Beat And Battered

When it comes to commodities investing there are an unbelievable number of scams out there.

I am not kidding when I say that there are literally hundreds of companies out there just waiting to railroad you through the door, part you from your money, and happily send you straight to the gas chamber.

I know we’ve talked a little bit about how to decide what a good commodity investment might be.

So, I wanted to conclude this series by giving you the information you will need to avoid the evil villains of the investment world, and hopefully, get your financial happily ever after.

The secret to spotting commodity scams:

There is one major test that every single commodity scam will fail:

They will promise to make you a lot of money fast, with little to no risk.

• Penny stocks to make you rich!
• The next Berkshire Hathaway!
• The price of Gold/Wheat/Oil is going to skyrocket, get in on the ground floor!
• They all boil down to one simple thing: Get rich quick! No risk!

Now, frankly we are all smart enough to realize that there is no such thing as “get rich quick”. You wouldn’t be here reading this blog if you weren’t. However, there are not many things in the investment world that are as risky as commodities. Particularly commodity futures. If someone is telling you there is little to no risk involved, turn around and run the other way as fast as you can!

There are also a few other notable ways to spot a scam.

1. Long “squeeze” pages - We’ve all seen these. They are single page advertisements on the internet designed to keep you reading and convince you to act against your better judgment. If you land on one of these pages, click away as quickly as possible. Nothing good can come of it.
2. They are in a hurry to get your money – “Prices will skyrocket in the next few days!” or “Invest now before it’s too late.” Seriously, we’ve probably all bought enough junk off of infomercials that we should know better by now! I still have that stupid Ab belt from the 1990’s. You know the one I mean – the one that delivers low grade electrical shocks and promises a 6-pack. Didn’t work for me! And these basic commodity and futures scams are no different.

   Legitimate companies and investment opportunities don’t need to come and beat your door down to get your money. They are already making enough profit on their own. That brings me to my third and final point.

3. If they appear to “need” your money in any way, shape or form - Run away. Far away. If they are calling you at home, emailing you, or cyber-stalking you in any way, drop them like a crazy ex-girlfriend and head for the hills!

Always take these steps before you invest your money:

• Find a legitimate broker, and make sure that you get a risk disclosure document. Your broker is required to give it to you by law. Anyone who tries to tell you it’s “just a formality” is scamming you.
• Explore your options carefully.
• Sleep on your options. At least overnight, maybe several nights, before you invest your money.
• Only invest in funds that have a minimum of 3-5 years of solid performance.

Follow those rules and you are far less likely to wind up on the bad end of a commodities deal. There is so much risk involved in commodities anyway, why choose a risky company to invest with?

For more information on commodity scams you can check out The U.S Commodity Futures Trading Commission web site.

I hope that you have enjoyed this series on commodity investing as much as I have enjoyed writing it for you. If you liked it, you can offer your feedback here for a chance to win $50. Thanks!

The Princess Bride photo is © Twentieth Century-Fox Film Corporation 1987.

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Last time I filled up my gas tank it cost me $64.28. As I was standing there at the pump I started thinking.

I realized I had absolutely no idea why the price of gas was so high.

I mean sure, I get emails from MSN money every day telling me that oil hit a new record high.

I hear mutterings about China, and problems in the Middle East.

But, when it came right down to it, all I really understood was this:

I’m getting squeezed at the pump – and I want to know why.

So, with that in mind, I thought I’d do a little digging, and share with you what I learned.

Basically the price of gas breaks down like this:

• Federal, State and Local Taxes account for about 15% of the price per gallon.
• The price of crude oil accounts for roughly 55% of the price per gallon.
• The cost of refining the oil is about 15% of the total price per gallon.
• Advertising costs also make up about 15% of each gallon of gas.

This is just an average breakdown. The actual numbers vary from year to year and company to company.

Now, the taxes I understand. I’m not happy about it, but I get it. I also understand the refining costs and the advertising costs. Based off of these numbers, I decided that the main reason I am getting my pocket picked twice a week when I fill up has to be the base price of crude oil, which is at an all time high.

So, what’s going on with crude oil?

High Demand:

Right now there is a booming commodities market where there used to be hardly any at all. Namely, all over Asia – especially China and India. They are demanding all types of commodities in quantity, especially oil. Over here in the U.S. much of the way we live our lives also depends on oil. Not only do we put the refined version of it into our cars as gas, but it’s used in everything from plastic bags to Styrofoam. Even though oil prices are at an all time high, our demand is not really decreasing.

