Over the modern age of investing, commodity trading has emerged as an important player in the way that people invest in and speculate. It was developed as a reaction to the way that business is conducted, and it continues today in the form of commodities trading online. Many different people turn their business know how into a profitable venture, and it is commodities and futures trading that helps them get there. Simply put, commodities are items like, wheat, corn, gold and silver, and cattle and pork bellies, and crude oil. When farmers take their crop to “market”, they are selling commodities. Trading commodities is the world’s one perfect business. The upside potential is unlimited and you can control the downside. You can trade commodities on a part time basis or a full-time basis. You can spend as little as an and earn a full-time income. People have started with a small account and in a short period of time built their account up to the point that they have been able to quit their jobs and trade commodities full-time providing themselves with a very comfortable living. Commodities are raw materials used to create the products consumers buy, from food to furniture to gasoline. Commodities include agricultural products such as wheat and cattle, energy products such as oil and gasoline, and metals such as gold, silver and aluminum. There are also soft commodities, or those that cannot be stored for long periods of time. Soft commodities are sugar, cotton, cocoa and coffee.The commodity market has evolved significantly from the days when farmers hauled bushels of wheat and corn to the local market. In the 1800’s, demand for standardized contracts for trading agricultural products led to the development of commodity futures exchanges. Today, futures and options contracts on a huge array of agricultural products, metals, energy products and soft commodities can be traded on exchanges all over the world. Commodities have also evolved as an asset class with the development of commodity futures indexes and, more recently, the introduction of investment vehicles that track commodity indexes.
Commodity prices have been driven higher by a number of factors, including increased demand from China, India and other emerging countries that need oil, steel and other commodities to support manufacturing and infrastructure development. The commodity supply chain has also suffered from a lack of investment, creating bottlenecks and adding an insurance premium and/or a convenience yield to the returns of many commodity futures. Over the long term, these economic factors are likely to support continued gains in commodity index returns. The potential for attractive returns is probably the most obvious reason for increased investor interest in commodities, but it isn’t the only factor. Commodities may offer investors other significant benefits, including portfolio diversification and a hedge against inflation and risk.
Commodities are real assets, unlike stocks and bonds, which are financial assets. Commodities, therefore, tend to react to changing economic conditions in different ways than traditional financial assets. For example, commodities are one of the few asset classes that tend to benefit from rising inflation. As demand for goods and services increases, the price of those goods and services usually goes up as well, as do the prices of the commodities used to produce those goods and services. Because commodity prices usually rise when inflation is accelerating, investing in commodities may provide portfolios with a hedge against inflation.
Why invest in commodities?
Leverage is very important to the commodities markets. Unlike the stock market, where you might have to invest 10,000 dollars to leverage 10,000 dollars. A commodities trader can leverage tens of thousands of dollars worth of a commodity for pennies on the dollar. Also unlike stocks, commodities have intrinsic value and will not go bankrupt.The futures markets are so crucial to the well being of our nation, that the government established the Commodity Futures Trading Commission (CFTC) to oversee the industry. There is also a self-regulatory body, the National Futures Association (NFA), who monitor the activities of all futures market professionals to ensure the integrity of the futures markets.
Commodities also give the investor the ability to participate in virtually all sectors of the world economy and have the potential to produce returns that tend to be independent of other markets. In fact portfolios that add commodity investments can actually lower the overall portfolio risk by diversification.
What is the difference between hedging and speculating?
Just about every product that you consume would likely cost dramatically more without the commodities futures markets. Because of the intrinsic risks associated to being in business, lacking the ability to shift risk, a manufacturer/producer of goods or services would be forced to charge higher prices, and the consumer would have to pay those higher prices. This shifting of risk to someone willing to accept it is called hedging. Manufacturers could effectively lock in a sales price by going short an equivalent amount of goods with futures contracts. If a mining company knew that they were going to sell 1000 ounces of gold in several months, they could protect themselves for a future price decline by going short 10 gold futures contracts today. If the price of gold fell by $30 in the following months, they would receive that much less in the cash marketplace for their gold, but earn that much back when they offset their short gold futures position. The futures price will eventually become the cash price. A user or buyer of goods can use the futures market in the same manner. They would need to protect themselves from a future price increase, and therefore go long futures contracts. The person willingly accepting a risk does so because of the opportunity to profit from price movements, this is known as speculating. The cotton in your shirt, the orange juice, cereal and coffee you had for breakfast, the lumber, copper and mortgage for your home, the gas or ethanol that you put in your car all would be priced many times higher without the participation of speculators in the futures markets. Through supply and demand market forces, equilibrium prices are reached in an orderly and equitable manner within the exchanges, and world economies, and you, benefit tremendously from futures trading.
Should I open a full service account?Many new commodity traders mistakenly believe that commission rates will have a greater impact on their trading success than the markets themselves. Reasonable full service rates are not usually the cause for losses. Bad trades are the cause for most losses. Many new traders begin trading commodities with a discount account and rationalize that their trading accounts are discount so why not do the same for their commodity account. The most important question to ask is, “Will a discount broker monitor your account to make sure you don’t make a costly mistake?” Other questions to ask are: “Will they let you know that your sell order you are trying to place will initiate another short future because you meant to offset a short with a buy not a sell to exit your trade? Will they alert you to the fact that there is a major USDA grain report coming out before you place your grain order? Will they call you and let you know that your options have just 1 week before they expire?” All of the examples above can be very costly to the new trader. The answers to all of the questions above is no, because discount brokers are not paid enough to do so.
What qualities do you want your commodity broker to have?
1. Experience – Always make sure that your commodity broker has seen both bull and bear commodity markets. Also, make sure that your commodity broker does not have a habit of being in trouble with the National Futures Associations.
2. Honest dialogue- Does your commodity broker call you when you are down in a trade as readily as when you are in a winner? Does your broker only call to ask you to send in more risk capital?
3. Availability during market hours – Are your calls returned in a prompt and professional manner? Commodities are a distinct asset class with returns that are for the most part independent of stock and bond returns. Therefore, investing in commodities can help diversify a portfolio of stocks and bonds, lowering risk and possibly boosting returns. Reaching this level of diversification has been made easier with the development of investment products that passively track a broad range of commodities.
