Soft commodities are commodities that are harvested and not mined. Some investors also call them agricultural commodities. Typical soft commodities include wheat, soybean, coffee, cocoa, and sugar. There are investors who limit the term to tropical goods such as oranges and cotton, but any type of commodities that is grown is a really a soft commodity. Soft commodities play a big role in the futures market because farmers often try to guarantee good prices for their crops before harvest time comes. They are also a part of many speculative investors’ portfolios. Like any other investment, soft commodities have their own particular benefits and drawbacks.
People are always going to need food. In fact, considering the world’s burgeoning population, the demand for food is guaranteed to rise. Farmers continually work to improve their yields to meet the demand, so investing in soft commodity futures can be a good way to make a nice profit trading futures contracts. Investing in soft commodities can also be a good way to break into emerging markets. For example, investing in coffee is one way to break into the lucrative Brazilian market, which produces approximately 33% of the world’s coffee. Like other future markets, you can use soft commodities to hedge your portfolio and help with capital gains and losses. Additionally, soft commodities are not vulnerable to financial market fluctuations like the stock market and mutual funds are.
Soft commodities can be a volatile market. Despite farmers’ best efforts to protect from crop losses, severe weather can completely undermine their efforts. By nature, agriculture can be a fickle business and investing in soft commodities can come with some big losses. Even though food prices are constantly rising, that does not mean you will always see the same price rise in your soft commodities. Yes, there is a growing demand for food and prices are largely determined by supply and demand; however, certain products may have a higher supply than others do. In other words, just because you invest in corn thinking that it is something everyone needs, that does not mean prices will rise if there is already an abundant supply of corn on the market. Last, but certainly not least, trading futures is risky and most soft commodities are traded as futures.
Determining whether you should have soft commodities in your portfolio is a personal decision. Like almost all investment decisions, the biggest deciding factor may be your risk tolerance level. Investors with a low risk tolerance tend to shy away from futures and options because of the higher potential for loss. On the other hand, if you have padded your portfolio fairly well and you are confident about your investment, you can make a lot of many on soft commodities. Soft commodities are a good way to diversify your portfolio, but you do research agricultural conditions every season and accept the fact that sometimes, unpredictable things will happen.