Commodities are the basis of the global economy as they are the raw materials used to produce energy, food, and clothing.
They are natural materials processed for human consumption. They are traded on many exchanges and provide investors with an opportunity to profit from the changing prices.
Commodities Explained
As aforementioned, they are uniform or standardized in utility and quality regardless of their producers. Investors pay attention to commodities that have high demand across the globe and raw materials that can be used to create finished goods.
Commodities can either be soft or hard; soft commodities are grown products such as wheat, whereas hard commodities are mined or drilled and include energy products like oil and metals like copper and gold.
Types of Commodities
While they can be hard or soft, commodities are officially broken down into four categories:
1. Metals
These are mined commodities like gold, silver, platinum, palladium and other industrial metals like ore, zinc, and copper.
2. Energy
This category includes natural gas, coal, oil, uranium, and even ethanol. Note that commodities trading plays a significant role in determining oil prices.
3. Agricultural Products
Agricultura products cover a wide range of goods. They include consumable products such as coffee, sugar, cocoa, and grains such as wheat, soybeans, and corn. It also comprises inedible products like lumber and cotton.
4. Livestock
Livestock commodities include live animals such as hogs and cattle.
What is Commodities Trading
Commodities trading involves buying and selling metals, grain, and energy products. Traders can exchange different assets through futures contracts based on the value of the underlying assets. Commodities trading is driven by the aim to make profits through profitable arbitrage opportunities and market trends.
When using futures contracts, the investors make bets and predictions of the future value of the commodities. They could forecast that the commodity price will go up or fall. If they think the prices will go up, they buy futures; when they predict the prices will fall, they go short or sell off futures.
How Does Commodities Trading Market Work?
Through commodities trading, the prices of commodities are determined. Commodities are traded 24 hours by dealers in exchanges, meaning commodities’ prices are likely to swing every day. It also increases the risk of farming.
Commodities are traded through futures contracts, and they involve agreements to buy or sell the commodities at pre-agreed prices on a specific date and are priced on the U.S. dollar. This means when the dollar’s value rises, it will cost the traders lesser to buy the agreed quantities of the commodities.
The ripple effect is a drop in the commodities prices.
The other derivatives markets where commodities are traded are forwards and options. Commodities can also be traded in spot markets, also known as cash markets, where the buyers and sellers exchange the commodities physically for immediate delivery.
What are The Risks of Commodities Trading?
Like other trade in the exchanges, commodities trading has associated risks. Commodities are sensitive to various events that can cause unpredictable price swings. For instance, when the storage capacity of the commodities is exceeded, the commodities futures contracts prices drop.
Note that options and futures contracts feature high leverages, increasing the risk of losses in case of unprecedented events. The other risk of commodities trading is that they don’t offer dividends like other asset classes like bonds and stocks.
Contango, which is a situation where the value of futures contracts is higher than the current price, can negatively impact ETFs.
Drivers of Commodities Prices
The prices of commodities are driven by events that affect supply and demand. They include:
1. Politics
If political events affect imports and exports, they can affect the demand and supply of commodities, causing price swings. In other cases, the changes in import duties, such as an increase, will drive up commodities prices.
2. Competition
The introduction of alternative goods and technologies can affect the demand for a commodity. Oil and gas are among the commodities susceptible to competition and specifically from renewable energy sources.
The rise in demand and investment in renewable energy has reduced investment in oil and gas.
3. Macroeconomics
Macroeconomics is also a driver of commodities prices. When the economy is weak, purchasing power reduces and, as a result, also reduces demand for commodities resulting in low prices. When the economy is booming, the demand for commodities increases, causing a price increase.
4. Natural Disasters and Weather
Unfavorable weather conditions and natural calamities can affect production. Floods and droughts can affect the production of crops. Transportation of the commodities can also be affected, impacting the entire supply chain.
Take Away
There are several options for both experienced and beginner traders to enter the commodities market. It is critical to assess the risks of the different types of investments before settling for one.
Commodities are considered risky as they are susceptible to different events such as geopolitical tension, regulations, macroeconomics, and even natural disasters.
