Commodities are mostly generic, largely unprocessed, goods that can be processed and resold. They are usually agricultural and natural resource assets and range from rice to natural gas to gold. Commodities are typically not differentiated based on brands or benefits, i.e. gold from Kebbi is the same as gold from California.
Commodities are typically grouped into 4 main groups:
- Metals (e.g. gold and iron ore),
- Energy (e.g. crude oil and LNG)
- Livestock and Meat (e.g. live cattle)
- Agricultural (e.g. rice and cocoa)
Commodities are bought and sold purely on price. They are tradable assets, with prices set via interaction of demand and supply between a willing buyer and a willing seller on a commodity exchange.
Evolution of commodity trading
Commodity trading started off as sellers of commodities e.g. farmers converging on physical locations to trade their agricultural goods for cash from buyers. Prices were agreed, cash was exchanged on the Spot and contract for sale closed. “Spot” thus refers to a transaction for immediate delivery of goods specified in a contract and involves the immediate exchange of cash for commodities.
This spot trading evolved to the same farmers coming to the market to trade their expected harvest from their farms. Thus, a contract was drawn up, not for immediate delivery but for delivery in the future. Thus, buyers came to the market to buy Forward deliveries. These transactions were also settled, not for the physical goods but for the right to receive those physical agricultural goods from the farmers later, in exchange for payment today. The farmers put their goods on sale, and the buyers called out their intentions to buy.
A Forward contract specifies the transfer of ownership of a commodity at a future date in time. Both the farmer and buyer agree to terms on the contract including price, quantity, quality, delivery date and expiration date for contract. The contract is settled on the expiration date in the future by the farmer delivering his goods at that date.
The evolution of the commodities markets was complete when the initial buyers of the Forward Contracts from the farmers, sold their options and rights to receive those goods to other buyers. Thus, a secondary market was created where investors could come into these primary transactions and take positions on the future prices of commodity contracts, in effect, betting on the demand and supply of commodities. Most of these buyers were not end-users of the commodities, they simply traded to profit from price movements. The market to accommodate these investors offer them Options to buy and sell the commodity contracts in the future
Futures contracts are a type of Forward contract traded on organized exchanges. The commodity exchange formalizes the terms of the transfer. For instance, it sets the minimum quantity of say paddy rice that can be offered to be bid on and when that transaction will be settled.
The role of the commodity exchange thus becomes to standardize contract terms. This standardization in turn drives trading, price discovery and liquidity. Trading on an exchange also enables enforceability contracts that protect all parties.
Thus, we can summarize the function of the commodity markets as:
- Enabling price discovery
- Enhancing risk management by allowing buyers and sellers hedge against price fluctuations
- Guaranteeing performance by all parties
Commodities trading are essentially betting on future demand and supply. If paddy rice today sells for N131,666 and an investor believes demand for rice will increase in the future, meaning an increase in prices in the future, then he can buy a Future contract at today’s price for future delivery or a call option. These positions give him the right to buy paddy rice in the future but at today’s price. If prices rise, the investor can thus buy at the lower price and sell his commodities at the higher price.
Notice, the investor is not looking at “fundamentals” of paddy rice, he is just focused on determining the future demand and supply direction of paddy rice.
Similarly, if the investor believes paddy rice supply will increase in the future, thus leading to a fall in prices, the investor can buy a Put i.e., an option to sell at today’s prices today in the future, thus if prices fall the investor can still sell at today’s higher prices in the future.
Keep in mind, buying an option gives the investor a right. If the investor sells an option, he is giving another investor and option to demand action from him.
Selling options is very risky
Commodity trading is about actionable information that can be translated to investment decisions. The commodity Investor only must make two decisions:
- Will the commodity demand rise or fall leading to a rise or fall in prices?
- What is the appropriate trade to make?
Thus, the commodities trader is macro focused, seeking demand and supply assumptions to guide investment choices. Will the weather affect harvest of cocoa? If rains will be high and harvests will be poor, then the investors take a position by buying calls on cocoa. If harvests will be bountiful, the investor can sell puts on cocoa.
Why invest in commodities?
- Commodities are not correlated with traditional asset cases such as Bonds and Equities. Goldman Sachs calls Commodities a “portfolio enhancer.” According to the investment bank “Commodities are significantly negatively correlated with both Bonds and Equities, implying that even a small allocation to commodities will reduce portfolio volatility.”
