returned to levels that preceded the shock, according to the semi-annual Commodity Markets Outlook report.

Agriculture prices were relatively unaffected by the pandemic, but the number of people at risk of food insecurity has risen as a result of the broader effects of the global recession.

Shockingly, geopolitical tensions such as the war between Russia and Ukraine sent a shockwave in the market, thereby hindering the supply chain of grains such as wheat, maize, and rice, which affected the prices of these products globally.

However, as economies around the world have begun to recover, commodities have staged a remarkable comeback, with prices soaring to new heights. The resurgence of industrial activity, coupled with stimulus measures enacted by governments to spur economic growth, has fueled a surge in demand for raw materials, propelling prices upward.

For investors, the commodities market offers a tantalising array of opportunities for profit. Unlike traditional assets such as stocks and bonds, commodities often exhibit a low correlation with broader market trends, making them an attractive option for diversification.

Moreover, commodities can serve as a hedge against inflation and stock market volatility, as their prices tend to rise in periods of currency devaluation.

According to the World Bank, the quantity of commodities consumed globally has increased considerably over the last century, driven by population and income growth.

In Nigeria, there are channels and commodities exchanges that offer an opportunity to invest in commodities as an alternative asset class to diversify their portfolios beyond traditional investments in fixed-income securities and equities.

These commodities represent some of the most actively traded assets in the global market, encompassing a diverse range of agricultural products such as wheat, sugar, maize, cotton, and cocoa, along with energy resources and metals.

Investors engage in various trading mechanisms, including forwards, futures, options, and spot trades, navigating the ebbs and flows of these dynamic markets with precision and foresight.

Furthermore, the Nigeria Commodity Exchange (NCX) is poised to tap into this lucrative arena, eyeing eleven key commodities for trading. Among these are staples like maize, rice, sorghum, and millet, essential for sustaining local economies and ensuring food security.

Additionally, high-value crops like cocoa, sesame seeds, and cashew hold promise for driving economic growth and diversifying agricultural exports. And with global demand for commodities like coffee, cotton, and wheat remaining robust, these markets present abundant opportunities for investors to thrive and contribute to Nigeria’s burgeoning commodity ecosystem.

As the NCX charts its course in this dynamic landscape, it aims to harness the potential of these commodities, fostering growth, stability, and prosperity for all stakeholders involved.

Yet, for all its potential rewards, the commodities market is not without its risks. Volatility reigns supreme in this realm, with prices subject to sudden swings in response to unforeseen events. Supply disruptions, geopolitical conflicts, and regulatory changes can all have profound impacts on commodity prices, catching investors off guard and leading to significant losses.

For those considering a leap into the commodities market, it’s all about careful planning and navigating risks. Diversification is the name of the game, spreading investments across various commodities to cushion against sudden price swings. And don’t forget about the tools at your disposal, like futures contracts and options, which offer flexibility and control.

But it’s not just about numbers. Keeping tabs on global economic shifts and world events is essential. Whether it’s monitoring crop yields, tracking oil production, or watching central bank decisions, understanding market basics is key to success.

Sure, the commodities market offers tempting rewards, but it’s no walk in the park. It takes a mix of skill, knowledge, and risk management to navigate its twists and turns. As one analyst rightly puts it, diversifying your investments and staying informed are your best bets for making the most of this market while protecting yourself from its ups and downs.

Oluwatobi Ojabello, senior economic analyst at BusinessDay, holds a BSc and an MSc in Economics as well as a PhD (in view) in Economics (Covenant, Ota).