INVESTMENT SPECIAL: Nature’s risks and rewards

A beginner’s guide to investing in commodities

The arrival on the London Stock Exchange of the Swiss-based mining and commodities behemoth Glencore, valued at £40 billion, has provided a rare insight into the mysteries of the natural resources world.

This remains a relatively little understood sector even though the first commodities trades can be traced back to biblical times (there are whole Talmudic tractates on the subject) and the modern world of trading financial futures owes its origins to pork- belly and corn trading at the Chicago Board of Trade.

What we have learned from Glencore’s initial public offering is that many transactions in physical commodities, natural resources and precious metals take place away from recognised exchanges, and involve traders taking controlling positions. Disclosures in Glencore’s prospectus revealed for the first time what a dominant player this hitherto very private company is in vital metals — with a global share of 60 per cent in zinc trading, 50 per cent in copper and 45 per cent in lead. It is also a huge player in thermal coal, with a 28 per cent share, and a significant force in grain markets with 9 per cent.

The lack of transparency and regulation in commodity and natural resource markets, together with the dominance of a few key traders, makes them a very difficult place to invest directly. Trades are more risky, market moves tend to be very lumpy rather than gradual and smooth, and liquidity can be difficult. Yet in the last year or so, as inflation has reared its head again and the dollar has come under attack, commodities have come into sharp focus.

There is a tendency in some quarters to see commodities as one seamless trade from gold to coffee. But that would be a mistake.