The Ups and Downs of Commodity Trading

    Emmah

    Commodities impact various aspects of our life, shaping prices of everything from food and household items to metals and energy. Trading in this area predates dealing with stock and bonds and was an essential form of business since the ancient times. Today, commodities take many shapes and forms and cater to varying risk and investment profiles. There are some unique advantages and disadvantages you have to weigh, but the problem is that some trading factors are borderline impossible to predict.

    Wide horizon of possibilities

    In the past, average investors used to steer away from commodity market due to steep requirements (time, money, and expertise), but that is no longer the case. Nowadays, commodity trading is a viable option for diversifying the portfolio beyond traditional securities. Even non-professional traders choose to go down this path and engage in transactions of primary and raw materials.

    First off, note that there are many commodity exchanges across the globe. The market can be virtual or physical space, which either features a few different commodities or focus on a single one. Also, commodities fall into the following categories: metals, livestock and meat, energy, and agricultural goods. So, the first thing to do is conduct the research and find a suitable platform for commodity trading.  

    Twists and turns

    Most often, these exchanges are subject to agreed-upon standards that facilitate transactions and the basic principles of supply and demand apply as usual. In general, the patterns are stable and predictable, but spikes in prices and major disruptions in supply are not exactly uncommon. Of course, some commodities have displayed more stability than the others.

    Take the example of precious metals, especially gold. It is a reliable material that has a conveyable value and can even serve as a buffer against inflation and devaluation. Energy trading, on the other hand, is a whole different ballgame. It is more susceptible to upward or downward surges as reactions to volatile global outputs.

    This reminds us that the prices of major commodities always fluctuate in the wake of production changes, economic downturns, ever-shifting demand, and technological advances. Some types of commodities, such as agricultural products, are also affected by unique agents like weather conditions and population growth.

    Futures contracts

    Furthermore, it is crucial to note that you can take multiple routes to the commodity market. One of the most popular ways to do it is via a futures contract. In a nutshell, it is a written agreement, which specifies (ahead of time) an amount and type of commodity that will be sold or bought. Commercial parties, institutional users, and speculators use them for every category of commodity.

    On the other hand, manufacturers and service providers utilize futures to outline budgeting processes and mitigate cash-flow hiccups. And if you want to take advantage of futures, you will require a brokerage account first. The leverage could bring you big profits. Alas, the downside is that the volatility of markets makes direct investments quite a risky proposition, while the leverage represents a double-edged sword.

    Other alternatives

    If that does not sound too enticing, you can opt for exchange-traded funds (ETFs) and exchange-traded notes (ETNs). Basically, you can capitalize on commodity price fluctuations without the need to invest directly in contracts. They trade much like stocks, which means that there are no redemption and management fees attached. However, the flip side is that there could be the discrepancy between market transactions and underlying ETFs or ETNs.

    Another type of an indirect approach is to invest via mutual funds and index funds. Namely, they do not invest directly in commodities, but rather stocks of companies in commodity-related industries (mining, for instance). And just like stocks, fund shares are affected by multifarious factors other than commodity prices. While the pros of this tactic come in the form of liquidity and diversification, the cons are high management fees and the non-pure play on prices.

    A lot of ground to cover

    There are many commodity investment opportunities out there that are worth considering. Commodity futures are the most direct approach, but that does not mean it is necessarily the safest one. The risk is always high, but so is the reward. Thus, newcomers to the world of commodity trading should tread carefully. There is no crystal ball: You depend solely on your knowledge, due diligence, number-crunching, and analytic skills.