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Commodity trading has been around since the ancient days of civilisation. In fact, it was traded way before the existence of asset classes like stocks, bonds and ETFs.
Back then, commodities such as cattle, grains and metals were traded from one merchant to another. While these could be done in the form of a barter trade, the trades were often carried out via some form of commodity money (commodity money is a type of commodity that is used as money) such as gold, salt and shells.
These days, commodities are still being traded even though we, as consumers, no longer need to purchase commodities directly for essential supplies.
A commodity can be understood as a tangible product with definite demand but supplied with a standardised quality across markets. What this means is that regardless of where the commodity is produced and sold, the quality of the product we receive is similar.
For example, precious metals like gold, silver and nickel (all of which are elements on the periodic table) are all considered commodities and they can be traded around the world, with no discerning differences in quality.
However, a gold jewellery designed and sold by a jeweller isn’t a commodity, even though a commodity (gold) may be used to create the product.
Buying And Selling Commodities On Financial Exchanges
Commodities can be purchased by both end-users (usually corporations that require the commodity to produce their products) as well as financial traders who hope to make a profit from the price differences between what they buy and sell the commodity at.
For financial traders, commodities can be bought and sold on exchanges such as the London Metal Exchange (LME) and the Chicago Board of Trade (CBOT).
Commodities traded on these financial exchanges can be segmented into a few groups.
Metals: Gold, Silver, Nickel, Platinum, Aluminium
Energy: Oil, Natural Gas, Heating Oil
Agriculture: Cattle, Sugar, Coffee, Grain
Based on demand and supply, commodity prices can fluctuate significantly in the short-term, even if they end up being relatively stable in the long run. For example, spot price for Nickel increased from US$25,438.50 on 1 March 2022 to US$48,196 on 15 March 2022 due to Nickel supply concerns following the Russian invasion of Ukraine.
As explained by IG, the world’s No.1 CFD provider (by revenue excluding FX, June 2020), there are some factors that may impact the prices of commodities.
#1 Demand & Supply
Since all traded commodities are used to produce finished goods, the prices of commodities can swing widely based on whether demand exceeds supply or vice versa. For example, if a big country such as China were to expand its infrastructure development over the next few years, it is likely that prices of traded metals will increase. Similarly, if there is a supply shock (e.g. due to war), prices may also increase.
For soft commodities such as wheat, cocoa and coffee, prices can increase if poor weather limits supply. This is because consumer demand for these goods will likely remain constant even though supply has declined.
Politics can affect prices. For example, if a major economy makes a policy change that restricts the import/export of a certain commodity, the prices of that commodity may fluctuate significantly.
#4 Exchange Rate
Most commodities are priced in US Dollars (USD). For Singaporeans, what it means is that the performance of our Singapore Dollar (SGD) against the USD matters to us, since any potential gains in our trades may be offset if the exchange rate moves against us.
Price Volatility For Commodities
Due to these factors, prices of commodities can be volatile in the short term. Such volatility creates an opportunity for financial traders to make profits on their trades, even if they don’t intend to purchase the commodities for their own use.
When trading commodities, there are a few prices that we can use and trade.
Spot price is the price we pay for buying the commodity on the spot. For example, if we want to buy an ounce of gold today, we will pay the spot price.
Future Contracts are contracts that set how much the price of a particular commodity would cost in the future, with the price agreed on today. For example, we can buy gold futures which state the amount of gold we can buy in the future, with the price set today.
Future contracts give the producer of the commodity the certainty of price and is a method to hedge prices against uncertainty in the future.
While spot price and future contracts are prices of what we pay for the commodity today and in the future, commodity options give us the right but not the obligation to exchange an asset at a specific price on a specific date. In such cases, the option value will likely be based on the price of the underlying commodity.
Trade Commodities Using CFDs
For many of us who trade commodities in the financial market, it’s unlikely that we actually want to take stock of the commodity. Rather, our main objective is to make profits off the price volatility.
Whether it’s trading on spot price, future contracts or commodity options, Contract for Differences (CFDs) is one way we can gain exposure to the price of a commodity, without buying or selling the physical commodity.
Through CFD brokers like IG, the World’s No.1 CFD provider (by revenue excluding FX, June 2020), we can trade multiple commodities in the financial markets including precious metals such as gold, silver, and nickel; soft commodities like live cattle and orange juices; as well as energies such as oil – brent crude and natural gas.
Similar to all types of CFDs, we can take long or short positions in our trade, depending on our views on how we think the price would move. If we think prices will go up, we can take a long position for our trade. If we think prices will go down, we can take a short position.
Do note that CFDs are leveraged products so this means that both our profits or losses when we trade commodities will be magnified, depending on the level of leverage we use. The use of leverage also means that we can take on a much larger commodity exposure for our trades with a small initial capital.
For those who are new to trading commodities, it’s advisable to start off with a demo trading account first before opening a live account. A demo account allows us to practise trading with virtual cash so that we can try different trading strategies and types of commodities that we are comfortable with trading, before putting in real money for our trades.