- Commodities provide a hedge against inflation, as they perform well during periods of rising inflations. Primarily because the Commodities producers also raise prices to ensure their assets keep pace with inflation.
[READ ALSO: How to build up your investment knowledge)
How do you invest in commodities?
- Investing directly in the commodity, e.g. buying soybeans.
- Investing via Derivatives, e.g., Futures and Options contracts.
- Buying shares of exchange-traded funds (ETFs) that trade in commodities.
- Buying shares of stocks in companies that produce commodities
 The Case for Commodities as an Asset Class. GS 2004
Where to invest using PE, PEG
Investors should always look at the sector P.E. and compare that with individual stock P.E.
Assuming, you the investor is interested in buying shares in the banking space, you have about 100,000 to invest and you want to buy the best stock that will give you the greatest return at the lowest price. You have two banks in your investment universe; you prefer Bank A and Bank Z. Bank A sells each share for N10 and Bank Z sell each for N5
|Share||Market Price N:K|
Which would you buy? Well that easy, I would buy Bank A why? because it is cheaper. With N100,000 I can buy more shares of Bank A than Bank Z.
Hold on, not so fast.
The market price of any stock relates to the expected future earnings of that stock. For instance, Bank A’s share price of N10 means the Present Value of the sum of expected earnings that will accrue to Bank A over the life of earnings is N10. Hence you cannot simply compare the price of Bank A to the price of Bank Z, you must compare Earnings of both banks to determine which is “cheaper”.
So, to compare earnings, we use a ratio called the Price to Earnings Ratio (P.E.). Earning here is the earnings per share, which means we divide total earning by issued shares. Again, we assume a total of 1m shares issued by both banks. To calculate PE, first get earnings per share, so if bank A posted earnings of 1,000,000, and we have issued shares of 100,000 then Earnings per Share is (1,000,000/100,000) or 10. The P.E. for Bank A would be (10/10) or 1. A P.E. of 1 means the share price is 1 times the earnings of Bank A, very good. (lower P.E. is preferred). Let’s also assume Bank Z has a P.E of 0.5
Now if we look at table 2 which now compares prices to earnings, we can see the PE of Bank Z is lower than the PE of Bank A. This means Bank at price of 10 is trading at 1 times its earnings when compared to Bank Z which is trading at o,5 its earning, thus we can say that Bank Z is “cheaper” than Bank A because we are buying at a lower multiple of earnings
|Share||Market Price N:K||P.E. Ratio|
We can also say that if a company has a high price relative to her earnings, then that company is a Growth Stock. If, however the price relative to the earnings is lower, then the stock is a Value stock. A high growth sector like IT or biotech will have a faster growth and relatively higher PE ratio than a company in the utility sector with predictable steady earnings growth. Investors should always look at the sector P.E. and compare that with individual stock P.E.
P.E. is known as a trailing ratio because it is based on the past. Company can give forward guidance on earnings and that is used to create a Forward PE ratio. What if we wanted to compare both banks but this time instead of looking at past earning, we want to investigate the future and ask which bank we should buy using expected earnings as our main guide. To do this, we have to input expected earnings into the mix
Perform advanced finasncial calculations on Nairamterics
Let us assume Bank A is buying a smaller bank, and that will give her more branches, leading to higher growth in the future. Let’s say this will; lead to a 20% growth in earning year by year. Bank Z is not as aggressive and earning will increase, only 10% does this change the current recommendation?
It does and it introduces us to another ratio called the Price to Earnings Growth Ratio (PEG). The PEG is the P.E. of the Stock of the company divided by the growth rate of its earnings. We have already calculated the P.E. Ratio, so the PEG for Bank A is (1/20) or .05. This is an exceptionally good measure indicating the stock is undervalued. A PEG less than 1 generally means undervalued, more than 1 means overvalue
Top AgriTech deals currently on sale in Nigeria – June 2020
These options were picked from firms known to insure their farms and farm produce.
The month of June is coming to an end, but just before it does, Nairametrics is bringing you Agritech deals you should consider investing in. Ordinarily, this is not the best time for AgriTech investments, as the rains have started and most farmers are done planting.
However, there are still some late planting to be done, so this means there are some late deals you can take advantage of. From the details of these deals, you will discover those meant for funds you intend to keep long-term and those for the short-term.
These options were picked from firms known to insure their farms and farm produce. There are some AgriTech firms that should also be in this list, but this list only captured those which had deals open for sponsors and investors as at the time of writing.
