Commodities are an integral part of our daily lives. In the physical commodities market, there will be an actual exchange of goods however most traders do not actually take or require the physical commodity. They speculate and take on long (buy) or short (sell) positions to profit from the price movements.
There are many reasons to be trading commodities, among them is the ability to hedge against inflation and diversification.
1. Diversification: Access to Different Markets
Commodities often have a low or negative correlation with traditional asset classes like stocks and bonds. This means that when stocks are underperforming, commodities might be performing well, providing a hedge against market volatility.
Meanwhile, as we mentioned in the article "What Are Commodities," there are many types of commodities, such as gold, silver, and crude oil, which provide opportunities to access different markets.
Including commodities in an investment portfolio can help diversify it, spreading risk across different types of assets, as commodity market prices move independently of other assets.
For example, gold, one of the most popular instruments, is often considered as a safe haven, especially in troubled times.
The safe-haven investment, gold, has historically reacted negatively to increases in the dollar and bond yields. During times of economic turmoil, gold appeals as a safe haven investment, while demand for metals and energy falls, and vice versa.
For example, in 2020, when the global equities market, currencies, and bond markets were under pressure due to the global outbreak of COVID-19, demand for energy and metals was also down, resulting in a drop in prices to multi-year lows, while gold—a safe-haven metal—soared to an all-time high. Crude oil prices even fell into the negative territory for the first time in commodities trading history.
2. Hedging against Inflation
Trading commodities can protect investors from inflation, as inflation hurts ordinary investment products. In times of inflation, returns on ordinary investment products such as bonds are relatively low.
Because rising prices raise the value of the commodities needed to produce them. So if your portfolio includes certain commodities, you may be able to reduce losses owing to inflation.
3. Supply and Demand Dynamics in Commodity Trading
The prices of commodities are primarily driven by the fundamental economic forces of supply and demand. Understanding these dynamics is crucial for commodity traders, as fluctuations in supply and demand can lead to significant price movements.
Seasonal Effects and Cyclical Trends :
Many commodities follow predictable seasonal patterns. For example, agricultural commodities see price fluctuations based on planting, growing, and harvest cycles. Energy commodities like natural gas rise in winter due to heating demand, while gasoline peaks in summer travel seasons. Understanding these cycles helps traders anticipate price movements.
Supply Constraints and Demand Surges:
Unexpected supply disruptions, such as geopolitical tensions or natural disasters, can cause sharp price spikes. For instance, oil prices soar during regional conflicts. On the demand side, rising consumer needs or industrial expansion (like the surge in electric vehicles driving demand for lithium) can also push prices higher.
4. Commodities trading with CFDs
Rather than holding the physical asset of gold, CFDs allow traders to speculate on the way the price of a commodity will change, without ever owning the commodity in question.
Traders who expect an upward movement in price will buy the CFD, while those who see the opposite downward movement will open a sell or ‘short’ position.
Example. If you opened a long (buy) CFD trade on gold when gold was priced at 1,500, and you closed the trade after the price of gold rose to 1600, you would make a profit on the difference in the gold price, or 100. If the price fell to 1400, you would make a loss of 100.
Accessibility and leverage are what make trading commodities with CFDs truly viable.
Availability
Commodities are traded globally and traders can trade 24 hours a day, five days a week, accessing opportunities from a range of commodities and exchanges all around the world.
Leverage
Before the introduction of leverage into the markets, traders needed to deposit 100% of the trade value to initiate a position. With the introduction of leverage, traders are only required to come up with a fraction of the actual capital to open a position, this deposit is called margin. (margin usually ranges from 1% to 10%)
Leverage allows for the magnifying of a small price fluctuation in a CFD into a larger change in profit and loss, with the degree of profit and loss depending on the amount of leverage used.
5. Summary
Trading commodities offers a unique set of opportunities and risks. Whether you're looking for portfolio diversification, an inflation hedge, or speculative profits, commodities can play a strategic role in your investment or business strategy. However, due to the volatility and complexity of these markets, it's important to approach commodity trading with a well-researched and disciplined strategy.
6. FAQs about commodities
#How do commodities differ from stocks and bonds?
While stocks represent ownership in a company and bonds are debt instruments, commodities are physical goods traded in bulk. Commodities often have different market drivers, such as supply and demand dynamics, which can lead to distinct trading opportunities.
#Can trading commodities help with inflation?
Yes, commodities often serve as a hedge against inflation. When prices rise, the value of physical goods like gold and oil typically increases, potentially preserving purchasing power.
# What factors influence commodity prices?
Commodity prices are influenced by various factors, including supply and demand, geopolitical events, weather conditions, currency fluctuations, and changes in economic indicators. Understanding these factors can help traders make informed decisions.
# Are commodities suitable for all investors?
While commodities can offer significant returns, they also carry risks. They may be more suitable for experienced investors who understand market dynamics and are comfortable with volatility.
* The content presented above, whether from a third party or not, is considered as general advice only. This article should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments.
