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Characteristics of commodity market

Commodities

In the production of everyday items commodities are the basic raw material. Important commodities, which include items such as oil, sugar, and metals, basically constitute the bedrock of the global economy. Exchange of commodities is very common. They are raw resources that play an important part in the production processes that result in final items. 

Standardization of commodities is important. It simply means that two same units of a commodity are identical in every way. But yeah regardless of their origin or production. They are often used conversely, as a result of that. To learn more about commodities check out more blogs by MGH. 

Types of commodities

Commodities broadly have two categories by investors: hard and soft. The term “hard commodities” refers to goods that the industrial sectors require. We usually acquire hard commodities by digging or extracting them from the land or sea. They have limited resources and are the ones who are most affected by geopolitical and economic factors. Gold, oil, silver, rubber, copper, and other commodities are examples of this type of commodity. The process for extracting them accounts for an important portion of the pricing. Finding hard commodities requires mining or drilling.

Soft commodities are those that are mostly agricultural or livestock-related. Suitable techniques are used for the manufacturing of it rather than mining or harvesting. They have virtually unlimited reserves.Only weather or natural occurrences affect them, not geopolitical events. Corn, wheat, barley, sugar, pig, coffee, and tea are examples of such commodities. Following are the three categories of commodities.

Agricultural commodities

Corn, soybeans, maize, potato wheat, rice, cocoa, coffee, cotton, and sugar are examples of agricultural commodities. They come under soft commodities. Grain prices are highly volatile in the agriculture industry throughout the summer months or during any period of weather-related changes.

Metal

Metal commodities include the basic metals like gold, platinum, silver and copper. Investing in precious metals is also a safeguard against periods of high inflation or currency depreciation. Metals are all hard commodities.

Energy

Energy resources like crude oil, gasoline, natural gas etc. are examples of energy commodities. Energy commodities are extracted so they are likely to be hard in nature. 

Commodity market

The commodity market, in simple words, is a physical or a virtual market place. This is where market participants meet and buy or sell positions on commodity products. For example, oil, gold, copper, silver, wheat, barley. Though it started with just soft agricultural commodities initially. But the commodity market today trades in all types of commodities. For example in base metals – gold, silver, copper, infrastructure like oil, electricity, and even weather forecasts. There are over 50 major commodity exchanges in the globe that trade in over 100 commodities.

A commodities market, in its most basic form, is a location where members exchange certain commodities. According to predetermined rules and restrictions virtually or physically it is defined. The trading objectives in market is any of these two:

  • to take possession of the goods in order to put them to use,
  • or profiting from the price fluctuations of commodities

The commodities market’s derivatives segment, which includes futures and options, is extremely active. Everyday, a large number of trades take place on the commodities market in this section. Traders frequently try to take advantage of this element in order to profit quickly.

Similar to stock trading, commodity trading allows you to do the same with commodity products. This trading takes place on specific exchanges. With the goal of profiting from changes in the commodity market through the purchase and selling of commodities. Commodity trading has evolved as a practice over time. Furthermore, today’s market has an exceptionally varied assortment of commodities.

Characteristics of commodity market

To trade in India’s commodity market, you first learn how to deal on commodity exchanges. The exchange of products happens on an item trade, which is a direct market.  A commodity exchange is a marketplace or an exchange where traders and investors exchange commodities. One can also change their derivatives, agricultural products, raw materials etc. In this blog MGH will let you know about the major characteristics of the commodity market. Have a better understanding here.

Commodities

Commodities are natural resources with a global market, the majority of which fall into the agricultural, energy, or metals categories. We discussed this above and there are also other blogs from MGH that will give you more information regarding commodities. Following are two key characteristics of commodities: Firstly, modern society needs that all time and their prices fluctuate substantially. Through forward and futures contracts, commodity markets serve to maintain price stability. They allow suppliers to lock in the price of their commodity. Before delivering it to the consumer, which likewise fixes the future price for consumers. The commodities sector is critical to developing countries’ economies as well. More than a hundred developing countries rely on basic commodities for their export earnings, notably agricultural commodities.

Traders

It obviously goes without saying that commodity markets will have traders as a characteristic feature. They are the ones that meet at a marketplace and buy or sell commodities for the market. Futures contracts are frequently purchased by speculators or traders with the intention of reselling them. This helps in getting profit before the delivery date. They most often serve as a link between farmers and consumers. A trader, for example, purchases a six-month rice contract. If the price of rice rises during that time, the trader will profitably resell the contract to a bread manufacturer. If the rice prices fall, the trader sells at a loss to a bread manufacturer. The traders solely buy and sell commodities in the marketplace while acting as an in-between link. 

Commodity market prices

Commodity markets are most often unpredictable, and their swings appear to have no pattern or reason. Even for the most experienced traders, commodity prices are unpredictable no matter what they do. Their price swings generally are usually a result of supply and demand. Naturally as the principles of supply and demand, prices tend to rise when the market reveals a decrease in supply. Higher supplies, on the other hand, usually result in cheaper pricing.

Due to the market’s technical situation, commodity prices vary greatly all the time. Price chart has influenced investors,traders and many other market participants. Changes in the global macroeconomic and geopolitical situation all around the world play a major role in affecting commodity prices.

Predicting commodity price changes gets really difficult due to all of these important factors. However, experienced commodities professionals,who evaluate past market activity, sometimes have an advantage in anticipating and working with future price movements.