Low Supply:

There have been disruptions in the supply of oil all over the world in the last few years. Nothing that would normally make much of a difference, but when you couple it with record demand for oil and oil based products, it is pushing the price up. Here are a few specifics:

• In April of 2008, Nigerian rebels launched attacks on Exxon Mobil. They temporarily stopped production of 800,000 barrels of oil a day.
• On July 18,2008 Eni SpA (Italy’s largest oil company) also stopped production in Nigeria because of faulty pipelines. They will lose 47,000 barrels a day until the problem is fixed.
• Saudi Arabia (which claims to own about 21% of the world’s oil) isn’t exactly falling all over itself to increase production – but they are finally going to. The good news is, they are planning to increase oil production by as much as 500,000 barrels per day starting this month. (July 2008)

Fear of a Limited Supply:

Many economists buy into a theory that we are reaching “Peak Oil.” That’s the theory that the world’s oil reserves are limited and that we will eventually hit a point where we reach a maximum output. A place where companies will begin to cut back on production to avoid running out of oil.

While there’s no arguing that oil reserves are limited, exactly when we will reach “Peak Oil” is anyone’s best guess. With the increasing demand from Asia, this theory is getting more and more attention.

Some people even speculate that Saudi Arabia has refused to produce more oil because they are afraid of reaching a “Peak Oil” phase sooner than anticipated.

War in the Middle East:

Obviously, things aren’t looking too good over there. If Iran is attacked and they actually back up their threats by closing off Straits of Hormuz then they would effectively cut off one fourth of the worlds oil supply. If that does ever happen, oil prices at $200 a barrel will seem generous. The threat of that alone is probably driving oil prices higher than they have to be.

The Declining Dollar:

In some ways, it appears we can thank the housing bubble for the rise in oil prices too. The price of oil is measured in U.S. Dollars. When our dollar value declines compared to the rest of the world, then the price of oil goes up because it takes more dollars to reach the actual value of a barrel. (Gotta love that logic!)

It’s our fault too:

Yeah, I know, that’s a hard one to swallow. Still, some economists believe that as the U.S. economy takes a dive, most investors start looking for “safe” places to put their money. Usually, they turn to commodities. This actually drives the price of those commodities up because of the sudden increase in demand.

So, what do I think about all this?

There are some investors who believe that oil prices are in a bit of an unnatural bubble right now. While I do agree that prices are at record highs, I also believe that this is just a natural part of the commodity process. Commodities run in cycles. When demand outstrips supply, prices rise. Usually there is a short period where supply stays low, and prices stay high.

Eventually, more and more companies with $$ signs in their eyes jump in and increase production. In the mean time, we (the consumers) simply find ways to do without whatever it is as often as we can. So, eventually the increased supply and decreased demand helps the price to “right itself”.

There are a couple of wild cards in this scenario. Mainly the increased demand from developing countries and the threat that we may be running out of oil sooner than anticipated. Still, I believe that eventually the price will right itself (though I don’t think the price of gas will ever return to it’s pre-cycle lows).

In fact, I think that if you truly understand the principles of supply vs. demand, as well as how the economy, and government factor in, then you can apply that knowledge to any commodity. The same rules are still going to apply, whether you are talking about oil, or oranges.

Allright. I’ve told you what I thought – It’s your turn!

Do you think we are about to see a turn around in gas prices? Do you think now is a good time to begin investing in oil, or a good time to start selling your shares?

Let me know – you can use the comment form below! And, if you loved (or hated!) this article, then this post explains how you can offer your feedback for a chance to win $50. Thanks!

Photo © Connie Brooks

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What does investing in natural resources mean?

When you choose to invest in natural resources (also known as commodities) you are investing in the building blocks of civilization.

In other words, commodities are materials that we use to make the finished products that we buy. Fritos are not a commodity, but the corn they are made from is. Jewelry is not a commodity, but the metal it’s made from is.

Other examples of commodities include: Oil, wheat, sugar, coffee, cocoa, orange juice, natural gas, and precious metals.

Just think of all the things that our ancestral traders traveled far and wide to acquire! Today we are not much different. We still need many of the same things, and as long as we do, there will always be a steady market for commodities.

So, how can commodities save my assets?

