What Are the
Commodities are essentially commercial products that are either agricultural outputs or raw materials that appear naturally in the ground. They can be considered as primary building blocks of the economy as they are used as inputs in the production of almost all other goods. This is the reason why the commodities market has an impact on other financial instruments.
The major difference between trading equities and commodities is that while stocks are impacted by a plethora of external factors, commodity market prices reflect the demand and supply dynamics of the core asset. As a result, commodities trading is considered a good hedging tool during times of political uncertainty, economic slowdown or currency volatility due to inflation.
Depending on their physical attributes, commodities are classified into two types:
Hard commodities: Those that require some kind of mining or extraction to be accessed
Soft commodities: These include agricultural products
Commodities are further classified into these four categories:
Metals: Gold, Silver, Platinum, Copper
Energy: Crude oil, Natural gas, Gasoline, Heating oil
Agriculture: Wheat, Rice, Cotton, Coffee and more
Livestock and Meat: Eggs, Pork, Cattle and more
The main exchanges for commodities are:
NYBOT - New York Board of Trade
NYMEX - New York Mercantile Exchange
CBOT - Chicago Board of Trade
ICE - Intercontinental Exchange
CME - Chicago Mercantile Exchange
What are the
Advantages of Trading
Before you trade commodities, it is important to understand why you may want to include these assets in your portfolio. Here are some of the main benefits of trading commodities:
Inflation, by its very definition, means a rise in the price of goods. When inflation accelerates, the prices of commodities also rise. On the other hand, high inflation diminishes the value of a domestic currency. Commodities are considered a good hedge against inflation as their prices tend to rise with higher inflation. Only a handful of asset classes benefit from rising inflation with commodities and real estate among the select few. This is particularly the case when there is unexpected inflation. Even then, commodity prices tend to rise.
Historically, the prices of commodities, particularly precious metals like gold and silver, have experienced a long term rise. This is the reason investors tend to add more commodities to their portfolios during periods of high political and economic instability. In addition to buying or selling a tangible asset, people can invest in commodity futures and more complex instruments such as CFDs.
Commodity prices have a low or even negative correlation to returns from other asset classes. This is particularly true for equities and bonds. Even if you have tried to diversify your portfolio with stocks of companies of different sizes, operating in different sectors and at different stages of their growth, a degree of positive correlation exists. Experienced traders and investors tend to diversify their portfolio by adding commodities, given their low correlation with traditional asset classes.
The Importance of
Liquidity in Trading
As we move closer to answering the main question about which are the most commonly traded commodities, it is vital to understand the premise behind arriving at that list. Liquidity has a big role to play in the selection of commodities. What does liquidity mean in commodity trading? Well, it refers to the ease with which traders can buy or sell commodities (based on futures contracts or via CFDs) on relevant exchanges.
High liquidity of commodities means that there are sufficient bid and ask orders, so that the financial instrument can be traded quickly and at stable prices. Higher liquidity minimises the impact that a buy or sell order will ave on prices.
When there are a large number of buyers and sellers for an asset, the liquidity of the security is said to be high. This makes transactions in the asset class easier and faster. In other words, a highly liquid security is one where there is a high demand for buy orders and a high demand for sell orders. This means you can trade at any time and can expect the order to be fulfilled almost immediately. Not all commodities enjoy the same degree of liquidity. In fact, there are certain commodities that have low liquidity and, therefore, tend to experience wide price swings.
Liquidity is also related to the extent of slippage. With high liquidity, the chances of slippage are greatly reduced. What does this mean? Let’s say a trader places a buy order at a certain price for an asset class with low liquidity. There is a chance that, at that moment, there are no matching sell orders. The buy order is then executed at the next closest price. This means you may buy the asset class at a slightly higher price than you intended to. This may also happen with sell orders, where your order is executed at a price slightly lower than the price at which you placed the order. In order to avoid slippage, it is a good idea to trade commodities that have high liquidity, so that orders can be executed almost immediately at your preferred bid or ask price.
So, how is liquidity determined? To understand this, let’s talk about the concepts of volume and open interest. Volume simply refers to the total number of contracts that are concurrently in trade. However, the most commonly viewed figure is the daily trading volume or the total contracts (in terms of price) that were traded in the last 24 hours. Open interest refers to the total count of open long and open short positions for a specific asset class at a given point in time.
Slippage is inversely related to volume and open interest. Higher volume and open interest translate to increased liquidity and a lower level of slippage.
Those who are new to trading commodities may wish to avoid high risk assets and start trading instruments with high liquidity. A simple indicator of liquidity is price fluctuation. A quick look at historical gold or silver prices reveals that any daily change in their value is rarely more than a few percentage points. This brings us to our most pertinent question - which are these highly liquid commodities that are traded the most?
What are the
Here is a list of the most actively traded commodities:
This hard commodity is a major source of energy for the world. Have you ever wondered why newspapers and news channels report so actively on crude oil prices? This is because this commodity has an impact on virtually all sectors of a country’s economy and all regions of the global economy.