Assumptions

Traders sometimes also opt to trade Futures contracts instead of taking physical delivery of commodities. A futures contract is an agreement to buy or sell a predetermined quantity of a commodity. Yeah it is at a predetermined price and by a specific date. A futures contract is simply a contract to buy or sell a specific commodity. That too at a specific time in the future.

Futures contracts help the buyers of food, metals and energy to set the price of the commodity they are interested in purchasing. Accordingly, their gamble of cost increments is decreased. Futures help the sellers of certain commodities to ensure that they will receive the agreed-upon price and gain potential profits. The primary function of this is that they eliminate the possibility of a price decline. The commodity’s price and quantity are established at the time of the contract as a requirement.

Product uniformity

Another feature of the commodity market includes the uniformity and fungibility of commodities and products. gold is gold, and platinum is platinum. The commodity is entirely fungible because it is not uniquely identified (interchangeable). While the quality of some commodities, particularly oil and many agricultural items, varies, these commodities are graded and categorized as a specific kind with uniform and, thus, fungible qualities, because inspecting the entire product would be difficult — if not impossible. Of course, the vast commodity markets, with their many dealers and speculators who can’t inspect the goods, can exist today only because inspection isn’t required.

Hedging risks

Traditional financial assets such as stocks and bonds typically collapse. Generally, during times of crisis, such as wars or recessions, potentially resulting in losses for traders. However, commodities help to mitigate this investment risk in these times. In fact, commodity trading is one of the most common approaches for hedging against the inflation that occurs during crises. Because most commodities, particularly agricultural products and energy, are needs, demand and hence prices remain stable even when the economy deteriorates.  This implies that their prices are inelastic at the bottom end of the demand curve. Commodities, like real estate, act as a natural inflation hedge.

A spike in commodity prices, in fact, could be the first symptom of inflation. Indeed, if significant inflation appears to be on the horizon, commodities may climb even faster as consumers move money out of non-inflationary investments and into commodity markets to protect their holdings.

Import-export competitiveness

This is an extended characteristic feature of futures contracts and hedging risks. Exporters  use the futures market to hedge their pricing risk and increase their competitiveness. The bulk of international traders that deal in physical goods want to buy futures. Purchases made on the open market sometimes expose them to the risk of price risk, which results in major losses. The existence of a futures market allows exporters to hedge their intended purchase by temporarily substituting for actual buying until the physical market is ready to buy. Physical transactions will be careful, time-consuming, and costly in the absence of a futures market.

Transparency

Commodity deals are handled on an electronic trading platform. And are available to all market participants, as opposed to the traditional system of the past. The modern day electronic trading platform provides a fair price discovery by allowing for large-scale participation. It is done without the need for buyer and seller involvement.

They are not entirely set in stone by the organic market, which takes out the chance of cost control. Price discovery refers to when the seller and buyer quote the same price and quantity. The buyer and seller remain anonymous during the transaction, allowing for a transparent price discovery with no room for manipulation. This ensures an effective and fair system for all parties involved.

Diversification

One of the key advantages of investing in commodities and an important feature is diversification. All commodity prices tend to increase and decrease at different times and rates than other investments like equities and bonds. When we compare commodity market returns to stock and bond market returns, commodities market returns are inverse. This is because stock and bond market returns often fluctuate during a rise in market prices of products. Individuals reap great returns on investment even during a stock market downturn by investing a set percentage of their investment portfolio in commodities, which further helps them in compensating for lower or negative profits earned by the capital sector.

Conclusion

Commodities, like any other asset class, get major influence by a range of causes, events and developments in global markets. Because these are raw materials, their primary application is in the industries In which they are of use. But now that they are on a worldwide platform, their role has grown from that of a commodity to that of a trading and investment route, as well as an important asset class. As a result, while macroeconomic changes have an impact on commodity price movements, commodity price movements also have an impact on the global economy, making it an interconnected global phenomenon.

Also, like any other investment product, comes with its own set of consequences, challenges and dangers. The primary economic premise of demand and supply is what essentially determines market commodity pricing. Some of these risks are specific to the commodities market, while others are common and similar across all asset classes.

Commodity trading is also extremely volatile at times. Therefore, it is important to constantly monitor your position, especially in unusual circumstances such as a pandemic or a war. Volatility determines the risk/return profile of the commodities. Since, highly volatile items generate large rewards at the same time; due to the unpredictability and higher degree of variation in commodity prices there is high risk.

Beginner traders should invest more in commodities with low volatility. Such as gold and oil, and less in commodities with high volatility, such as copper and agricultural products.

End of Topic

These are some commodity trading recommendations that a newbie trader should follow in order to make money. It is best to limit your trading to a few commodities at first. Then as you gain experience, you can expand your portfolio to include more commodities. This extreme volatility, by the way, provides plenty of opportunities for traders to profit from market movements.

All kinds of trade require a high level of liquidity. So choosing an exchange with enough liquidity is important. This will further relieve the stress of constantly looking for buyers and sellers. Since, the commodity market is open for a longer period of time. There are sometimes instances when fewer market players are present, and vice versa. Also, most investors would need to square off the position before expiration. There is a risk of late settlement there. If there aren’t enough buyers on both sides of the trade. You are likely to get trapped with certain commodity contracts.

Other than this, there are always more blogs by MGH to help you out. We have all kinds of commodity trading and also learn some tips and tricks. 

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