Commodities are a variety of resources that have
been quantified or standardised. Exchanges have
established specific standards for each commodity.
This way, buyers and traders know exactly what
they are trading and what the value is even without
seeing the product. Commodities include soft
commodities such as:
• Agricultural - soybeans, wheat, cotton, sugar, etc.
• Livestock - cattle, lean hogs, pork bellies, feeder
cattle
Hard commodities are those that need to be mined
or extracted such as:
• Energy - crude oil, natural gas, heating oil, gasoline
• Metals - gold, silver, copper, platinum
As society progresses, new commodities are added
to the trading centres. Commodities now include
plastics, iron and steel, machinery, and vehicles.
They may include things like wind, solar, biofuel, or
even carbon emissions or offsets and renewable
energy certificates.
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Commodities have symbols similar to stocks. West
Texas Intermediate crude oil goes by WTI and is a
benchmark for other oil standards. Wheat traded
on the Euronext Exchange goes by EBL and live
cattle go by LE. Contract sizes tend to be huge. Live
cattle trade in 20 tonne lots, wheat in 50 tonne lots
and West Texas Crude in 42,000 US gallon lots.
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Because lot sizes are so large, commodity trading
has traditionally been the province of hedge
funds and large institutional traders. Even trading
with leverage and margins requires a sizeable
investment and risk. Trading with CFDs lets people
trade fractions of lots and makes the trading
available to the average investor.
Commodity trading takes place in exchanges
around the world. Different exchanges specialise
in different commodities. Often they trade in the
commodity produced by their country or those
nearby. Some of the largest exchanges are:
• Chicago Mercantile Exchange - USA
• Tokyo Commodity Exchange - Japan
• Euronext - Europe
• Dalian Commodity Exchange - China
• Multi Commodity Exchange - India
• Intercontinental Exchange - Multinational
• African Mercantile Exchange - Kenya
• Uzbek Commodity Exchange - Uzbekistan
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The market that drives commodities is different
from that which propels stock exchanges. They
respond to different stimuli than stocks or
currency, and so offer another avenue to trade.
Weather, natural disasters, politics, and supply and
demand all inuence commodity prices. In areas
of political unrest, the market prices can uctuate
more dramatically.
For example, when there is tension in the middle-
east, oil prices react. A drought in the mid-west
section of the USA will affect wheat prices.
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Or alfalfa scarcity will drive up cattle prices. While
some of these issues may also affect stock or
currency prices, many of them will have a much
more volatile effect on commodities. This gives
traders the chance to profit in commodities when
the volatility may be low in other assets.
The Sumerians may have been the earliest people
to use commodity-based money or trading. As
early as 4500 BC they inscribed clay pots with the
commodity - grain or goats - to be delivered. Thus,
the beginning of futures contracts.
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People continued to trade gold and silver, pigs
and sea shells. In the 1400s reliable scales allowed
farmers to weigh their commodities for better
standardisation. And in 1530 the Amsterdam Stock
Exchange began using complex contracts like
options, forward contracts, and short sales.
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The
Chicago Board of Trade (CBOT), started in 1864,
was the first to truly quantify and standardise
commodities.
The CBOT started by trading agricultural products:
wheat, corn, cattle, and pigs with the kind of futures
contracts and options still in use today. By 1940
the CBOT had expanded to include a multitude
of soft commodities. In 1952 the Bureau of Labor
Statistics started publishing a Spot Price Market
Index that followed 22 commodities. Traders
started using it as an early indicator of possible
changes in the economy of the country.
It wasn’t until the 1990s that commodity index
funds were created. After all, it’s hard to hold the
perishable underlying assets. Instead, the funds
invested in financial instruments that were linked
to commodities in the index. The exceptions to this
were some gold and silver funds that actually held
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‘Commodity Market’, Wikipedia
101
Stringham, Edward ’The Extralegal Development of Securities Trading in Seventeenth Century Amsterdam’ Quarterly Review of Economics and
Finance. 43 (2): 321. SSRN 1676251
15.1 Commodity Trading History
214
the physical gold or silver in vaults.
The 1990s also saw expansive growth of emerging
economies in Brazil, Russia, India, and China.