Crude oil is used in the production of diesel and gasoline, making it indispensable for the travel and tourism sector along with the automobile industry. It is used for manufacturing different petrochemicals. It is also used for producing fertilisers, cosmetics, textiles, steel, and more.
What are the main reasons for price fluctuations in crude oil?
As with any other asset or financial instrument, crude oil prices fluctuate based on the demand and supply of this commodity. Signs of economic growth or thriving business activity support crude prices. Any disruption in the supply or a decline in stockpiles can exert pressure on crude prices. Also, geopolitical tension that impacts oil producing regions can cause crude prices to decline.
The supply of crude is carefully planned by the Organization of the Petroleum Exporting Countries (OPEC) and their allies. The group, along with allies, is known as OPEC+ and comprises of the major oil producers of the world.
OPEC members: Saudi Arabia (the de facto leader), UAE, Iran, Iraq, Kuwait, Libya, Nigeria, the Republic of the Congo, Venezuela, Algeria, Angola, Equatorial Guinea, and Gabon.
OPEC+ members: Apart from the above OPEC members, OPEC+ countries include Russia, Mexico, Oman, Sudan, Azerbaijan, Bahrain, Brunei, Kazakhstan, and Malaysia.
Up until 2019, the demand for oil was on an uptrend, with the ever-increasing global population and the corresponding rise in energy consumption. The covid-19 outbreak in 2020 and consequent travel restrictions and business lockdowns resulted in a sharp contraction in crude demand. This led to the oil market being in an oversupplied state, resulting in a steep decline in crude oil prices. The OPEC+ nations came together to control supply, so that prices could be supported. The cartel unanimously agreed to reduce production cuts off by around 10 million barrels per day through June and July.
What are the most actively traded types of crude oil?
There are two most traded types of crude oil - WTI Crude and Brent Crude Oil. The WTI (West Texas Intermediate) is a specific grade of crude oil that is considered a benchmark for oil prices in North America, mainly because it is sourced in the United States. On the other hand, Brent oil is the international benchmark price, which is used by OPEC. This is the reason why Brent oil is higher in demand and subsequently more expensive than WTI.
WTI trades on the NYMEX (New York Mercantile Exchange), while Brent trades on the Intercontinental Exchange (ICE). Crude oil and its various derivatives are also traded on the Dubai Mercantile Exchange (DME) and Central Japan Commodity Exchange (C-COM).
Precious metals like gold and silver are an important and popular asset class among commodities. Trading in precious metals is linked closely to the prospects of the overall global economy, the financial markets around the world and the major currencies. If you have experience trading in the forex market, you may pick up trading in precious metals very quickly, as the price movements and strategies are quite similar..
Factors affecting the price of metal prices include interest rates, economic outlook, industrial output, and strength of the US dollar. Some of the top exchanges across the globe for trading precious metals are:
New York Mercantile Exchange (NYMEX)
Brazilian Mercantile and Futures Exchange (BMF)
Dubai Gold and Commodities Exchange (DGCX)
Tokyo Commodities Exchange (TOCOM)
While gold and silver are the most traded precious metals, there are others that have grabbed the attention of traders in recent years. First, let’s look at the most popular ones.
What to know about gold trading?
For centuries, this precious metal has been put on a pedestal, being considered a store of value and a medium of exchange that is accepted globally. This is the reason that the gold market offers high liquidity.
What traders should understand is that the normal market forces of demand and supply do not work that well for gold and other metals. The supply of other commodities, like oil or coffee, gets consumed. This is not the case for gold. What has been produced remains in supply. Also, to increase the supply of gold takes time - months or even years. Therefore, the gold supply cannot increase to meet a sharp rise in demand. This means that when there is a rise in demand, prices may remain elevated for an extended period.
For traders, gold’s safe-haven appeal is significantly higher than any other commodity. That is why the yellow metal finds its way into the portfolios of new and seasoned traders alike. It is considered as a hedge against inflation as well as geopolitical and economic uncertainty. In August 2020, gold prices spiked to a record high above $2,000 per ounce. This was driven by concerns around a global economic recession, political tensions between the United States and China along with other uncertainties related to the covid-19 pandemic. In fact, amid unprecedented uncertainties, the demand for gold was being projected to rise to as high as $3,000 per ounce.
What to know about silver trading?
Silver is similar to gold as it is also a precious metal that is commonly used in jewellery and coins. However, what gives silver its value is that this white metal has the highest electrical conductivity of any metal. As a result it is more commonly used that gold and utilised by several industries. Silver is quite frequently used in manufacturing photographic films and solar panels. China, Mexico, and Peru are among the major miners of silver. Silver is also considered a safe-haven option that can be used for hedging inflation and economic uncertainties. However, its appeal for these reasons is far less than that of gold.
What is the correlation between the US dollar and precious metals?
