As a trader you have a huge range of assets at your disposal to trade. One of the most popular asset classes is commodities. These are natural resources or agricultural products around the world that are traded on specific exchanges.
Getting into commodities is a popular route for anyone who is interested in trading. Whether you are brand new to trading, or an experienced trader, we will take a detailed look at how to get into commodities trading, what types of commodities are available to trade, and things you need to know about the market.
Basics of Trading Commodities
The first key point to note is that the commodities market is made up both of natural materials and agricultural products which are sold in bulk. They are generally sold on the markets by producers, and purchased by companies who need to use these materials. The commodities market is also a popular trading place for speculators due to the nature of how they are traded. Commodities are an asset class that rival stocks, bonds, forex, and others as one of the most popular for investors.
While commodities refer to natural raw materials and agricultural products that are traded, you will typically find them divided into two categories. Soft commodities, and hard commodities.
In the category of soft commodities you will find agricultural products like sugar, coffee, cotton, corn, and more. You will also find livestock in this category.
When it comes to hard commodities they include precious metals such as gold, silver, palladium, and platinum as well as oil, gas, and more. This category could also be further specified through terms like energy commodities, precious metals commodities, and industrial commodities.
How and Where You Can Trade Commodities
While the forex market is decentralized, when it comes to trading commodities there are specific exchanges in the world on which commodities are traded. The major examples in the world when it comes to commodities exchanges are:
- The New York Mercantile Exchange (NYMEX)
- Shanghai Metal Exchange (SHME)
- ICE Futures Europe (Formerly LIFFE)
These exchanges operate in similar fashion to any stock exchange, allowing for the trading of commodities contracts in the market.
You will note the term used here is “contracts”. This is due to the fact that commodities are traded in the form of futures contracts. Futures contracts are basically agreements to purchase a set amount of a particular commodity, at an agreed price and date in the future.
This essentially means that if you are trading in any commodities, you do not immediately own the underlying asset. This means you can trade in large volumes of commodities without having to take physical ownership of the asset.
You do though, have a contract with an expiry date. When this expiry date is reached your payment would “come due” and you would have to take delivery of the actual commodity you have traded. This is a very unlikely situation, and commodity futures prices will typically track alongside the actual spot prices of the commodity.
Who Usually Trades Commodities?
As mentioned above, commodities are typically traded on the futures markets by producers of the raw materials or products such as farmers, and miners, and the consumers who need these bulk materials to run their business. Here is a look at some common examples:
- Some farmers may decide to sell certain crops on the futures market. This will give them a stable price is not subject to market fluctuation for the future sale of their crop to the buyer.
- Oil producers are huge commodity sellers on the futures market. This oil will then typically be bought by refineries and others who have access to refineries.
This does not mean there is no room for individual traders in the commodities market. In fact, it is a market which is generally full of speculators. This could be in the form of CFD trading with your broker, or directly on the futures market.
Speculative traders will purchase a commodity contract in the hope that the price of the commodity increases and it can be resold prior to the expiration date.
What Influences Commodity Prices?
Commodity prices are influenced by a wide range of factors. With that said, there are always two constants when it comes to price influence in commodity trading with few exceptions.
Supply: Supply and demand will typically impact a commodity price in the same way as most other assets. If the supply is restricted, interrupted, or reduced for whatever reason, a commodity price will invariably rise. Similarly, if there is a lack of demand or an oversupply, a price drop is likely. The price of crude oil is one clear example of how supply can be altered to achieve a certain price level.
US Dollar: Since the majority of commodities are priced in USD the value of the dollar can have a significant impact on commodity prices. The Dollar and most commodity markets tend to have an inverse relationship. That means that when the Dollar is weak, commodity prices tend to increase, and vice versa.
There are of course exceptions to these rules, and a wide range of other factors to consider. There can also be a certain unpredictability to the commodities market. This can be seen in the recent example of negative prices for oil futures during the COVID-19 pandemic. This was a result of astonishingly low demand combined with a lack of storage space for purchased crude around the world.
Commodities not only make up some of the most essential raw materials and natural resources in the world for business but also form one of the most actively traded markets for investors globally.
While this comes with the same risks and market fluctuations you can see in many other markets, it can still present an opportunity if you are looking to further diversify your portfolio in a tried and tested manner.