We use commodities every single day. If you look down at your outfit, there is a good possibility that you are wearing multiple items that use one or more of these commodities as a raw material: rubber, plastics, clothes, grain, precious metals and fuel (for transportation and the production of electricity). Due to the daily use or necessity of these commodities, they are greatly affected by supply and demand. Beyond these basic factors, commodities’ prices can also be affected by geopolitical and adverse weather events – because many commodities are produced in specific geographic locations.
For example, it’s common knowledge that a disruption of crude production in the Middle East can cause an increase in the commodity’s price due to a drop in supply; even though Saudi Arabia is only the third largest producer of oil.
Another example of this effect is when Hurricane Harvey caused refineries along the Gulf Coast in the United States to cease the production of Gasoline in the Summer of 2017. In this case, the closing of refineries caused a temporary drop in the demand for crude, pushing prices down but at the same time causing gasoline prices to increase due to the instant drop in supply.
We saw coffee prices increase in 2017 when Brazil, the world’s third-biggest producer, experienced an extended drought that caused a drop in supply, thus an increase in the commodity’s price.
Unlike other financial products, commodities can be affected by a wide range of factors including but not restricted to diplomatic or political events and change in governments’ policies.
It’s therefore vital to consider risk management before beginning your trading journey – which although explicit in its name – may be overlooked by many traders. Risk management begins with knowing what is going on in the world politically, economically, and even physically, which can help you achieve your investment goals. It can be detrimental to be unaware of an event that could affect the markets you trade on.
Commodities are traded around the world on different exchanges and are usually traded as futures contracts, which is an agreement to trade at a set price and set date. We provide CFDs, which are contracts based on the price of an underlying asset that doesn’t grant ownership of the physical goods. However, traders traditionally prefer this aspect since you do not have to actually own the asset, yet you can trade them whenever you want.
Having a variety of commodities in your trading portfolio can be a great addition and can potentially increase returns. Commodities do not pay dividends, and at the same time they do not go bankrupt. Commodities can also protect against inflation; when economies experience inflation, the prices of commodities have a tendency to go up.
Although they are grouped together, commodities are a diverse group of products. This includes agricultural wheat, soybeans, sugar, coffee, cocoa, corn, cotton, industrial products such as oil, natural gas, heating oil, and crude. Different factors affect them but their price is largely based on supply and demand.