Commodity Exchange report © Fotog, Tetra Images, Corbis

It used to be that most individual investors seeking to bet on commodities faced a stark choice: buy shares in companies that produce raw materials, or drill for oil near the bullion buried in the backyard.

Now individuals have a much wider range of options, thanks to a growing menu of mutual funds and exchange-traded funds.

In addition to funds that hold commodity-related stocks, which have been around for decades, there are ETFs that invest in physical metals and commodity futures, as well as some more narrowly drawn commodity-stock portfolios.

All those options mean more opportunities -- and a lot more confusion for investors. But fund managers say there are some general guidelines that can help investors zero in on the kind of commodities exposure they want and the investments that can help them get it. When trying to decide how to play the commodities game, they say, investors should keep these points in mind:

  • Commodity prices can be volatile, but investors who are convinced they know which way prices are heading in the near term -- and want to bet on their conviction -- may have a better chance of a big payoff if they're right by investing in funds that hold futures or physical materials, rather than stocks.
  • Shares of commodity producers can sometimes rise over time even if the material they produce is getting cheaper or prices are stagnating, because companies can add value and cut costs.
  • Funds that hold futures or physical materials can provide diversification because they are less likely to rise or fall in tandem with the stock market.
  • Some major materials, such as iron ore, are difficult to wager on except through equities. On the flip side, few big publicly traded companies are direct producers of corn, wheat and some other crops.

With those guidelines in mind, here is a look at three growing parts of the raw-materials landscape and some of the ways investors can play them, using mutual funds and ETFs:

Metals

What's available: There may be no other single commodity for which there is a wider variety of investment choices than gold. In addition to funds that hold gold futures and funds that hold mining stocks, there are ETFs backed by bullion. One fund even stores its bullion stash only in politically neutral Switzerland.

What investors should know: Gold is a prime example of how commodities can provide diversification. Gold prices are on track to rise for the 12th consecutive year, during a time when the stock market has seen the most breathtaking swings in decades.

What's more, gold prices haven't necessarily tracked the performance of companies that mine the metal. Last year, gold prices logged a 10% gain, while the Market Vectors Gold Miners ETF ($GMI) fell 16% as many miners struggled with rising costs, among other challenges.

More recently, however, mining stocks have risen more strongly than gold as investors concluded the shares had become unreasonably cheap. As of Aug. 31, gold prices had climbed 12% since hitting a low for the year in mid-May, while the Market Vectors fund surged 34% over the same period.

Mining companies are trimming expenses and giving better guidance to investors, says Joseph Foster, a portfolio manager who specializes in precious metals at Van Eck Global, which operates the Market Vectors Gold Miners fund.

Keep in mind that funds holding physical gold likely will follow the gold price more closely than funds that hold futures. That's because buying new monthly futures contracts to replace expiring ones can erode returns if they are more expensive, or boost returns if they are cheaper. Whether those new contracts are more expensive or cheaper depends on supply-and-demand dynamics, which can change rapidly.

When it comes to metals that aren't widely traded on futures exchanges, fund options are more limited. Owning shares in large mining companies such as BHP Billiton (BHP), Rio Tinto (RIO) or  Vale (VALE), for example, is often a more practical way for investors to make bets on materials such as iron ore and coal, which are too bulky to store efficiently.

If you want exposure to the iron-ore price or the coal price, "you've got to take the equities," says Graham Tuckwell, chairman of ETF Securities, which runs several commodity funds backed by physical commodities, but not for those two materials.

Energy

What's available: Investors who want to bet on energy prices can either buy funds that hold shares of energy companies or invest in funds that hold futures linked to oil and gas.

For those who decide to take the equities route, fund choices are plentiful. Some funds hold big stakes in oil and gas giants, while others home in on niche markets such as oil-services firms. For investors interested in futures, there are ETFs focused exclusively on oil or natural-gas futures, as well as broader commodity ETFs with a heavy energy component, such as the iShares S&P GSCI Commodity-Indexed Trust ($GSG).

What investors should know: As with gold, events in the energy market can affect futures and stock investments differently. Oil prices may rise sharply in a crisis without dramatically lifting the fortunes of oil companies, which may be exposed to fresh political or economic risk.

When an uprising in Libya last year sparked concerns about lost crude supplies, oil prices leapt but many oil-company stocks fell amid concerns for the broader economy. In the month after those concerns spiked in mid-February 2011, U.S. oil prices climbed 17%, but the Energy Select Sector SPDR ETF ($XLE), which has oil giants ExxonMobil (XOM) and Chevron (CVX) as top holdings, fell 2%.

"First thing I do is ask (investors) what their time-frame is," says Doug Ober, chief executive of a closed-end fund that largely, but not exclusively, holds energy-related stocks. "If a person believes that in the next three months, Israel is going to bomb Iran and the price of oil will go up, we're not the place to go," he says.

The prices of oil futures -- and thus futures-owning ETFs -- often respond more directly to supply-and-demand changes, while companies may or may not be exposed to those dynamics, depending on how or where they process or consume oil.

Agriculture

What's available: Investors seeking exposure to crops and livestock can buy funds that hold shares of agriculture firms or funds that hold futures linked to those goods. But unlike gold, farm products are perishable and bulky, so getting exposure to the actual goods is hard for investors without a silo or ranch.

What investors should know: For stock-market fans, one challenge is that few publicly traded companies are directly involved in producing corn or wheat. The Market Vectors Agribusiness ETF (MOO) holds stock in firms such as farm-machinery maker Deere (DE) and agricultural products provider Monsanto (MON), which can benefit when crop prices rise, but not necessarily to the same extent or at the same time.

The Teucrium Corn Fund (CORN), which is issued by Teucrium Trading and holds corn futures, rose 15% from the end of June through Aug. 31, boosted by a U.S. drought over the summer that sent corn prices to record highs. MOO, however, rose 4% in that same time.

There are funds that hold a broad basket of agricultural commodities, including the PowerShares DB Agriculture Fund (DBA). But investors who wager on agriculture futures need to be especially alert to changes in the supply-demand balance, which can shift rapidly.

This past spring, U.S. farmers planted more corn than in any year since the Great Depression, and the U.S. Department of Agriculture forecast a record crop, depressing prices.

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That projection fell apart within the space of a few weeks this summer because of the drought.

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