What Is A Commodity Stock?
A commodity stock is a debt offering from a corporation involved in the consumption, extraction, refinement or delivery of raw materials. Accordingly, both company performance and share price are correlated to the relative value of an underlying commodity(s).
Valuing Commodity Stocks
Acting as the basis for a broad spectrum of securities, commodities are a premier asset class in the global marketplace. Essentially, any item with a tangible value originating from within the earth is considered a commodity. Prominent examples include agricultural goods, minerals, livestock and fossil fuels. Accordingly, the trade of commodity-based products is an integral aspect of finance, specifically related to the trade of futures, forex and equities instruments.
Due to the role of commodities in the capital markets, the valuation of dependent stocks is a bit more involved than that of a conventional corporate offering. For non-commodity companies, traditional methods of analysis are typically used. The scrutiny of income statements, ratios and balance sheets are common practices. However, for those corporations reliant upon commodities, the pricing of related underlying assets is crucial to determining the real and intrinsic value of stock issues.
In practice, a vast array of companies are impacted by commodity pricing. Nonetheless, the degree of this interrelationship varies and may be characterised in one of two ways:
- Direct: Farmers, miners and drillers are a few examples of companies that directly depend upon the value of commodities to secure marketshare. To illustrate this point, oil and gas extraction companies are particularly sensitive to the pricing of crude oil as well as natural gas. During the crude oil crash of 2014/15, North American drilling and fracking operations were hit extremely hard, with dozens eventually filing for bankruptcy protection. Among these companies was industry leader Magnum Hunter Resources (MHRCQ).
- Indirect: Corporations that require raw materials to conduct business indirectly rely on commodity pricing. The travel industry, refiners, artisans and transport companies periodically show sensitivity to the pricing of designated inputs. For example, trucking companies are indirectly impacted by rising crude oil values and the subsequent appreciation of refined fuels. Given that roughly 30% of operating costs pertain to fuel, any upward movement in price can negatively affect a trucking company's profitability and stock value.
As a general rule of thumb, the greater a company's reliance on a raw material(s), the more share price is impacted by swings in commodity pricing. Subsequently, companies that deal directly with commodities, such as gold miners or wheat farmers, are typically more sensitive to any abnormal behaviour taking place in the underlying markets.
Trading And Investing In Commodity Stocks
Commodity stocks furnish investors with several key attributes that frequently boost their appeal. In contrast to trading raw materials on the futures and spot markets, stocks offer unique functionality in several key areas:
- Diversification: Shares of corporate stocks are readily purchased in various amounts, offering both direct and indirect commodity market exposure. This element is especially useful when actively managing risk.
- Long-Term Investment Horizon: Unlike derivative products such as futures and options, equities have no expiration date. Barring insolvency, issues of corporate debt may be theoretically held into perpetuity.
- Transaction Costs: Physically stockpiling raw materials can be expensive and include storage, transport and security costs. In addition, the active trade of futures and options products can incur substantial fees as well as commissions. Depending on the frequency of transactions, commodity stocks may offer more affordable alternatives.
- Limited Exposure: While the valuations of commodity stocks are related to that of an underlying asset(s), the markets are not 100% correlated. Because of this, corporate performance and share price may exceed expectations in spite of turbulence in the commodity markets. Further, the outright purchase or sale of commodity derivatives involves the implementation of financial leverage, which can magnify losses exponentially.
Whether you're interested in portfolio diversification or executing a traditional "buy-and-hold" investment strategy, commodity stocks can be particularly useful. Below are a few of the world's leading publicly traded offerings in this area:
- Agriculture: Archer Daniels Midland (ADM), Associated British Foods (ASBFY), Groupe Danone (DANOY) and Coca-Cola (KO) are global leaders in the agricultural sector.
- Livestock: Tyson (TSN), JBS SA (JBSAY) and Smithfield Foods (SFD) are among the top meat producers in the world.
- Energy: Exxon Mobil (XOM), Gazprom (EDR), PetroChina (PTR) and British Petroleum (BP) are the largest energy-sector companies listed for public trade.
- Metals: BHP Billiton (BHP), Rio Tinto (RIO), Glencore (GLNCY) and Barrick Gold (GOLD) head up the docket of exchange-listed mining stocks.
In addition to buying individual issues, commodity stocks may be engaged via exchange-traded funds (ETFs) or mutual funds. ETF and mutual fund products give investors the ability to address a single security that derives its value from a "basket" of commodity stocks. For example, products such as the VanEck Gold Miners ETF (GDX) and iShares MSCI Global Gold Miners ETF (RING) afford interested parties an opportunity to gain exposure to the gold market without actually acquiring bullion.
ETF and mutual fund offerings are available across the commodity gamut, facing the agricultural, energy and metal asset classes. These products may be especially beneficial, as they bring professional money management and enhanced liquidity to participants.
Commodity stocks can be an attractive way of engaging the markets of agricultural, livestock, energy and metal goods. Featuring a collection of unique valuations, these securities may be traded in isolation or as part of a fund. Whether one is looking to diversify or speculate, commodity stocks offer many beneficial ways of gaining exposure to the raw material asset classes.
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…