Thrive Agric is quite popular in the Agritech space but as at the time of writing it, there was no farm deal open for sponsorship.
Wealth.ng also has a couple of agricultural investment options, but they have been completely subscribed by the start of June. Only real estate investments and stock options are open.
Farmcrowdy usually offers a variety of investment options, from maize farms to rice, potatoes, fish, cassava, poultry, cattle, but most of these options have been sold out and closed, after full subscription. Its farms located in Kaduna, Oyo, Ogun, Niger and Lagos states are all insured by Leadway Assurance.
Only one option is still available from Farmcrowdy as at the time of writing.
The Farmcrowdy food gives 10% Return on Investment (ROI) per annum with the minimum holding period of 7 months. The minimum investment is N20,000 being for the sponsorship of one farming unit.
At this rate, an investment of N100,000 would yield another N10,000 by the end of 7 months.
This investment funds covers the cost of production of several farm produce like potatoes, vegetables, and staple foods, and the farms are located in Lagos state.
Another deal you could consider is the Fish farm investment with Groupfarma. This investment gives 27% ROI. A unit of the fish farm investment can be sponsored at N52,000, and the Oyo based farm runs a nine-month farming cycle. The farm is insured with the Nigerian Agricultural Insurance Corporation (NAIC).
Farmkart also offers a fish farm option but with different terms. You need N100,000 to purchase a unit of this option, with 15% ROI over a period of a 6-month farm cycle. The investment funds cover the farm inputs, the pond rents, organic supplements, payment for the farm workers, insurance and the farm is located in Ijebu-Ode, Ogun state.
With the Groupfarma option, every N100,000 invested in the fish farm will yield N27,000 at the end of the 9-month cycle, while the same investment with Farmkart will give you a yield of N15,000 in 6 months.
The choice of investment here would be determined by how long you want the funds to be held.
The Federal Government had complained of the millions spent on importation of fish into the country. Worse still, Nigeria has been tagged the largest importer of fish and fishery products in Africa and the world’s fourth largest in volume terms (5.4% of global imports) after China, Japan and the US.
What these figures tell you is that any investment towards improving the aquaculture industry and fish production, has a profitable value chain. So, you might want to consider it among your options.
Payfarmer also offers a Catfish Farms investment where investors can sponsor a unit with N50,000 and expect 20% ROI after the farm cycle of 7 months. This means that N100,000 investment will grow to become N120,000 in 7 months. The farm is located in Epe, Lagos state.
Payfarmer has a couple other investment options still open as well.
The Payfarmer Pepper Farm investments opens at a unit entry of N25,000 investments and you get 12% returns with a minimum holding duration of 5 months. An investment of N100,000 here would give you additional N12,000, and if you are looking for an investment that frees up your funds just before the yuletide, then this would be a good option to consider. The pepper farm is located in Epe, Lagos.
Payfarmer also has several Pig farm options. The first requires a minimum investment of N5 million naira for a unit and gives you 34% returns with a minimum holding period of 10 months. This means one-unit investment here will yield of N1.7 million at the end of 10 months.
There is also another Pig farm option which allows an entry investment of N250,000 for a unit, giving you 28% ROI in 10 months. Every N1 million invested in this farm will earn a profit of N280,000 at the end of the cycle.
The third Pig farm option has a unit investment of N500,000 with a 30% return and a 10 months farm cycle. An investment of N1 million here earns N300,000 at the end of 10 months.
The fourth Pig Farm option allows a minimum of N1 million for a unit and gives you 32% returns in 10 months.
All of these pig farms are located in Epe Lagos. Again, it comes down to the investor’s choice and availability of funds.
Farmfunded is another popular name in the space and even though most of its plans are sold out, there is one still open.
The integrated rice mill financing offers impressive returns but, it is strictly for investors who have funds to hold in the long-term. Because the company is trying to increase rice production capacity in Nigeria all investments have to be held for a minimum period of 24 months at the end of which the investors get 80% returns.
To make things easier, the investor may or may not cash out his 10% returns every quarter (3 months) but will not have access to the capital until after 24 months. This ensures that the farms have a stable capital base to grow and expand over the next 2 years. The thousands of acres of land to be used for these are located in Kano State Nigeria.
If you have N100,000 to purchase a unit, and you decide to wait till the end of the 24 months period, you would be receiving a profit of N80,000 and a total of N180,000. The profit is not compound, so even if you don’t take your profit, it does not form a part of your investment.
