How to trade commodities?

How to trade commodities?

Commodity goods, like corn, flour, oil, and metals, are essential raw materials, and commodities trading involves buying and selling these materials, usually through futures contracts. A futures contract is an agreement to buy or sell a commodity at a specific price on a set future date. This type of trading enables speculation on price movements without the need to handle the physical commodity.

Commodities provide portfolio diversification and can hedge against inflation, but they are also highly volatile. Price fluctuations are often driven by unpredictable factors like weather and political events, adding complexity and risk to trading.

There is a number of classifications related to commodities, we will mention one of them.
Commodities generally fall into four primary categories:

• Agricultural commodities: This group includes food crops like cocoa, corn, coffee, and cotton, as well as livestock such as pigs and cattle, and industrial crops like lumber and palm oil.
• Energy commodities: These consist of resources like crude oil, natural gas, gasoline, coal, uranium, ethanol, and electricity.
• Metal commodities: These cover both base metals, such as copper, iron ore, aluminum, nickel, zinc, and steel, and precious metals, including gold, silver, platinum, and palladium.
• Environmental commodities: This category includes items like carbon emission credits, renewable energy certificates, and white certificates.

Source: capital.com

So, by now we know the types of commodities, but let’s look at the next question in case we are able to select in which type to invest.

Investing in commodities can be done in several ways beyond direct trading (we mean trading on exchange in contracts for difference, for example)

1. Direct Purchase: You can buy physical commodities like gold or silver from a dealer and store them, then sell later. This method avoids intermediaries but can be complex for perishable or bulky items like oil or livestock due to storage and delivery challenges.
2. Futures Contracts: Through a brokerage account, you can trade commodity futures, though this approach requires maintaining margin. While leveraged trading can enhance gains, it also increases the risk of margin calls due to price volatility.
3. Commodity Stocks: Buying shares in commodity-producing companies (e.g., energy or mining firms) gives indirect exposure. Company performance may not always align directly with commodity prices, as factors like production volume and contracts also play a role.
4. ETFs and Mutual Funds: Commodity ETFs and mutual funds provide diversified exposure without direct ownership. Funds can focus on specific commodities (like the SPDR Gold Trust ETF) or a broader commodity index, though they may not always perfectly track the underlying commodity’s price.

These methods allow investors varying levels of exposure, depending on their preference for direct or indirect involvement in the commodities market.

Source: linkedin.com

"Commodities are the lifeblood of the global economy—volatile yet indispensable, they demand respect for their power to shape industries, influence nations, and reward the informed trader.", - Oleksandr Romanyeyev, Analyst at Fondexx

In general, there are many factors influencing commodity prices, actually as any class of assets and moreover, the degree of impact of each factor varies depending on the type of commodity.
To understand the economy, behind trading, what is a key to making informed investment decisions let’s look at those factors.

What Moves Commodity Prices?

Commodity prices are influenced by multiple factors:

1. Costs and Currency Fluctuations: Storage, insurance, and financing costs impact prices, as do changes in the U.S. dollar’s value. A weaker dollar often raises demand for commodities, while a stronger dollar can decrease it.
2. Geopolitical and Economic Stability: Political unrest, wars, or sanctions in key regions can disrupt supply chains and raise prices, while global economic growth typically boosts demand.
3. Government Policies: Trade tariffs, subsidies, and environmental regulations shape commodity prices by affecting production costs and supply.
4. Inflation and Interest Rates: Commodities often serve as a hedge against inflation, with prices tending to rise alongside it, while interest rate changes impact the cost of financing commodities.
5. Market Speculation and Storage Costs: Speculative trading influences prices, as do storage and transportation costs, particularly for perishable goods.
6. Supply and Demand: Limited supply relative to demand drives prices up, and the opposite drives them down.
7. Technological Advances and Environmental Events: Innovations can lower production costs or shift demand to new resources, while weather events, such as droughts or hurricanes, can cause price volatility, especially for agricultural and energy commodities.

Source: researchgate.net