Why Individual Commodities Have Fallen

In the first part of the feature, we outlined the three key macroeconomic factors which have driven commodity prices lower. But it's important to understand that while global factors can affect commodities, these staples are usually driven by highly product specific factors.

Commodities are driven by macroeconomic factors, but also differ by individual sector and product. This soon becomes apparent by comparing the year-to-date price movements of individual commodities. The price of WTI crude oil, for example, has fallen by 29 percent while the spot price of gold has only contracted by 4.97 percent. The price of copper on the London Metal Exchange decreased by 21 percent while Bloomberg's grain index dropped by 14.2 percent.

Martin Arnold, global commodity & FX strategist at ETF Securities, said: "It's a good idea for investors to understand the very divergent factors which drive individual commodity prices."

OPEC Plays Havoc With Energy

Energy is the largest and most important commodity sector. The recent slump in the price of the black stuff has been driven by oil cartel OPEC keeping its taps turned on, despite increased supply. Jodie Gunzberg, global head of commodity indices at S&P Dow Jones Indices, said: "As long as OPEC continues to build inventory, prices will remain low."

The situation is made all the more complex by China's decision to stock pile their strategic petroleum reserves. Gunzberg said: "If China decides to use this supply, it could keep oil prices lower for longer."

China Dictates Precious Metal Prices

The price of industrial metals is largely determined by the performance of the Chinese economy. Gunzberg said: "Ironically the stronger dollar has kept a lid on the cost of producing copper making it easier for mines to maintain supply."

Gold, however, is driven by quite different factors. Gunzberg said: "This metal acts as a currency, tending to rise when fears about inflation mount."

The huge success of physical gold exchange-traded funds has also exacerbated the falls in the price of this metal as volume has unwound.

Gunzberg said: "It's unlikely we will see a recovery in the price of gold as there is little fear inflation is likely to spike and investors continue to sell physical gold ETFs."

It's Raining – Again!

In contrast, agricultural prices are principally driven by the weather. Gunzberg said: "Crop yields were better than anticipated resulting in higher inventories which kept prices down."

However, the perishable nature of these products along with the high probability of El Niño makes it likely prices will soon bounce back. Gunzberg said: "This might be the first sector to recover."

In theory, investors with a particular view on a specific commodity could buy an exchange-traded commodity. But these products use derivatives to achieve their exposure. Adam Laird, head of passive investing at discount broker Hargreaves Lansdown, said: "The costs of rolling these derivative contracts can erode any returns."

Buying The Whole Basket Instead

A better way to get exposure to a specific commodity could be to buy a mining or resources sector ETF.

Laird said: "Then the investor can benefit from the profits generated at the company."

However, this would introduce equity exposure and might not suit an investor who wants to invest in commodities to provide portfolio diversification.

Perhaps the most sensible way to access commodities is to buy a product tracking a broad index, as diversification can help to keep a lid on the volatility of individual products.

Not All Broad Indexes Are The Same

As each index has a slightly different exposure to alternate commodity sectors, investors can find the index that best matches their view of which commodity sector is most likely to recover first.

For example, the S&P GSCI Index is heavily exposed to the energy sector while the Bloomberg commodity index is more evenly split between the different sectors. Andrew Walsh, head of UBS ETF sales UK & Ireland, said: "It's important that an investor picks the index which most accurately reflects their investment outlook."