What are commodities?
Commodities are simply assets that can be used or exchanged for other assets. From owning a gold ring, and using it as a wedding band, to having a divorce, and needing to exchange it for cash. Commodities are an everyday part of life, we all own some version of a commodity. Although commodities are there mainly for end-user consumption, there are other ways in which they are used, especially within financial markets.
Below we explore these ways and analyse the ways in which you can be involved in these markets from a speculative perspective.
Understanding commodity trading
Aside from day to day consumption, commodities can be utilized in several other ways. Particularly in a speculative sense. In times past commodities were exchanged for other commodities or even labour. In a modern sense, commodities are mainly transacted in exchange for money, however, the value of the raw commodities are now based on supply and demand and market uncertainty. Let’s explore.
Best Brokers for Commodity Trading
Supply and Demand example
So going back to the example of the gold ring being used as a wedding band. The rings are created and crafted from the raw metal which is gold, so if we say hypothetically a new law would be passed, requiring every single person on earth, to marry, you will see an absurd increase in the price of Gold as a commodity as the demand for it would be through the roof. So let’s say that there were rumours that this could be on the cards, a speculator may buy Gold in hope of a rise in price. However if found to be fake news, sell as they know the value will drop on the news.
Although we don’t foresee such an occurrence taking place, there are other more realistic catalysts for movement in prices of Commodities. For example recently where we saw an attack on the oil production line in Saudi Arabia, wiping out 5% of the world’s total oil supply, we saw a significant rise in price. However soon after President Trump tweeted, that the US would fill the supply glut, meaning the initial price rise reversed, as the lack of supply was no longer a factor increasing the level of demand.
Traders and speculators of commodities look at a variety of factors that would affect the price and then speculate on the direction they believe the price could be heading to as a result.
What commodities can be traded?
Historically before fiat currencies, and the exchange of commodities for money, individuals would have exchanged a bar of gold, for a herd of sheep, or coffee beans for labour service, or even rice for silk etc. Then with the creation of currencies, those commodities were assigned a dollar value and purchased instead of exchanged.
There are various commodities that can be traded and these are usually broken down using the following tiers. Seen as hard and soft.
- Livestock – meats etc
- Agricultural – cotton, coffee, rice, sugar etc
- Metals – copper, gold, silver etc
- Energies – Oil, gas etc
What are the most popular commodities to trade?
Popularity in commodity trading is always relative to two main factors. These, of course, are the supply and demand. The greater the demand and the easier it is to access supply, the more liquidity will be involved, which is the core aim of trading, generating returns. We know and it goes without saying that the Forex markets are the most liquid markets, however, commodities are among the markets which rank high in terms of popularity.
That said, which of the commodities as individual assets are highly traded? These would predominantly be the hard commodities, metals and energies, or to be more specific Oil and Gold. Let’s explore the specifics of how there are operated in a trading sense.
Gold historically was the de facto currency prior to the introduction of the FIAT monetary system. Any exchange of goods or services which wasn’t a commodity for commodity or commodity for labour would have been settled with a payment of gold. However with the physical burden carrying lumps of gold carried, exchanges began taken place with IOU slips used as a banknote, meaning that the issuer was depositing a gold bar with a central party/bank, then in order to liquidate this, the receiver would take this note to the central party in exchange for the gold etc.
These IOU’s then went on to become the everyday currency we see today. Pegged to the US Dollar, gold is often now viewed as the safe-haven currency to dollar negative news or global market uncertainty. So when we see the price of gold going up, we would likely see events occurring leading to a weakness of dollar related assets.
Every one of us directly or indirectly use oil, from cooking oil to oil in beauty products to the diesel or petroleum used to fuel our vehicles. Oil prices simply are all based on supply and demand. The supply and its increase or reduction directly impact the demand and the value per barrel. Also pegged to the US Dollar, like most commodities, Oil usually moves whenever we see tensions that could impact the flow of supply.
So in the middle east where a huge percentage of the world’s oil is located, whenever we see war, or threat of tension in the region, creating uncertainty prices fuel up, no pun intended.
However, in looking at the volatility created by the supply and demand of these 2 commodities, you see why traders looking to speculate on price movement, as the prospect of significant movements in price creates a desire for involvement not seen in many other markets.
How to Trade Commodities
Trading commodities is just like trading any other asset, as mentioned it’s a case of buying low and selling high. With CFD’s now a big instrument in the trading world, it means you can trade almost any asset without actually owning the underlying asset. Actually buying oil or gold and making money from it would involve a lot of investment, whereas using a CFD, you are leveraged and can then profit from small fluctuations in the price.