Don’t Trade in Commodities Before Reading
Commodities are natural resources that have a global market, most of which fall into four categories of trading commodities which include: Energy (including crude oil, heating oil, natural gas and gasoline) Metals (including gold, silver, platinum and copper) Livestock and Meat (including lean hogs, pork bellies, live cattle and feeder cattle) Agricultural (including corn, soybeans, wheat, rice, cocoa, coffee, cotton and sugar).
Most commodities have a limited geographic distribution. Only certain nations, regions, or companies have economic access to these specific resources, but virtually every region needs the resources. Hence, a large global market has developed to enable the distribution of commodities from their most economical sources to where it is needed.
Commodities are physical assets and include metals such as gold, silver and copper, oil and gas, and so-called ‘soft’ commodities such as wheat, sugar and cocoa bean etc
Investment into commodity such as precious metals has grown significantly over the past decade, While gold has acted as a store of value for thousands of years, the recent performance of precious metals, their diversification benefits and inflationary concerns have restarted the discussion of this investment in commodity market.
Commodity prices have almost tripled over the previous decade.
Getting involve in commodities usually involves buying physical assets, such as gold coins or bars. This can be expensive, including the cost of storage and insurance. It is wise to buy at a low price but this can be difficult to achieve, particularly when buying in small quantities.
Investing in commodity, such as oil and gas is by buying shares in companies such as BP, Royal Dutch Shell or Tullow Oil. The same applies to ‘soft’ commodity companies.
Other ways of accessing the commodity market is via investment fund. This is an easy way to access the commodity sector because there provide a degree of diversification. They will typically invest directly in a variety of commodities as well as in production companies.
Some other ways of investing in the commodity market is via Passive funds. This have also risen in popularity over the past few years, with ETPs (exchange traded products) becoming a viable way to access commodities either indirectly or directly.
Equity-based commodity exchange traded funds invest in shares of commodity companies, whereas exchange traded commodities are instruments that track the price of the commodity or a basket of commodities.
However, ETFs only track an index such as oil futures, so there is little room for manoeuvre.
Commodity prices, like the prices of everything else, depends on supply and demand. Increased demand and lower supply increases prices, and vice versa. And because the supply-demand equilibrium for any commodity continually changes, so does its price.
Need to know before Trading Commodity
1. SEASON – The prices of many commodities are affected by the season, especially agricultural products. For instance, corn usually peaks in March and April before the growing season, and reaches a low in September and October.
Also crude oil prices tend to rise in the summer because of increased driving for vacations, while natural gas peaks in the winter since its main use is to heat homes.
2. Inflation – Commodities like real estate is a natural hedge against inflation. In fact, a rise in commodity prices may be the 1st sign of inflation. Indeed, if rapid inflation seems imminent, then commodities may rise even faster, because people will be moving money out of investments that don’t offer a hedge against inflation to the commodity markets to protect their assets.
As people moved much of their money out of stocks, bonds, and real estate, they moved some of it into the commodities market, which pushed up the prices of commodities, and further depressed stock prices because the profits of many companies are diminished when commodity prices are higher. This was the primary reason why oil prices increased 150% during the spring and summer of 2008 and naturally this increases costs for most companies, since virtually every depends on oil to some extent.
3. Weather/Forecasting – forecast of a colder than normal winter may cause the price of frozen orange juice to shoot up or the threat of another war in Nigeria or the Middle East may cause oil prices to spike or the threat of hurricanes that can limit oil refining can cause the price of gasoline to spike, which happened after Hurricane Katrina damaged oil refineries in the Gulf of Mexico. During the spring and summer of 2008 crude oil went from under $100 per barrel to almost $150 per barrel due mostly to speculation.
4. Political – There are also geopolitical risks with many commodities. Events in countries of major suppliers of commodities can cause the prices of commodities to gyrate wildly from day-to-day, such as happens to oil prices whenever there is civil conflict in Nigeria that may threaten the supply of oil. A major geopolitical risk for companies that extract natural resources is the threat of nationalization or major increases in taxes. For instance, in 2006, Bolivia nationalized the natural gas industry, and expelled the foreigners of companies that were extracting and processing their natural gas.
5. Currency fluctuation – Another major risk is currency risk, where the value of the currency used to buy the commodity can decline with respect to the currencies of the major suppliers of that commodity. For instance, when the value of the United States dollar declines against major currencies, the price of oil increases.
Hence, to be successful intimate knowledge of both the commodity and its market is necessary. Success also requires constant monitoring of news that may affect the supply and demand of the commodity, since the price depends on it.