The commodity market is one excellent avenue you may explore as an investor. It doesn’t just give you the potential for profit and offers different market types to utilize multiple trading methods and a barrage of assets to diversify your portfolio.
All these are the exact factors an investor like you needs to maneuver any investment market properly. However, before diving into the commodity market, you must understand all its intricacies.
Our article presents you with all you need to know about the commodity market, including its definition, how it has evolved over the years, and some differences between the commodity market and the stock market. Let’s get right in.
What Is The Commodity Market?
A commodity market has commercial activities centered around trading primary goods. Unlike regular marketplaces that may deal with finished goods, the commodity market solely deals with raw materials and primary products such as crude oil, fruits, livestock, or gold.
These products are distinguished into two groups; soft commodities and hard commodities. Soft commodities are products obtained from agricultural processes, like orange, cocoa, fish, and sugar, while hard commodities are obtained from mining processes, like oil, silver, and gas.
The commodity market involves both physical and non-physical trading of commodities, with products available to buyers, sellers, and investors in a centralized and liquid environment. For investors, commodities, especially precious metals, are typically used as safe havens during stormy economic conditions.
How Has the Commodity Market Evolved?
No one can put a date on when commodity trading started, as it is as old as human interaction itself. However, we see records of futures commodity trading activities as early as 6000 BC when the Chinese traded rice and 4500 BC when the Sumerians implemented the use of clay.
Intricate forms of the market were then created by the Chinese, Greek, and Roman civilizations through the Silk Road. All of these led to the first ever stock market, the Amsterdam stock market.
The mention of the Amsterdam stock market is important here as it originated from a physical commodity market created in 1530. Today, these early forms of commodity trading have birthed a range of non-physical and highly-supervised markets across multiple commodity exchanges around the world.
Types Of Commodity Markets
There are two kinds of commodity markets; the Spot market and the Derivative market. The spot market is also called a cash market and involves the physical and mostly instant exchange of commodities between a buyer and a seller. It is the more direct form of commodity trading.
Derivative markets involve the exchange of derivative contracts based on the price of these physical commodities. This is the non-physical, mostly online market that is more intricate and gives you access to futures, forwards, and options trading.
Futures and forwards trading are similar, as both involve reducing pricing risks by agreeing on the price of goods today and receiving these goods at a later date. The only difference is that futures contracts are typically traded on regulated exchanges, while forwards are done over the counter or through peer-to-peer interactions.
Additionally, the contracts are usually ended before delivering the goods with online futures trading, as there is only interest in the change in the price of the goods. In contrast, forward trading always has delivery finalized. One popular exchange that facilitates these trading activities is the Chicago Board of Trade (CBOT). It is an online commodity market that initially allowed only spot trading on soft commodities before expanding to the more complex derivative trading on hard commodities.
Commodity Markets and Stock Markets
The significant difference between commodity and stock markets is in the assets dealt with. While commodity markets only deal with hard and soft commodities, the stock market deals with the shares of companies.
Sometimes, however, you may indirectly trade commodities through the stock exchange. This is possible when trading the stocks of mining companies, as the price of shares typically correlates with the fluctuation in the price of commodities they deal with. Nonetheless, the two markets share a lot of similarities.
Futures and other derivative trading methods are available in both the stock and commodity markets. You additionally have exchange-traded commodities just like exchange-traded funds in the stock market. You don’t need to have extensive training on how to trade commodities if you have an understanding of the stock market. All you need to know is the factors that cause shifts in the prices of assets in these two different markets.
Advantages Of Commodity Market
The commodity market offers you a barrage of benefits against the stock market. Firstly, it serves as an option to hedge against your investments in the stock market, given commodities like precious metals serve as safe havens during economic downtimes.
You have multitudes of assets to diversify your portfolio, as well as highly-regulated exchanges that offer protection and transparency in case you wish to trade online. You also enjoy low margins on your trades from brokers.
What’s more, the prices of some commodities are also stable enough to almost guarantee profitable returns. However, this is seldom the case and only applies to essential products.
Disadvantages of Commodity Markets
Even though some commodities are stable, many products traded in commodity markets are highly volatile. They depend on the levels of supply and demand, so any slight change in these leads to a change in price.
Oil is a great example when talking about volatility in commodity markets. Its relatively high risk is tied to the inelasticity of demand and supply to meet price changes, which may be said of other commodities.
Commodity markets are profitable ventures for investors, but like every other market, also come with their risks. How to trade commodities depends on what you want, as you have the choice to either speculate, buy and sell products, profit from derivative contracts, or hedge existing positions. Online commodity markets are not hard to find today, especially if you wish to deal with gold and crude oil.