Commodities markets, both historically and in modern times, have had tremendous economic impact on nations and people.
There are four categories of Commodities:
- Energy (including crude oil, heating oil, natural gas and gasoline)
- Agricultural (including corn, soybeans, wheat, rice, cocoa, coffee, cotton and sugar)
- Metals (including gold, silver, platinum and copper)
- Livestock and Meat (including lean hogs, pork bellies, live cattle and feeder cattle)
Energy commodities such as crude oil are closely watched by countries, corporations and consumers alike. The average Western consumer can become significantly impacted by high crude prices. Alternatively, oil-producing countries in the Middle East (that are largely dependent on petrodollars as their source of income) can become adversely affected by low crude prices.
Commodity trading in the exchanges can require agreed-upon standards so that trades can be executed (without visual inspection). You don't want to buy 100 units of cattle only to find out that the cattle are sick, or discover that the sugar purchased is of inferior or unacceptable quality.
Futures and Hedging
Futures, forward contracts and hedging are a prevalent practice with commodities. The airline sector is an example of a large industry that must secure massive amounts of fuel at stable prices for planning purposes. Because of this need, airline companies engage in hedging and purchase fuel at fixed rates (for a period of time) to avoid the market volatility of crude and gasoline, which would make their financial statements more volatile and riskier for investors. Farming cooperatives also utilize this mechanism. Without futures and hedging, volatility in commodities could cause bankruptcies for businesses that require predictability in managing their expenses. Thus, commodity exchanges are used by manufacturers and service providers as part of their budgeting process – and the ability to normalize expenses through the use of forward contracts reduces a lot of cash flow-related headaches.
Supply and Demand
In a market economy, price is determined by the interaction of supply and demand. The stocks to use ratio is a closely watched figure in when establishing asking prices for commodities. In order to understand stocks to use, you must understand the economic theory of supply and demand.
At the risk of repeating ourselves, it's important to note that futures trading is not for everyone. You can invest in the futures market in a number of different ways, but before taking the plunge, you must be sure of the amount of risk you're willing to take. Avic Management offer Managed Commodities Accounts which allows our clients access to alternative Commodities investments.
Risk Warning: Trading in financial products always involves a risk. As a general rule, you should therefore only trade in financial products if you understand the products and the risks associated with them.