Adding commodities to your investment portfolio performs one simple (but valuable!) task. It offsets your risk. There will always be a market for wheat, corn, and gold. There may not always be a market for the next big Dot.Com, and that brand new cure-all drug could turn out to cause Jekyll and Hyde symptoms. When you have commodities safely in the backseat of your portfolio you are free to take a little more risk in other areas.

So, how do I start investing in commodities?

Investing in commodities can be as hard, or as easy as you want to make it. You can take on large amounts of risk and hope for a quick profit, or you can take very little risk at all and use commodities to stabilize your overall portfolio.

Here’s a rundown of some of the ways you can add commodities to your portfolio:

Commodity Mutual Funds:

A Commodity Mutual Fund is a professionally managed fund where investors pool their money and buy stock together. Because mutual funds are professionally managed, they have to pay the manager. Sadly, the management fees alone can eat up your profits pretty quickly. Also, in order to invest in most mutual funds you required to have at least $1,000 to invest. Because of the high fees, low yield, and high price of getting into the funds, I typically prefer Exchange traded funds.

Exchange Traded Funds (ETF’s):

ETF’s also buy groups of stocks. However, instead of a group of individual investors pooling their own money, ETF’s usually have backers with deep pockets who put up the money for the funds. Then, they give investors the ability to buy shares in the fund itself, rather than it’s individual stocks.

It’s kind of like buying into someone else’s pre-diversified portfolio. This way, you don’t have to take the risk, or have the money, to invest in all of the oil companies in America. The fund does it for you, and you buy into the fund. It’s cheap, and instant diversification. ETF’s also have very low management fees, so you have more of a profit margin when the fund does well.

This is the type of commodity investing that I believe will save your assets in the long run. You may never make an enormous profit quickly, but you can usually expect reasonably solid, steady performance.

Of course, I am not an all-powerful wizardess that can predict the future of the market, and I can’t leap tall buildings in a single bound either. Your mileage may vary. See your doctor before beginning any exercise program.

For a list of just a few of the Natural Resource ETF’s available you can visit this site.

Individual Corporations:

Now, we are talking about a lot more risk with this one. Always remember that when you put your money into a single company, you had better be sure it’s a worthy investment. After all, if the company goes under, so does your money!.

That said, there are an unbelievable variety of individual companies you can buy into. In fact, if you pick a commodity; let’s say, oranges, you can invest in companies that handle nearly every stage of their growth and production. You can choose to invest in the orchards themselves, or in the companies that distribute the finished products to your local supermarket – whatever sounds most attractive to you.

Futures Contracts:

No article on commodities would be complete without a mention of Futures. This is an extremely high risk method of investing. Not too many brand new millionaires walk out of Vegas, and for every person who makes a mint buying futures there are thousands if not hundreds of thousands of people crying all the way to the bank. So. Be warned. Don’t expect this type of trading to offset the risk in your portfolio. This would be the risk in your portfolio.

How it works: Futures contracts are speculations, pure and simple. When you purchase stocks or bonds you do actually own something tangible, even if it is only a small percentage of a company or a debt. When you purchase a futures contract you do not actually own anything at all. Instead you are betting that the price of a given commodity (like coffee) is going to rise in the future. If you thought the price of coffee were going to fall in the future, you would sell your contract.

So why would anyone do this? The Reality Based Trading Company has an excellent example on their web site.

On one side of a transaction may be a producer like a farmer. He has a field full of corn growing on his farm. It won’t be ready for harvest for another three months. If he is worried about the price going down during that time, he can sell futures contracts equivalent to the size of his crop and deliver his corn to fulfill his obligation under the contract. Regardless of how the price of corn changes in the three months until his crop will be ready for delivery, he is guaranteed to be paid the current price.

On the other side of the transaction might be a producer such as a cereal manufacturer who needs to buy lots of corn. The manufacturer, such as Kellogg, may be concerned that in the next three months the price of corn will go up, and it will have to pay more than the current price. To protect against this, Kellogg can buy futures contracts at the current price. In three months Kellogg can fulfill its obligation under the contracts by taking delivery of the corn. This guarantees that regardless of how the price moves in the next three months, Kellogg will pay no more than the current price for its corn.

For more information on the buying and selling of futures contracts, you can visit this site.

In the next article we’ll talk a little about how to research potential investments step by step, so stay tuned!

What do you think is the best way to invest in natural resources? You can give us your opinion below!

Trading Places promotional photo courtesy of Paramount Pictures. 1983

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