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How to trade commodities
Commodities trading is a popular way to speculate on a wide number of different markets and assets. Here, we take a look at what it entails and how you can get started.
What are commodities?
The term Commoditiesis a broad umbrella that covers many products that are pretty much essential to everyday living. In this case, it’s raw, naturally occurring materials that are then processed in thousands of different ways, before turning into products everyone uses in their daily lives.
Crude oil, metals, gold, crops, sugar and so on are all part of the commodities family. These raw ingredients are taken away and turned into food, energy, and clothing.
One thing that sets commodities apart from other tradeable products is pricing. There is a higher degree of standardisation on prices worldwide. It doesn’t matter who is producing the asset or material in question.
For instance, gold produced in a Russian gold mine or Brazilian gold mine would have the same price.
This does change from asset to asset, however. It’s not a hard or fast rule. For example, certain crude oil blends are priced differently using different benchmarks, such as Brent Crude or West Texas Intermediate (WTI).
Why do traders like commodities?
There are a number of reasons why traders like commodities.
- Variety – With plenty of markets to choose from, traders can select to trade across a wide variety of markets.
- Safe havens – Some commodities, like precious metals, are strong value stores. They retain their physical value – even in times of global economic turbulence.
- Speculation potential – Prices of some commodities can be quite volatile. Just look at how oil has changed over 2020-2021 for instance. That means there is a lot of potential for high profits if you speculate correctly. However, this does mean you could lose more money too.
- Hedging against inflation – Commodities’ value is not pegged to currencies. If a currency’s value falls due to inflation, then a commodity may hold its value in contrast. As such, many traders and investors use them to hedge against inflation.
Adding commodities to an investment or trading portfolio is also a great way to increase diversification. A diverse portfolio, in theory, is more insulated against the risks inherent to financial trading. If one instrument or asset, say equities, falls, then the commodities could help cover those losses.
What commodities can you trade?
We briefly touched on this earlier, but there are lots of different options available to would-be commodity traders.
Generally, commodities can be split into four categories:
- Metals – This incorporates precious metals like gold and silver, as well as more common, industrial ores like iron, copper, nickel, and lithium.
- Agricultural products – This category includes both edible and non-edible products. Wheat, grain, cocoa, and sugar are edible commodities. Cotton, palm oil, and rubber are examples non-edible commodities.
- Energy – The energy market covers crude oil, gasoline, natural gas, coal, and heating oil. It also include renewable energy like wind power and solar.
- Livestock – Cattle, hogs and other live animals fall under the livestock category.
What drives commodity markets?
Price action in commodities markets is defined by supply and demand. Generally, the higher the demand the higher the price and so on. Low supplies coupled with high demand can lead to high prices too.
We’ve seen this recently with oil markets. Crude oil output had been negatively affected by the COVID-19 pandemic. Demand was low and output was minimal. As of October 2021, demand is high, but output is being kept relatively scarce by producers such as the OPEC+ nations to protect prices.
However, commodities prices can be more versatile than other assets. This is because there are lots of factors at play relating to their production. For example, livestock levels may be impacted by health issues, such as foot and mouth disease. A bad harvest will impact wheat prices. Weather can affect production of commodities, such as a hurricane shutting down natural gas infrastructure in the Gulf of Mexico.
Global economic trends can affect prices too. China and India’s emergence as industrial powerhouses has caused the availability of metals like steel to drop off in other nations.
The above trends make commodities prices hard to predict. Prices can show high levels of volatility. As such, it can be seen as riskier than trading or investing in other assets. Remember: you should only invest or trade if you can afford to take any losses.
How are commodities traded?
Commodities are typically sold on exchanges, in the same way stocks are traded on exchanges. In fact, many would say the birth of trading as we know it started with 18th and 19th century merchants trading crops.
At Markets.com, we offer commodities trading through contracts for difference (CFDs). These allow you to speculate on commodity price movements without owning the underlying asset. These are leveraged products, which means you can take a position with only a fraction of the trade’s value. This means your profits can be amplified – but so can your losses.
There are also commodity exchange traded funds (ETFs). These group together a number of assets into a single basket. Some ETFs will hold the physical assets they’re cover, for example a gold ETF might hold a certain amount of bullion or coins. Some are more complicated and synthetically mimic their underlying market.