Commodity exchanges expanded throughout the
world to feed the increased demand from these
countries. This commodity boom lasted until 2012.
By 2011 electronic trading had taken over the
buying and selling traditionally handled by oor
traders. This allowed high-frequency trading
and algorithmic trading that favour commodity
speculators. As speculators entered the market,
some feared they were ramping up the price of the
commodities.
People claimed rich banks and traders were
making money by starving people with high food
prices. An article in Forbes indicates this has little
merit.
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Over the last 50 years as the population
has increased from 3 billion to 7.2 billion, the cost
of food, as shown by the World Food Index, has
gone down. This decrease has come even as the
number of traders and speculators has increased.
There were also complaints that the commodity
traders increase price volatility and make it more
expensive for companies to hedge their costs by
fixing the price of the commodities they need. But
others said that companies and farmers need
the speculators as counterparties for the other
side of their trade. In 2014 the US Commodities
Futures Trading Commission (CFTC) set limits on
28 commodities. They restricted the amount of
supply speculators could use to trade.
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Traders of commodities can feel confident their
trades are not affecting market price. Plus, when
you trade CFDs you are free from any of these limits
because you are not trading the commodities, only
trading on the price changes that occur.
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Worstall, Tim, ‘Commodities Speculation Doesn't Increase Food Prices’, Forbes 10 Mar 2016 https://www.forbes.com/sites/
103
Fuhrmann, Ryan C. ‘The Role Of Speculators In The Commodity Market’, Investopedia 11 Aug 2014 http://www.investopedia.com/financial-
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Before you start trading commodities, it’s useful
to understand the specific language traders use.
Here is a brief glossary to get you started:
Cash Commodity: holding the actual asset of gold,
silver, oil, cattle, etc.
CBOT: Chicago Board of Trade. One of the world's
oldest futures and options exchanges.
Derivatives: These are contracts such as futures,
options, or forwards based on the physical asset.
They can be redeemed by the asset or, more often,
sold before the commodity transfer takes place.
Forward Contracts: An agreement between two
parties to purchase a commodity at a specific price
on a specific date. This is a form of hedging and the
settlement takes place on the closing date.
Futures Contract: These exchange-traded
contracts are standardised and the payment is
made at the beginning of the period and ‘settled’ or
rolled over each day until the end of the contract.
Speculators use these contracts to try to make
money on the changing price of the commodity
and typically close them out before maturity.
Margins: A certain level of funds needed in
your account when you use leverage to make a
commodity trade.
Margin Call: The requirement to deposit more
funds into your account to cover a commodity
trade that has lost money. This is done to bring
your account up to the appropriate margin needed
for trading. If funds are not promptly deposited,
the broker will liquidate a position to cover the
margin call.
15.2 Commodity Terminology
216
Options: Options give you choices. You can buy
or sell the right or the obligation to buy or sell a
commodity within a specific time. The end of the
time is called the expiration date. Buying a put
or call, gives you the opportunity, but not the
obligation, to collect the commodity if the price
rises (call) or falls (put) into the price you set for
the option. Selling a put or call brings you up-front
money. But it requires you to deliver the asset
if the price comes in the money or beyond your
agreed upon price at or before the expiration date.
This exposes you to unlimited risk if the commodity
spikes (with a call) or drops like a stone (with a put.)
OTC: Over the Counter trades. These are made by
two parties without going through the exchange.
It is more private and less secure.
Short Sales: This is selling a commodity you don’t
own. Traders who make short sales assume prices
will drop during the term of the contract and they
can repurchase the commodity at a lower price. If
they are right, they profit from the price difference.
If the commodity rises, they must pay the difference
between the sell and buy prices.
Spot Contract: Commodity delivery takes place
immediately or within a day or two of the contract
start date.
Standardisation: Specific tests and standards,
so traders know the quality of the commodity
they are buying. All coffee beans of a certain size,
colour, and species may be one standard. They are
identical even if they come from Panama or Kenya.
Swaps: The consumer gets the commodity at
a guaranteed price and pays in advance for the
commodity. The producer is hedged from a price
decline but gets a slightly lower price for the
commodity. Since he pockets the money up front,
the sales price is reduced by the interest earned
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on the money over the swap period. At the end
of the period, the swap can be settled with a cash
difference or with the commodity. Swaps are a
common hedge.
