The ChoosaBroker Trading Academy
Commodity markets are one among the very few investment vehicles that empower even an individual with limited capital to make astronomical profits in a relatively short span of time. Just ask the “Prince of Pit,” Richard Dennis, who borrowed $1,600 in the early 1970s and turned it into a whopping $200 million fortune in a little over ten years, speculating solely on commodities.
What is a Commodity?
- It must be standardized.
- It must be usable upon delivery.
- Its price must fluctuate enough to justify the creation of a market for it.
Types of Commodities: Agricultural and Non-Agricultural
- Soft Commodities – A soft commodity is a general label used to denote agricultural commodities that are grown on farms. Wheat, coffee, corn, cocoa, sugar and soybean are some examples of soft commodities. These have a limited shelf life and are prone to damage in the absence of favourable weather conditions. As such, the prices of soft commodities tend to be much volatile in the short term.
- Hard Commodities – They are either mined from earth or extracted from naturally occurring resources. Crude oil and gold are the two most widely traded hard commodities. Some hard commodities are also produced by processing other hard commodities. For example, heating oil is an important by-product of crude oil refining. Hard commodities are not perishable and are easier to store compared to soft commodities. Besides, weather seldom directly impacts production and supply. The prices of hard commodities are influenced more by global macroeconomic conditions and geo-political outlook.
- Meat Commodities – These are futures contract on livestock reared for meat. The four main meat commodities are live cattle, pork bellies, feeder cattle, and lean hogs. Meat futures are highly leveraged instruments and gain or lose in value depending on demand for the underlying asset.
Basics of Trading and Investing in Commodities
How are Commodities Priced?
- Changes in Weather – For starters, unexpected shifts in weather patterns can have a great impact on commodities, especially the agricultural kind. Since production is heavily reliant on climatic conditions, unusually hot summers or severe winters or too much rain or acute droughts can wreak havoc with production, curtailing supply in the market.
- Changes in Political Conditions – Geo-political uncertainty is a dominant market force as far as hard commodities are concerned. Any flare up in tensions in the Middle East for instance can trigger supply disruption fears, boosting prices of crude oil. This is exactly what happened when Saddam Hussein invaded Kuwait in 1990, propelling oil from $17 per barrel to $36 per barrel.
- Changes in Economic Conditions –The commodities market is one of the first to react to changes in the global economy. A downturn in an economy reduces the purchasing power of consumers, who in turn cut-back on their commodity expenses, stifling demand. In addition, commodities are a natural hedge against inflation, often producing the first signs of a general price rise. If inflation is imminent, commodity prices typically rise.
Commodities vs. Stocks
- Unlike stocks, investing in commodities is primarily done through the futures and options route.
- In the commodity market, a single product may have several varieties or grades. For example, three different gold contracts are available on the Chicago Mercantile Exchange – a standard 100 troy ounce contract, a mini 50 troy ounce contract and a micro contract of 10 troy ounces. In the stock market, one unit of a security does not differ from another unit of the same security.
- An equity investor can generate a steady income flow from company dividend payments. Commodities don’t yield any dividends.
- Investing in commodities is free from the perils of insider trading. Also, there are no company specific risks as experienced in stock markets.
- Commodity assets are often influenced by seasonal factors. Seasonality is virtually absent in stock markets.