To begin with, precious metal prices are mostly stated in US dollar terms. This already makes them negatively correlated. Moreover, the US dollar and precious metals are both considered as relatively stable asset classes. Both enjoy safe-haven preference among traders. During periods of volatility in other asset classes like stocks, times of political unrest or economic uncertainty, investors increase their holdings of safe-haven options. They often choose between the US dollar and gold making them competing for safe-haven instruments. When the demand for the greenback rises, it often translates to lower demand for gold among traders and investors.
Just like crude oil, this commodity is also an important source of fuel and energy. It takes a lot of time and huge investments to explore and drill new resources of natural gas. This makes the commodity exceedingly rare and highly volatile. It means that a small change in the demand or supply of natural gas can cause a meaningful movement in prices.
What are the major drivers of the price of natural gas?
Availability of Substitutes: A great deal of research funds are being directed into identifying and developing renewable sources of energy known as bio-fuels. These sources will act as substitutes for natural gas.
Storage capacity: A higher rate of availability than demand brings with it a cost of storage. If inventories grow, it will exert pressure on natural gas prices.
Weather conditions: Lower temperatures mean a higher demand for heating homes and offices. News of colder winters can boost the prices of natural gas.
This is a popular commodity that is traded frequently on the following exchanges:
New York Mercantile Exchange (NYMEX)
You may relate more to this soft commodity as your mornings probably begin with consuming it. If this is the case, you’re not alone as more than 2 billion cups of coffee are consumed every day around the world. The top coffee producing nations are Brazil, Indonesia, Vietnam, Ethiopia, and Colombia.
What are the major reasons for price fluctuations in coffee?
Weather: The production of this commodity is extremely sensitive to climatic conditions, as it requires a specific combination of rainfall and sunshine. Due to this, weather reports can cause price fluctuations.
Oil Prices: Most coffee growing countries export a major part of their produce. Therefore, coffee prices may fluctuate with changes in the price of oil.
Geopolitical unrest: Any political unrest in coffee producing regions or in areas that are the major consumers can cause price fluctuations.
US Dollar: A strong greenback has a dampening impact on the price of this commodity.
Some of the popular exchanges where coffee is traded are:
New York Board of Trade (NYBOT)
Singapore Commodities Exchange (SICOM)
Euronext (in London)
Kansai Commodities Exchange (In Japan)
Also known as maize, this commodity is an important food source. It is also used in the production of ethanol as well as in animal feed, corn syrup, and starch. Brazil, US, China, and Argentina are among the major producers of corn.
What are the factors influencing corn prices?
Weather: Adverse climatic conditions can lead to poor supply of corn and impact its price.
Government Subsidies: The availability of farming subsidies to motivate production of corn influences its price in countries like the United States.
Demand for animal feed: Growth in animal husbandry results in an increase in demand for animal feed, which in turn boosts corn prices.
US dollar: America is one of the major producers and has a thriving beef and other meats industry.
Top exchanges where agricultural commodities like corn are traded:
Winnipeg Commodity Exchange (WCE)
Chicago Board of Trade (CBOT)
Tokyo Grain Exchange (TGE)
Kansai Commodities Exchange (in Japan)
Minneapolis Grain Exchange
This metal is a good conductor of heat and electricity. It is also weather-proof and corrosion-resistant making its use widespread in the electronics industry. It is also used to produce alloys, manufacture pipes, electrical wire, industrial machinery, and roof wire. Some of the top producers of copper are China, Peru, the United States and Chile.
As this commodity is widely used in the manufacturing sector, the price of copper fluctuates with news on the economy. This could include economic data on factory orders, manufacturing PMI and foreign trade. Infrastructure concerns and trade disputes have a bearing on its prices.
Copper, along with several other high-utility metals like nickel and lead, is traded on the following exchanges:
New York Mercantile Exchange (NYMEX)
London Metal Exchange (LME)
Shanghai Futures Exchange (SFE)
Tokyo Commodities Exchange (TOCOM)
Being strong and available at a low price, steel is extremely popular for industrial applications in manufacturing, construction, and infrastructure. Steel is mainly an alloy of carbon and iron, but includes certain other elements like nickel, manganese, chromium, and tungsten.
What are the factors influencing steel prices?
Given its high demand in various industries, steel prices tend to fluctuate with expansion in the manufacturing sector and economic growth.
Steel prices are also dependent on the cost of the products that constitute this alloy.
In 2018-19, the US-China trade war saw America impose tariffs on steel exported by the Asian nation. Such external factors can also cause fluctuations in steel prices.
Apart from the above, there are various other commodities that have gained popularity among traders. These include iron ore, aluminium, and soybeans.
How to Trade
As you know by now, there are several frequently traded commodities. The most common way of trading these are on the futures market via CFDs (Contracts for Difference). With advancements in technology and high interest speeds, individual traders are trading CFDs. far more regularly. An easy way to learn about trading CFDs is to open a demo account which allows people to learn about financial instruments and trading platforms prior to outlaying any of their own capital.
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