Commodity Investing 101

Commodities such a soil have a large impact on the economies of the world. We can see from the recent downturn in oil that this is in fact, very true. There’s several things you need to understand about commodities and how they impact the trading world.

Commodity Trading 101

Commodity Trading 101 photo by @deapeajay

The History of Commodities

It’s suggested that around 6,000 years ago, rice futures were traded in China. In some cases, when commodities have been in short supply, wars have started over them. In World War II, Japan was after rubber an oil. When there’s an oversupply like now with oil, this has a huge impact on economies as the price drops dramatically and nations suffer as a result because they can’t get the price they want for the commodity. Many empires from history relied on commodities and trade routes to stay in power.

Why Commodities Are Traded

We trade commodities because these are the life blood of the economies of nations. For example, in the middle East, oil is the big commodity. In places like South America, it’s coffee and in Asia it’s rice or soybeans. In the United States, it’s corn and many other commodities. Whatever raw resources a country has to trade, can be called a commodity. The economy of a country can be greatly impacted when their commodity prices drop in the market as they have fewer buyers for their goods.

Categories of Commodities

We trade four basic commodity categories which are:

  • Energy — this includes gas, oil, natural gas, and heating oil
  • Metals — this includes gold, silver, copper and other metals
  • Meat and Livestock — this includes pork bellies, hogs, feeder cattle, and live cattle
  • Agricultural — this includes rice, wheat, soybeans, sugar, cotton, coffee, and coca

Investing in Commodities

Commodities tend to rise and fall very rapidly depending upon market conditions and the supply and demand for those goods. For example, oil is low because there’s glut of supply and not as much demand for it. A lot of the time a country may be growing economically and have a need for certain commodities like steel or copper for example, and this will cause the price of those commodities to rise. Commodities can quickly rise and fall so they are volatile in the marketplace. These stocks have to be watched closely to increase profits and sold when it’s warranted. It’s not a good idea to have a large portfolio of commodities they should be around 10% of your portfolio due to their volatility.

Commodity Futures

A commodity future is an agreement to sell or buy a commodity at a predetermined date and price range. Buyers do this to decrease risks which are associated with price fluctuations of a raw material or product. A seller will do it to lock in prices for their products. For the unexperienced, it can be risky to trade on commodity future contracts. There’s a lot of leverage in holding a future contract. Small move sin the price of a commodity, could lead to large losses just as easily as large gains. It’s a gamble to invest in futures and should only be done by experienced investors that know what they are doing.

Commodities are a big part of the financial world and goods such as oil, corn, gold, and other commodities will continue to be traded and the market will reflect these trades.

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