Commodities

What are Commodities?

A commodity is an agricultural product or natural resource that is interchangeable with other goods of the same type. They are often used as inputs in production and are traded freely around the world. This is possible because while the commodity may differ slightly from one producer to another, in general they are quite uniform no matter who the producer is. Commodities make up one of the major financial asset classes along with currencies, bonds, stocks, and real estate.

Popular Commodities

Commodities are split into hard commodities and soft commodities. The hard commodities are typically extracted from the earth and are limited in quantity. The most popular hard commodities include gold, silver, and crude oil. Soft commodities are typically agricultural products that are either grown, such as soybeans and corn, or raised like pigs for pork bellies.

How do I Trade in Commodities?

There are a number of ways to trade commodities and each has its own advantages and disadvantages. The common way to trade commodities for years has been as futures. This involves speculating on the price of a commodity at some future date, which could be a month, or even years away. In some cases, it is possible to trade commodities by buying the physical commodity. This is most common with precious metals like gold and silver. You could also indirectly trade in commodities by purchasing stocks of companies that produce the commodities, or by speculating in ETFs and mutual funds based on the performance of the underlying commodity.

One of the ways to trade in commodities though is through the use of CFDs. These are contracts in which you trade against a broker and speculate on the direction the price of a commodity will take. So, if you buy a gold CFD you are speculating that the price of gold will rise. If it does, you can sell the CFD and collect your gains. However, if the price falls you will lose the amount invested, when you close out the CFD.

Precious Metals

Precious metals are some of the most popular commodities. These include gold, silver, palladium, and platinum. Some also include copper in this group, even though copper is an industrial metal. Speculating in precious metals doesn’t only involve the supply and demand for the metal itself, but also an understanding of the movements of the U.S. dollar, of inflation, and of all the geopolitical factors tied to gold and silver.

Energies

Energies are another very popular type of commodity. The energies include crude oil, gasoline, and natural gas. Traders like the energy commodities because they tend to trend very well. They are also seasonal in nature. For example, oil and natural gas prices may often rise during the winter when extremely cold temperatures are forecast. Gasoline may often rise in the summer in anticipation of rising demand from vacationing consumers. Because many of the energy commodities come from the Middle East, they can be quite sensitive to geopolitical risks in that region.

Trading Example

Let’s say you want to trade gold and you’ve decided to do so using CFDs. We’ll presume gold is being quoted at $1,821.00 bid and $1,821.50 ask. The ask price is what you’ll pay to go long. You can open a mini CFD on 10 ounces of gold, which represents $18,215 worth of gold. Furthermore, say you’re using 20:1 leverage. That means you’ll need to put up 5% margin, or $910.75.

If gold is at $1,851.50 a week later you’ll profit $300 on the trade, however if gold falls to $1,791.50 you’ll suffer a loss of $300 on the trade. The broker will take interest charges for the week that you held the contract, but you would roughly see either a gain or loss of 30% on your investment in this scenario.

Benefits of Commodities Trading

There are a number of benefits to trading commodities, and the most frequently mentioned is diversification. Commodities don’t correlate with most other assets, so they can provide some form of hedge against moves in other markets.

Speculators are also fond of commodities for their tendency to trend strongly, and for their volatility. Both of these may help provide an opportunity for good trades when the trader makes correct forecasts but sometimes these factors may have a negative impact to the trader. Finally, some commodities may provide an important hedge against inflation, which can be welcome when the value of currencies, bonds, and stocks is being eroded by inflation.

Disadvantages of Commodities Trading

Just as leverage increases the potential gains in any commodity CFD trade, it also increases the potential losses. This makes leverage a double-edged sword and both a benefit and a disadvantage when leverage is not used properly.

Another disadvantage, often not considered by aspiring commodity CFD traders is the amount of research and knowledge required to successfully predict commodities movements. The markets are very complex and it isn’t unusual for traders to get caught by geo-political risks they hadn’t considered.