Unlike stock traders who buy and sell equities, commodity traders invest in raw or primary products – or the commodity market. By definition, a commodity is ‘a tangible product for which there is demand but which is also supplied without qualitative differentiation across a market’ and as such, the commodity market is a market in which traders buy and sell products from the primary economic sector rather than manufactured products.show more
Classified as either hard or soft commodities, there are more than 100 primary tradeable commodities, approx. 50 major commodity markets, traded across 6 of the major global exchanges.
Globally, there are more than 6 billion agricultural, energy and non-precious metals contracts traded yearly with the most liquid tradeable assets listed as crude oil, natural gas, heating oil, gasoline and gold. China and India are the largest commodity market participants.
By definition, hard commodities are natural assets that are mined or extracted. With supply and demand for hard commodities often used as a gauge for global economic health (because supply is often quite fixed in nature), hard commodities include gold, oil, copper and natural gas.
Soft commodities are agricultural products or livestock. Unlike hard commodities where supply is reasonably predictable, demand and supply of soft commodities is subject to a number of influences such as weather and crop production. Popular soft commodity assets include corn, wheat, sugar, pork, soybeans, orange juice, coffee and cocoa.
Hard and soft tradeable commodities are classified into four category types. These are: metals, energy, livestock and meat and agriculture.
Critical for use in global construction and development, as a hedge against inflation and their inclusion as some of the world’s most coveted resources, tradeable metal commodities are grouped as precious, base, raw or minor and include gold, silver, platinum, palladium, copper, nickel, zinc and aluminum.
Indispensable for human survival, energy commodities – fossil fuel and renewable – include coal, natural gas, solar and wind power, ethanol and uranium/nuclear power.
Livestock and Meat
Helping livestock producers, processors and agribusiness to better administer food chain management and constant price risk and used as a food product or for leather, the livestock and meat commodity market is a volatile marketplace where traders buy and sell live and feeder cattle, lean hog, pork bellies and poultry.
Heavily price dependant on weather and seasonality as well as global political climates and health (such as bird flu or contagious virus outbreaks), popular agriculture commodities include corn, soybeans, wheat, rice, cocoa, cotton and sugar.
Commodity codes for futures contract symbols are divided into three parts: the commodity code, the month code and the year code (one digit). Cash Prices or spot prices (when available) can be obtained by affixing Y0 (zero) to the commodity code.
EXAMPLE: CZ7 – C(Corn) | Z(December) | 7(2017)
Global commodity trading has a long, vibrant and well documented history.
As old as human civilization and with artefacts confirming early trade for delivery of goats and pigs found as early as 4500 BCE in Sumer (modern Iraq) commodities trading was primarily livestock and meat market until medieval Europe favoured gold as a primary commodity of exchange and trade because of its’ scarcity, density, shaping and moulding characteristics making it a favoured natural trading asset.
In 1530, the Amsterdam Stock Exchange originated as an early market for the exchange of commodities with commodity exchanges themselves growing in number (and popularity) throughout the 1500-1600’s.
The Chicago Board of Trade (CBOT) opened in 1864 initially facilitating the trade of wheat, corn, cattle and pigs as standardised instruments with other food commodities such as rice, butter, potatoes and soybeans added throughout the 1930’s and 1940’s. CBOT brokers streamlined the process of buying and selling by creating terms of trade relative to the quality of the asset, deliver and terms.
The 20th and 21st century witnessed exponential growth in commodities markets. Commodities exchanges populated the industrialised world facilitating both hard and soft commodities trading. Global access to the internet increased information and trading materials to investors and the advent of trading systems and strategies allowed hedges and speculators the equal participation opportunities in the market.
Traders can buy or sell a commodity either in the spot market, that is; a cash market where assets are traded at current prices for immediate delivery, or the futures market.
The futures market is a centralised marketplace whereby traders buy and sell futures contracts. A futures contract is standardised agreement to buy or sell a commodity at a predetermined price at a specific date in the future.
Standardisation ensures the commodity is homogenous (in type and quality), traded in a single currency (determined by the trade location) and fixed in quantity and delivery date. That is, futures contracts of a single type must be identical to endure continuity and free trade.
Most commodity market transactions take place on the futures market, primarily because it is a market where traders exchange with each other for speculative, risk management and/or hedging purposes as oppose to physical delivery. If fact, less than 2-percent of contracts traded on commodity exchanges result in the physical delivery of the contract.
While commodities instruments are either exchanged-traded or over-the-counter (OTC), traders can also participate in the commodities market using financial derivative instruments such as commodity options, swaps and forward contracts as well as an Exchange-Traded Commodity (ETC) which tracks the performance of an underlying commodity index and offers traders exposure to commodities (referred to as the underlying) in the form of shares.
Commodity prices can be volatile. Economic principles of supply and demand are key price drivers of commodity markets. Reduced supply increases demand resulting in higher prices. Conversely, increased supply decreases demand ensuing lower prices.
Commodity inventory data is a useful tool for traders in correctly pricing commodities and identifying commodity demand and supply levels. Commodities with low inventory levels typically lead to more volatile pricing.
Price drivers including the fundamental state of the commodity market such as oversupply in the market or an inventory deficit push prices higher or lower and the technical state of the market for example, the behaviours of traders, investors and other market participant reacting to market events such as flash crashes or herd buying and selling also influence prices.
Economic, political, or natural events is another factor that can also affect commodity prices. National elections (and election results), advancements in technology reducing costs of production, weather events (cyclones, flood), terrorist threats and health scares in livestock (bird flu) are all potential contributors to changes in demand and supply of commodities and consequently commodity pricing.
Like other financial markets, participants in the commodities markets are primarily hedgers and speculators.
In the first instance, there is the commodity producers and manufacturers. These are participants such as the farmer or grower, or those who need the commodities for their primary business purpose such as electronic manufacturers who require silver or copper to produce necessary components. These participants are primarily ‘hedgers’. That is, they are a producer of a commodity or a company that needs to purchase a commodity in the future and both are attempting to limit their price risk through hedging by locking in prices for a future date. Hedgers trade primarily as a risk management strategy to protect against rising or falling prices.
A ‘speculator’ is a commodities trader who buys and sells for short or long-term gain in anticipation of future directional price movements. These participants are banks, hedge funds or individual retail traders who have no interest in taking delivery of the commodity. Speculators trade for the pursuit of profit.
A commodities exchange is an open marketplace where commodities and commodity related investments (such as commodity futures) are traded. The exchange determines and enforces commodity trading rules and procedures for example contract standardisation and commodity volumes.
Commodity exchanges are loosely divided in three primary commodity categories: metals exchanges, fuels exchanges and soft commodity exchanges and is also the physical centre where trading occurs.
With more than 90 commodity exchanges globally, major exchanges which facilitate the majority of commodities trading include the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBOT), the London Metal Exchange (LME), the Intercontinental Exchange Inc (ICE) and the Multi Commodity Exchange (MCX).
The New York Mercantile Exchange (NYMEX) is the world’s largest physical commodities exchange.
The U.S. Commodity Futures Trading Commission (CFTC) is an independent body that regulates commodities futures trading through the enforcement of the Commodity Exchange Act 1974.
Regulating a multi-trillion dollar marketplace, the CFTC aims to safeguard traders and ensure the competitiveness, efficiency, and integrity of the commodities futures markets and protects against manipulation, abusive trading, and fraud. Focusing on agriculture, energy, technology and environmental markets, the CFTC represents traders, industries, futures and commodity exchanges as well as consumers.