As has been explained above, there are many ways
to try to profit from commodities. Here are some
specific buying, selling, and trading strategies.
Consider your risk tolerance as you review them.
1. Own the Asset. If you live on acreage, you
might buy cattle or goats. If you desire gold, buy
the physical asset. If you heat with fuel, buy larger
tanks and store more. When you own the asset, you
take advantage of upward prices, but fall victim to
price drops. Still, the asset of gold or silver carries
intrinsic value and beauty, and many people own
it as a hedge against devaluing currency.
Owning the asset limits your losses to the amount
you invested.
2. Commodity Exchanges. By far, the majority of
trades take place on exchanges. Here the products
are of a standard quantity and quality. Commodity
exchanges are all over the world, with some trading
in a few specific commodities and some covering
almost all of them. Most individual traders, hedge
funds, and companies who speculate, trade on the
exchanges. These exchanges guarantee the trades
will be executed and honoured. However, they still
carry considerable financial risk.
3. Trade Commodities OTC. Usually companies,
farmers, and those who have or need the resource
use OTC (over the counter) contracts to buy or
sell commodities. These commodities may be
personally inspected to see the quality as they are
15.3 Nine Ways to Trade (or Own)
Commodities
218
not guaranteed to be a specific level or standard
by a governing body. Some commodities are not
sold on exchanges, such as rare metals, common
minerals, pressed oils, or vegetables. They are
only available OTC. OTC contracts can take the
many forms shown under futures contracts. These
contracts may expose you to more risk than your
initial investment and carry the additional risk of
default, where the other party does not fulfil their
part of the agreement.
4. Futures Contracts. The most common method
of trading is with futures contracts. The futures
contract specifies the:
• Commodity
• Exchange traded on
• Quantity
• Quality
• Delivery location
• Delivery date
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The seller agrees to deliver the commodity on the
delivery date. Speculators sell the contract before
the delivery date. The amount of a commodity in
any one contract is substantial. It will be thousands
of bushels or barrels, or tonnes of goods. Traders
use leverage to take advantage of price movement
without needing to have the entire cost of the trade
in hand.
You can buy (go long) or sell (go short) a futures
contract depending on the direction you think
the market will go. Long anticipates the price will
rise and you keep the profit when you sell. Short
anticipates the price will drop and you can buy it
back at a lower price. As the trade progresses and
your exit points are reached, most traders exit the
trade. They do not want to own the commodity,
only to trade on the price volatility.
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’Futures Markets - Part 4: What is a Futures Contract?’ Futures Trading Short Course http://futures.tradingcharts.com/tafm/tafm4.html
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Be aware that futures contracts are settled each
night, and a new contract price is in effect for the
next trading day. If the price has dropped, the
margin amount changes and the traders must
immediately ensure they have enough money in
their account to cover it. These overnight or carry
fees are shown on your trading platform. Traders
are ultimately responsible for the entire amount,
even when they have borrowed money from the
broker for the trade. This creates very high risk.
The longer you hold the trade, the more carry fees
you will incur.
5. Options. As mentioned above, options give you
a chance to buy or sell puts and calls. Most options
expire worthless or ‘out of the money’. This means
that traders who sell puts or calls usually just collect
the money and don’t have to pay out. But the risk
can be substantial if the price of the commodity
changes rapidly. The advantage of buying options
is that you limit your downside. The most you will
ever lose is the amount you paid for the option.
And if the commodity comes ‘into the money’ or
even closer to the agreed upon price before the
expiration date, you can make a nice profit. Some
traders use a mix of puts and calls, both buying
and selling at different prices or expiration dates
to minimise risks and enhance profit potential.
6. Binary Options. Binary options, or digital
options, are derivatives that trade on the underlying
asset. You don’t own the asset, rather, you buy
an option based on the direction you think the
commodity will trade. You can use small amounts
of capital and no leverage. You have a fixed price
and fixed payout or loss on a yes/no question.
Binary options can expire in an hour, a day, or a
week. Most binary options brokers are scams and
regulators are currently cracking down on them.