The farm is located in Kano state and allows investors to provide funds which will be committed into the procurement of milling machine, and processing of paddy rice to premium parboiled rice. Considering the gap between local production and actual demand for rice, this looks like a solid investment plan.
The company has also sought to protect its base by ensuring that investors may cash out their profits, but not the base investment, so that it can be ploughed in again for the next cycle.
Note, however, that whatever your choice of investment, you should consider the holding period as against when you would need to liquidate your investments. The crux of the deals offered is to engage your idle funds and help them grow while you continue your hustle.
On SEC: Last May, The Securities and Exchange Commission (SEC) proposed a new set of rules that will regulate crowdfunding businesses and deepen the capital market in Nigeria. This includes AgriTech firms like those listed above. The commission plans to regulate the crowdfunding business in Nigeria in order to reduce the risks associated with it for investors and financiers.
Disclaimer: This is not an investment advice or guide as Nairametrics is not affiliated to and cannot vouch for any of the AgriTech firms listed above. Kindly do your due diligence before investing.
Time Value of Money Explained
TVM is a principle that everyone must understand how it works and its application in taking business decisions.
Let us talk this week about the Time Value of Money (TVM). This is principle everyone one, not just finance or accounting folks should know about and apply. Yes, it involves math’s
TVM simply means cash in hand today is worth more than cash tomorrow, why? Because cash in the future will come under the influence of factors like inflation which will affect its purchasing power. TVM allows the investors to compare two separate cash streams, employing quantitative methods, and select the best option.
For instance, you live in a flat in Lagos, your rent is N1,000,000 per annum, paid two years in advance. your landlord, informs you he needs cash and is willing to accept rent payment in advance for N900,000 for two years per annum if you paid now. You have two choices, pay N2m in full next year, or Pay N1.8m now. Which option will you choose?
A good way to solve this question is to ask how much in interest would an investor earn if the N2m is invested in a bank, that rate becomes our discount rate. Then compare this to the cash offer made by the landlord. So, we have our tenor of 2 years, we assume an interest payment of 5% per annum if money is put in the bank, we know our Future Sum is N2m. we want to determine how must that N2m paid in the future will be worth today.
This we determine with a Present Value calculation. Present Value (PV) is simply the current value of a future sum of money, at a predetermined rate of return. PV in our example is calculated as
Present Value =FV (1+R) ^n
FV is Future Value or N2m
R is the Discount rate or 5%
N is a period of 2
Thus, the PV of N2m invested for 2 years at 5% is N1,814,058.96. Now compare to N1,800,000 the landlord requested, we should not accept the landlords offer because the Present Value of N2m paid in two years is worth more than the value of N1.8m paid today.
Keep in mind we have no way of knowing what the interest rate in two years will be. Thus, it’s always a good idea to have a sensitivity analysis where we can project out scenarios on interest rates, thus we can project with 6% or 4%. The higher the discount value the lower the PV of the cash flow
PV can also be used for just planning when making any comparison of cashflows. For instance, if you had a daughter aged 5 who wished to go to Harvard when she is 18, and the cost of Harvard tuition is $50,000. How much should you save as a one-time payment to a bank today, to have $50k in your bank account in 13 years?
Present Value =FV (1+R) ^n
FV is Future Value or $50
R is the Discount rate or 2%
N is the period of 13
You will have to save in bulk today $38,651. What happens is the discount rate doubles to 4%, then your bulk payment today falls to $30028.70.
In our earlier example, we used a single lump sum and calculated the Present Value, what if the payments in future were not a lump sum but instead were spread out into the future, in a stream of equal payments called an Annuity. The principle will still be the same, but we change the formula and use the Present Value of an Annuity to calculate Present Value
You earn N500,000 a year, should you request a loan of N5,000,000 today at a 5% interest rate, or simply save N500,000 every year to get N5m and spend.
Again to answer this we have to compare 5m less 5% in cash today to the present value of an N500,000 paid every month. Again, our equation
PV is Future Value or N500,000
PMT is each stream of payment of N500,000
R is the Discount rate or 5%
N is the period of 10
The PV is N386,000. This means you are better off borrowing N475,000 today (500K less 5% interest cost), as it has a higher value than N386,000.
Today, you can calculate PV on your phone, simply plug in the numbers. You don’t have to be a math’s guru, however, you must understand the working of TVM and its application in taking business decisions.