A Markets.com account will give you access to a wide range of commodity markets, as well as thousands other assets. Open yours today and start trading your way.
Can the Fed beat inflation?
Perhaps the single biggest question mark over the broader economic picture and the macro-outlook is one of inflation. This is the key doubt we might have about the current pace of Fed policy and its willingness to look through what it sees as temporary rises in prices. Over the next few months, we will get a great deal more clarity over just how strong the inflation impulse is, how long it is likely to last and what this will imply for the path of inflation expectations, Treasury yields and Fed policy. The Fed says it will look through this – the question is really whether this is the right thing to do.
Quite apart from the asset price inflation we have seen for years; even by the relatively narrow gauge of inflation used by central banks, the kind of pricing pressures we are seeing seem pretty unprecedented. I think you are going to see Powell, Lagarde and co kind of get slapped around the chops by some hefty inflation prints over the next few months. Question is can they tough it out – bond yields will almost certainly move in one direction higher. The phrase ‘be careful what you wish for’ springs to mind.
Commodities are roofing. Corn, wheat and soybeans are trading around eight-year highs while coffee and sugar are also up strongly. It looks like there is a perfect storm of pricing pressures in the form or weather-related supply constraints and surging demand. Several factors at work: bad weather in the Upper Midwest has hit corn, whilst drought conditions in the Dakotas could also impact wheat and soybeans. The crops in South America are known to be lower this year, and demand is peaking in China and other Asian nations. Lumber prices seen a well-documented rally on a post-pandemic building boom. Copper is at a 10-year high on a mix of surging demand and supply problems in Chile, while palladium is at a record. Massive infrastructure spending is a factor, so too a major rebound in demand and supply constraints.
Last week’s PMIs told the story that has been talked about in this column for some months now. US manufacturing PMI reported input costs increased at the sharpest rate since July 2008 on severe supplier shortages and marked rises in transportation fees. The increase was the second-fastest on record as firms continued to partially pass-through costs to clients. And importantly clients can cope – consumer confidence is high, stimulus cheques have filled the coffers and people are ready to spend.
In the UK, IHS Markit recorded that rapid cost inflation persisted across the UK private sector, led by higher fuel bills, staff wages, commodity prices and freight surcharges. “A combination of greater operating expenses and stronger customer demand meant that average prices charged continued to increase at one of the fastest rates for the past three-and-a-half years,” the composite PMI reported told us.
In Europe, average input prices for manufacturing and services rose at the sharpest rate for ten years. Higher costs are usually being passed on to customers. “Average prices charged for goods and services rose at the fastest rate since January 2018, fuelled by a record increase in goods prices … Prices charged for services rose only modestly by comparison, though showed the biggest increase since the start of the pandemic,” the report said.
Meanwhile corporates are flagging the cost input inflation. Earnings calls have been charged with references to higher commodity and transport costs, which they will pass on to consumers. The comments from executives suggest their views do not seem to match squarely with the Fed’s view on a temporary inflationary impulse. The Fed looks set to be too accommodative for too long. It will ultimately need to start hiking rates really fast – if it wants the cycle to be a long one, it will need to act fast at the end of it.
Lumber prices roof to all-time high
Corn highest since June 2013, +37% YTD
Wheat highest since February 2013, +16 YTD
Grain and oilseed compared
Treasury yields rose yesterday, with the 10-year yield up at its fastest pace in 4 weeks to 1.64% ahead of the Fed statement today. Stock markets in the US were flat yesterday, whilst European bourses fell slightly. Big tech largely delivered: Alphabet shares jumped 4% as it reported a massive earnings beat as YouTube ad revenues rose 50% year-on-year. Total earnings were up 34% to $55.31bn vs $51.70 expected, as earnings per share hit a lofty $26.29 vs $15.82 expected. Cloud revenues were up 46%. Meanwhile Microsoft also reported earnings and sales that beat analyst expectations, driven by growth in the cloud. Still, with shares bid up ahead of the earnings the stock dipped a little in after-hours trade.
Elsewhere, oil rallied to a week high as OPEC+ kicked their April meeting down the road for a May gathering after having set out planned production increases through to May at the March meet. WTI (Jun) rose above $63, its best since its big decline on April 20th. Gold was weaker as Treasury yields rose. Bitcoin eased back to test the 38.2% level around $53,900 with near-term MACD showing a bearish bias.