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Notice that the binary options trade does not
follow the price of the commodity; rather it varies
between zero and 100%. When the option expires,
the trade closes. Either you are right, or you are
wrong, two choices. That’s why it’s called binary
options. For example: Will gold rise above $1200
by 6pm tonight? You think yes, and open the trade
at the going rate - say $50. At 6pm, gold trades for
$1213. You are paid the rate fixed for this trade,
say $100 and earn a $50 profit. If it closes at $1195,
you lost your $50 and earned nothing. It does not
matter if gold climbs to $1300, your max profit is
the agreed upon payout. And your max loss is the
cost of the trade.
7. ETF. Stock market investors gain access to the
commodities markets through exchange traded
funds(ETFs). This is an easy way for the average
investor to gain exposure to this asset class. Some
of these funds actually hold the commodity, usually
gold or silver funds. Holding physical gold or silver
carries risks of security and also tax consequences
with buying or selling. Most ETFs just hold derivative
papers such as futures contracts or options.
These instruments do not align exactly with the
commodity prices. So if the commodity goes up a
certain amount, the ETF is unlikely to rise the same
amount or at the same time.
8. Stocks. Stock market investors who want
exposure to commodities may also buy companies
that have a holding in the commodity such as
oil and gas companies, junior mining stocks, or
precious metal streaming companies. They can
invest in aluminium through Alcoa, or steel through
ArcelorMittal or other similar companies.
9. CFDs. Contract for Difference (CFD) offer an
alternative entry to commodity trading. You trade
on the underlying asset, so your prices correlate
exactly with the price changes. You can trade
fractions of a lot, so you don’t need as much money
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to enter the trade or as much margin to stay in
the trade. You can still use leverage to increase
your profit potential and your risk. It’s also easy
to move between stocks, indices, currencies, and
commodities because they are all traded on the
same platform.
Remember all trading carries risks. Use of leverage
increases your risk factors. You have the chance to
profit or lose money in your trades.
Many speculators focus on trading in precious
metals and oil and gas. These commodities
have intrinsic value, are highly volatile, and trade
frequently. The easiest way for individual day
traders to take advantage of commodities is
through CFDs. Let’s take a look at why you might
want to trade in these commodities.
Copper: Copper is the third most widely used
metal in the world and is in demand, especially
as economies grow. High conductivity and
malleability make it useful in electronics, motors,
wires, and cables. It’s also used in solar panels,
telecommunications equipment, and car batteries.
It does not corrode and is an essential part of alloys
such as bronze and brass. It also is one of the most
affordable metals.
Copper prices moves in tandem with the state of
the economy, especially the construction industry.
Copper can signal an uptick in the health of a
nation as sales of homes, electrical appliances,
and other copper using technology increases.
Spot prices can also be inuenced by mine strikes,
political instability in mining regions, and increased
demand as people turn to solar power. Supply
and demand affect price and current mines have
a limited number of productive years remaining.
15.4 Commonly Traded Commodities
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Prices can move dramatically even within an
hour, so traders must pay close attention to their
trades or pre-set exit points. As always, trading
commodities involves a high level of risk. Copper
trades in 25,000 pound lots under the ticker
symbol HG.
Gold. Gold has long been valued as money and
as a safe haven in times of unrest. It is also used
in computers and jewellery. Most of the gold
comes from China, South Africa, the United States,
Australia, Canada, Indonesia, and Russia.
Gold moves with supply and demand. Demand
increases in times of insecurity or increased
prosperity as more people buy gold. World and
national politics, political turmoil, monetary policies,
and the US dollar affect gold prices. Since gold is
typically quoted in US dollars, strength or weakness
in the dollar usually, but not always, affects the
price. Gold prices decrease when investors are
confident other assets offer better returns.
Gold is sold in 100 troy ounces lots with the ticker
symbol of GC.
Natural Gas: Natural gas is a highly volatile
commodity that is cyclical in nature. It is used
primarily for heating and cooling as well as running
energy plants. Price moves with supply and
demand, which are often controlled by nature.
A cold winter increases demand. Increase or
decrease in oil output also inuences supply.
Traders keep an eye on stockpiles and the weather
forecasts as they trade. Natural gas prices are most
volatile in the high demand seasons of December
to February and in July and August. At other times
of the year, natural gas prices may see a lull.
