Commodity-Linked Securities: Explained | Investment Guide

Commodity linked securities are investment instruments or securities that are linked to one or more commodity prices. Unlike commoditiesCommoditiesCommodities are another class of assets just like stocks and bonds. Most commodities are products that come from the earth that possess, which provide no income to the owner, commodity linked securities usually give some payout to holders.

Commodity Linked Securities – Bonds

Commodty linked bonds are securities offered by governments whose yield depends on the price of a specific commodity or a global inflation index. Historically, governments offered loans with couponsCoupon RateA coupon rate is the amount of annual interest income paid to a bondholder, based on the face value of the bond. or principal indexed to the price of a specific good or a global inflation index during times of high inflation. Commodity linked bonds include an explicit indexation clause, i.e., the bond, by construction, is linked to the price of a commodity or a set of commodities.

• Inflation-indexed gilts first became popular in the UK during the 1980s. The principal and coupons of the bonds are linked to British retail prices.
• The United States first offered Inflation-Indexed Securities in 1997 when the US Treasury introduced the Treasury Inflation Protected Securities (TIPS). The first TIPS was a 10-year government bond that provided a real return of 3.45%. The principal amount is adjusted based on the Consumer Price Index (CPI)Consumer Price Index (CPI)The Consumer Price Index (CPI) is a measure of the aggregate price level in an economy. The CPI consists of a bundle of commonly purchased biannually. The CPI-adjusted principal is reimbursed after the bond matures.
• Gold bonds and bonds that promise returns based on the price of gold were popular in Europe after the First World War. The bonds were seen as a substitute for holding actual gold bars or coins, which came with high storage and maintenance costs.

Commodity Linked Equities

One form of commodity linked securities is equity issued by companies whose value depends on the price of a commodity or several commodities. The most straightforward example of a commodity linked equity is the stock price of energy companies such as Shell and BP.

• Oil and gas companies are directly affected by the evolution of oil prices. Commodity linked equities include an implicit indexation clause, i.e., the stock is implicitly linked to the price of a commodity or set of commodities through the market. Oil companies often take advantage of economies of scaleEconomies of ScaleEconomies of scale refer to the cost advantage experienced by a firm when it increases its level of output.The advantage arises due to the and reduce such risk through expansion and vertical integrationVertical IntegrationA vertical integration is when a firm extends its operations within its supply chain. It means that a vertically integrated company will bring in previously.
• Gold mining companies are directly affected by the evolution of gold prices. Unlike gold-linked bonds that contain an explicit indexation clause (via a contract), the value of a gold mining company depends on mining economics, i.e., the cost of extracting gold vs. the revenue generated by the extracted gold.

Additional Resources

Thank you for reading CFI’s explanation of commodity linked securities. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

• Capital Gains YieldCapital Gains YieldCapital gains yield (CGY) is the price appreciation on an investment or a security expressed as a percentage. Because the calculation of Capital Gain Yield involves the market price of a security over time, it can be used to analyze the fluctuation in the market price of a security. See calculation and example
• Guide to Commodity Trading SecretsGuide to Commodity Trading SecretsSuccessful commodity traders know the commodity trading secrets and distinguish between trading different types of financial markets. Trading commodities is different from trading stocks.
• Marketable SecuritiesMarketable SecuritiesMarketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion.
• New York Mercantile Exchange (NYMEX)New York Mercantile Exchange (NYMEX)The New York Mercantile Exchange (NYMEX) is a commodity futures exchange located in Manhattan, New York City. It is owned by CME Group, one of the largest