In this 3 part series we are going to have a look at commodities, what are they, and how can you get involved with trading them. While there are so many diverse ways to trade them, some being relatively simple and others immense complex, we are not going to look at every single possible way to trade them. Rather, we are going to stick to the most common and most relevant ways that would apply to your average person wanting to diversify their trading portfolios.
Commodities are quite common in all of our lives, whether or not you realize it, you probably take part in the commodities market every day. If you fill up your car with petrol or diesel you are participating in the energies market. If you go grocery shopping on your way home from work, you are participating in the agricultural as well as the livestock and meat markets. Obviously, this is in an overly broad and derived sense. You aren’t actually placing futures orders in or taking part in an ETF, but you are purchasing the raw goods that the commodities market is based on.
So, commodities are basic goods that are used in commerce to exchange for other goods of the same or similar type. Some examples include oil, meat, grain, minerals, and natural gasses. The most common commodity that most traders know about is gold (XAU/USD) – although most people trade it in the form of CFDs (Contracts For Difference). They are directly proportional to supply and demand. The price of the good will depend on how much of it is available to be bought and how much of is it wanted to be bought (how many people want to buy it).
In a larger sense, for the likes of investors and possibly fund managers, commodities can be a way of diversifying their portfolios past traditional securities. Commodities have, in the past, tended to move in opposition to stocks. Because of this, commodities have been relied upon in times of market volatility or in bear markets.
Before we go any further, lets break down commodities into their four basic groups.
The four categories that most commodities can be put in are:
- Metals
- Energies
- Livestock and meat
- Agricultural
Metals
Commodities in this category include precious as well as basic metals such as copper, zinc, platinum, silver and of course gold. As mentioned earlier, investors tend to use commodities in times of market volatility or irrationality as a way of spreading risk and protecting capital. Gold is a favourite in times like these due to its status as a reliable dependable metal with real, tangible value. Investors also hedge their portfolios against periods of high inflation or currency devaluation using precious metals as they retain their value.
Energies
This includes crude oil, heating oil, coal, natural gasses, and gasoline. Investors or traders who are interested in entering the energy sector should be aware of how fundamentals have a large impact on the value of the raw goods. Economic downturns, changes in production enforced by the Organization of the Petroleum Exporting Countries (OPEC), as well as advances in alternative energy sources (wind power, solar energy, biofuel, etc.) that aim to replace crude oil as a primary source of energy, can all have a huge impact on the market price for commodities in the energy sector. However, reduced oil outputs from established oil wells and global economic development have historically led to an increase in oil prices since demand has gone up where supplies have dwindled. This is an example of how commodities are pretty must just supply and demand – as mentioned earlier.
Livestock and meat
This section would include lean hogs, pork bellies, live cattle, and feeder cattle. The worry here would be things like disease or famine. The livestock and meat futures used to be a lot more volatile but due to modern medicine and farming and rearing techniques, this sector has become a lot more stable.
Agricultural
Agricultural commodities are such a vital part of human life on this planet as it is the market that deals with our supply of food. In South Africa, we have had many scandals of large corporations burning or throwing out excess goods as a means of keeping the prices up (again, supply and demand). This sector would include things like corn, maise, soybeans, wheat, rice, coca, coffee, cotton, sugar, etc. During any period of weather-related transitions, such as summer, grains can be very volatile. For investors, population growth can provide opportunities for profiting from rising agricultural prices. It’s the idea that more people need food but there isn’t enough to go around – however, the debate on the veracity of that argument has been going on for a long time and is not relevant to this article.
So, now that we have outlined the types of commodities you get, how does one trade them? That will be discussed in the second part of this article to be published with the next edition of the newsletter.
For now, here are some of the basics:
- In layman’s terms, commodities can be rather risky investments due to their prices being influenced by things that we cannot control or predict.
- However, there are many ways to invest in commodities such as futures contracts, options, and exchange-traded funds (ETFs)
Until next time, Happy Trading!
Samuel Commons, Trader