Natural gas trades in 10,000 million BTU lots and
has a ticker symbol of NG.
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Oil: Crude oil is the basis of petrol, liquefied
petroleum gas (LPG), naphtha, kerosene, and diesel
and jet fuel. Oil is also the basis for most plastics.
Oil with less sulphur is called sweet. Oil with low
density is called light. Light, sweet crude takes less
time to refine and so is more desired.
Crude oil is traded more frequently than any other
commodity in the world. Volatility in oil prices
comes from the news: political unrest, possible
disruption of oil fields, and changes in supply or
demand can all impact the price. Russia, the Middle
East, and the United States produce the most oil,
so changes in their politics or production make the
most impact.
Nature also plays a role in crude oil’s volatility.
Heating fuel comes from oil, so a cold winter
will increase prices. A temperate summer can
encourage a busy summer driving season which
may increase gas demand. Emotion also drives the
oil market. Fears and worries, even unrealised, can
rocket oil futures.
1,000 US barrels or 42,000 gallons make a futures
trading lot. Oil trades under a variety of tickers
depending on the type and quality of the oil.
Palladium: Palladium is similar to platinum, but
even rarer. It’s resistant to heat, chemicals, and
tarnish. It is softer, so it can be more easily shaped.
An inert metal, palladium can absorb 900 times
its own volume in hydrogen. Palladium is used
in jewellery, dental work, electronics, fuel cell
production, and, most often, in catalytic converters
for cars.
Traders like palladium because it is 30 times rarer
than gold. The demand for palladium is increasing,
but the price is still relatively low compared to gold.
Some use it as a hedge against ination.
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Russia and South Africa produce about 80% of the
world’s palladium. Because Russia controls nearly
50% of the market and is secret about its stockpiles,
uncertainty makes the asset volatile. Political
tensions in the regions and auto production impact
price. Typically the price of palladium goes up as
car production increases.
Palladium contracts sell in 100 troy ounce lots with
a ticker symbol of PA
Platinum: Platinum has a high melting temperature
and is corrosion resistant to air. It has high electrical
conductivity and yet is non-reactive to chemicals. It
is more useful than gold as it is a part of products as
diverse as catalytic converters, dental equipment,
jewellery, and thermometers. It is also about 15 to
20 times scarcer than gold which typically gives it
a higher price than gold.
Russia and South Africa produce a majority of the
world’s platinum, so strikes or political unrest in
either area can shock the price. As always, supply
and demand play a part. Nearly half of the platinum
goes into cars. If a cheaper option for catalytic
converters is found or if too many cars shift to
electric, demand may drop.
Contracts trade in 50 troy ounce lots with a ticker
symbol of PL.
Silver: Silver is easy to shape and very conductive.
It has a long tradition of use in jewellery and money.
Indeed the British pound originally equalled one
pound of sterling silver. It also serves industrial
purposes and can be found in electronics,
household appliances, photographic equipment,
x-rays, and even anti-bacterial odour control in
shoes.
Silver has traditionally stood as a hedge against
ination, deation or devaluation. It is highly volatile
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and has traded as high as $110 in 1980 to a low
of under $6 in 2001. The peak came as a group of
investors tried to corner the market on silver.
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The price spiked, then tanked.
The low cost and high volatility of silver make
it attractive to trade. Its price changes seem
correlated to other precious metals. People
buying physical silver as a hedge against currency
concerns may affect the price.
A silver contract is 5000 troy ounces and trades
under the symbol of SI.
Gold, silver, oil, and natural gas are the most
frequently traded commodities. If you decide to
enter commodity trading, keep tuned to the news
that affects the industries that use your commodity.
Pay close attention to countries that hold large
reserves and the political events surrounding
them. Recognise that supply delays and shipping
problems caused by weather or disasters are likely
to impact price.
Know that commodity trading is high-risk trading.
Your capital may be at risk. Leveraged trading
increases your risk. While you may only use a small
amount of your money to control a large contract of
assets, you are responsible for the entire amount.
Trade wisely.
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Drakoln, Noble ‘Commodities: Silver’, Investopedia http://www.investopedia.com/university/commodities/commodities18.asp
Your capital is at risk. Past performance does not guarantee future results. This information is for educational purposes and not investment advice.
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