Home » Commodities Trading: A Basic Overview

Commodities Trading: A Basic Overview

by Nathan Zachary

A smart investor will tell you that it is not wise to add all your eggs in a single basket. Though it does not rule out all risks entirely, it is smart to have a diverse portfolio so your investment goals are in place and you can enjoy good returns. 

There are a number of different investment vehicles that you can choose from stocks, bonds, mutual funds, futures, and currencies. These can be further put into different categories that have common characteristics such as large-cap stocks, financials, and government bonds.  

This also includes commodities that can be changed into different goods and services. Both experienced as well as amateur traders can explore numerous commodity investment options. However, before you are ready to take the dive, make sure you’re well-versed with all the information you need to know about commodity investments. 

Earlier, commodity trading was particularly demanding and needed you to invest time, and money while also having some experience at hand. It was typically limited to professional traders. On the other hand now, there are multiple options for people to invest in commodity markets. 

What do we mean by investing in commodities?

Commodity trading is not new. It has been in existence for centuries now much before stocks and bonds were in the market. It was certainly essential as a business since it gave various cultures and people a platform to work with one another. What started off with spices and silks has now turned into assets being traded. Even today, it remains one of the best investment vehicles to put your money in. 

Investors who wish to get into commodity trading have many options to choose from. If you’re hungry for commodities, you may want to invest directly in a particular commodity or you could indirectly buy shares in such commodity firms, mutual funds, or exchange traded funds (ETFs).

1. Invest directly in the commodity

The most direct way to invest in commodities is to buy a commodity. A plus point of doing this is that you don’t have to engage with an intermediary. All you need to do is carry out an internet search to find out the dealer who will give you a certain good. In case you do not want the commodity anymore, the dealer will most likely be happy to buy it back. However, you will still have to work around the logistics and delivery. Buying gold, is fairly simple. It is easy to find a dealer who will sell you a coin or a bar and you too will find buyers later without hassle. But the troublesome bit is when you’re dealing with how to store commodities like cattle, crude oil or bags of wheat. Thus, investing in physical commodities is a tedious task that requires a lot of effort. 

2. Invest in futures contracts

Commodity derivatives like futures contracts can be easily traded if your trading company lets you. However, futures contracts are majorly created for large companies that deal with commodities and may not be very useful for individual traders. 

To be able to trade futures you will be required to hold a margin in your trading account which is essentially a particular amount of capital. A major risk of trading commodities is that margin requirements are often way lower than for stocks. Margin trading is essentially trading with the help of borrowed funds which can magnify both your profit and loss. Since commodity prices can be volatile, you should ensure that there are enough resources at hand to cover up for any margin call.

3. Invest in commodity stocks

Yet another way of investing in commodities is to purchase shares of the companies that make these goods. For instance, you can invest in metal stocks, energy stocks, or meat stocks. A company that produces these commodities may not always rise or fall as per the commodity it makes. In the case of an oil production company, crude prices will affect its rates too but what matters more is the amount of oil that’s there in the reserves. In addition to that, are there any tempting supply contracts with high-demand buyers? 

4. Invest in commodity ETFs and mutual funds

Commodity exchange-traded funds (ETFs) and mutual funds allow commodity exposure to those who do not wish to buy commodities directly. You could look for an investment fund that pumps money into physical materials, commodity stocks, futures contracts, or something that is a combination. 

Characteristics of the Commodities Market

In the largest sense, the key guiding principles of supply and demand are what steer the commodities market. Demand is affected by a change in supply, poor supply implies higher prices. Thus, all major changes in a commodities’ supply like a health disease that is rapidly spreading can affect the demand for livestock. 

Types of commodities

Investors can categorize commodities into two broad groups: hard and soft. Hard commodities are the ones that have to be mined or drilled so they can be obtained. Soft commodities are the ones that are grown, ranched, or farmed. So far, there are four main kinds of commodities.

  1. Agricultural products:

These are soft commodities that are inclusive of crops like coffee, corn, wheat, soybeans, cotton, and lumber.

  • Livestock and meat: 

Again these are soft commodities inclusive of live cattle, beef, pork bellies, and milk.

  • Energy products: 

Energy products fall into the category of hard commodities. Crude oil, natural gas, unleaded gasoline, propane, ethanol, and coal are included in this. 

  • Metals: 

Quite naturally, metals are hard commodities. Precious metals like gold and silver and industrial metals like copper, aluminium, and palladium are included in this. 

How to start trading commodities?

If you wish to start commodity trading, you can do so by setting up a trading account and buying shares of the commodity-linked firm of your choice. You could also choose a commodity ETF once you have all your research in place and are sure of the investment.

Just like how different investments work, commodities also come with a set of risks. An investor should be able to gauge the commodity markets they want to trade in and also take into account the type of investment they want. 

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