The Wide Reach Of Commodities

“Commodities tend to zig when equity markets zag.”

-Jim Rogers

The commodities we mine and grow represent the cornerstone of civilization, forming the building blocks that support modern economies. Whether the food used to feed the world’s growing population, the metals responsible for all aspects of industry and construction, or the fuel that powers our homes and vehicles, commodities play a widespread role in nearly every aspect of our daily lives.

Spot versus Futures Trading

Although exchanging physical commodities in barter arrangements has been around for millennia, that all changed with the introduction of standardized rice futures agreements pioneered in the Japanese Dojima Rice Exchange. The idea behind commodity futures was enabling farmers and merchants to exchange rice for money at a future date and agreed upon price, granting each party added stability and the opportunity to transfer certain risks.

It ensured that merchants could access a steady supply of a commodity while farmers could avoid the price fluctuations involved with spot markets. Unlike the futures market which represents agreements between two parties to make an exchange in the future, the spot market can be viewed as today’s market, or how much a unit of a commodity costs at a specific moment in time.

Fast forward to the present day and the commodities market features both spot and futures markets. Futures markets are commonly used by commodity producers to protect (hedge) against steep price declines in spot prices, enabling them to plan and stabilize their future production costs. An airline might also use the futures market to hedge their own fuel costs, locking in a fuel price to defend against major fluctuations in prices which could impact ticket costs.

What has changed in the last 20 years is the growing availability of commodities trading for smaller investors instead of simply institutions and producers that formerly dominated the marketplace. Traders with FXTM ECN accounts gain access to 5 spot commodities, including metals and energy products, granting access to one of the most fascinating global markets.

• Trade Precious Metals And Energy Products With FXTM

An Exercise in Standardization

One of the defining properties of commodities that makes them tradeable is standardization. Just like Apple stock is broken down into standard units, or shares, a single share looks and behaves the same as any other. Commodities are similar in this respect, with standardization implying that the asset being traded is interchangeable with any other single unit of the same asset. Whether barrels of oil, troy ounces of gold, or bushels of wheat, each tradeable unit of a commodity must meet certain specifications and criteria.

In reality, small differences in the characteristics of certain commodities may still exist. For instance, West Texas Intermediate Crude Oil requires less refining to produce petrol for vehicles, jet fuel, and other petroleum-based products. However, further north in Canada, crude oil extracted from oil sands is thicker and contains higher sulfur content, requiring more costly refining.

The Factors That Impact Commodity Pricing

Commodity prices are susceptible to numerous factors that may impact their pricing. Although supply and demand play a large role determining how prices behave, these factors can be broken down further:

• Weather: For agricultural commodities like wheat, sugar, cocoa, cotton and more, warmer, colder, or rainier conditions may impact harvests and therefore supply. On the opposite side, colder weather may increase demand for heating oil and natural gas, causing prices to spike.

• Production Costs: If the cost of producing a commodity exceeds its market value, producers may decide to shut operations to avoid losses. However, if market prices are well above production costs, it might incentivize higher production, thereby adding to supply, and eventually contributing to falling prices.

• Geopolitics: The threat of conflict or trade wars may negatively impact global economic activity, hurting demand for key commodities while heightening demand for others.

• Regulations: A greater focus on the environment may cause governments to try and increase fuel economy or decrease harmful pollutants, which may impact commodity producers and consumers, affecting both supply and demand.

• Flight to Safety: When investors grow concerned about the outlook for the global economy, they may seek the relative safety of certain commodities like gold which are known to provide greater stability during periods of turmoil.

Although the list of factors above is not exhaustive, it highlights the many different factors that can contribute to commodity pricing.

Some Final Thoughts on Commodity Trading

The rapid pace of globalization means that commodities play an important role across the global economy. Investors have more access to this market than ever before thanks to the introduction of spot and futures products on online trading platforms.

Commodities are especially useful for a diversified portfolio because of their weak relationship to the movements of other asset classes like stocks and bonds. Although they can be volatile at times due to the wide cross section of variables that may impact pricing, their role in modern investing cannot be overstated enough.

• Open A FXTM Account To Uncover Commodity Trading Opportunities