I want to show you the best way to invest in gold and other commodities. But there is something you need to know...
Commodities are risky. One of the riskiest things an individual investor can attempt.
Really, the only people that make serious money in commodities trading are the brokers. They pocket hefty commissions from clients that speculate on gold, wheat, oil, cattle, lumber and even coffee.
But that gravy train is ending.
Wall Street's commodity trading revenues stand at just half of what they were in 2008. And the buying and selling of grains, metals, energy and other goods now accounts for a thin 6.5% slice of the overall trading revenue pie -- down from 30% five years ago.
Banks used to rake in billions, not just from commissions but from their own trading book. Now, position limits and other regulations put in place by the Dodd-Frank Wall Street Reform Act have reined in those profits. Some companies have exited the business altogether.
The smooth, quiet trading in many hard assets last year also proved to be an obstacle. That's because speculators like extreme volatility. The wider and more erratic the price swings, the greater the trading potential. It's much harder to extract profits from a flat market.
What do I think about all this? I say that futures contracts are best left to experienced pros and those who use them for hedging purposes, not sheer speculation. Betting on whether a price moves up or down (especially over the short term) isn't investing anyway -- it's buying a lottery ticket.
If you really want to invest in scarce natural resources such as oil and platinum, then buy shares in quality producers that own vast reserves of these critical goods.
One of my favorite precious metals producers, Goldcorp (NYSE: GG), has distributed 111 consecutive monthly payments, even in flat and declining gold markets -- you won't get that from a futures contract.
And if underlying commodity prices do rise, then production growth and operating leverage usually push profits (and stock prices) up even faster. Take a look at another producer, New Gold (NYSE: NGD), and you'll see what I mean.
Back in 2008, the company sold its gold for $863 per ounce, from which a cost of $566 was deducted, leaving a profit of $297. By early 2012 the price of gold had since risen to $1,575 per ounce. But New Gold's mining costs remained basically unchanged (in fact, they dropped to $543), so profit tripled to $1,032 per ounce.
Look at it this way... an investor who bought gold or gold futures would have netted a gain of 83% over this period. Not bad. But New Gold converted that into a more powerful 247% increase in profit margins ($1,032/$297). Earnings per share zoomed to $0.44 per share in 2011 from $0.12 per share in 2009, an increase of 267%.
Since 2008, shares of New Gold have jumped 1,010%.
So if you want to get the most out of every dollar increase in the price of gold, a stock like New Gold is a superior option.
Risks to Consider: This is not to say investing in producers is without risk. Many of these companies operate in parts of the world plagued by labor unrest, unfriendly governments and other hurdles. But, with just a little research, you can find solid producers to invest in.
Action to take --> My advice is to steer clear of the dangerous futures market and invest in commodities through reliable, fast-growing, low-cost producers.