From the energy that fuels our vehicles to the crops that nourish us to the coffee that helps you kickstart your morning, the commodity market is one big market place where everything the planet blessed us with can be traded. Commodities can be raw materials that can be turned into gold, gasoline and many more and it can also be economic goods.
Roman Zenon Dawidowicz says the commodity market is an ancient profession that is one of the earliest economic pursuits of humankind. Looking to dive into the world of commodity trading? Here, commodity market expert Roman Zenon Dawidowicz explores everything you need to know about the commodity market, from how it works to things to consider before dipping your feet into the market.
Types of Commodities:
Commodities come in two main categories:
- Hard Commodities: These are nature’s underground treasures that need to be mined or extracted– think precious metals like gold and silver, or energy sources like oil and natural gas.
- Soft Commodities: These are agricultural products we cultivate – think wheat, corn, the aromatic coffee beans, or the cotton used in our clothing.
How does Commodity Market Works:
People have been trading commodities since the beginning of time. A bustling bazaar brimming with sellers and consumers exchanging money for meat, cotton, livestocks, grains and many more. This has been the backbone of the economy over the centuries. However, this market can now be traded on exchanges like Chicago Mercantile Exchange (CME), New York Mercantile Exchange (NYMEX) and London Metal Exchange (LME). This is how it works. Let’s say you’re a farmer with a bountiful wheat harvest. The commodity market connects you with buyers who need your crop, like bakeries or food manufacturers. You can either sell your wheat directly (spot market) or lock in a future price through a contract (derivatives market). This ensures a steady income for you and a reliable supply for the buyers.
The commodity market is a dynamic and ever-evolving facet of the global economy. It functions through a well-defined structure involving distinct participants and established mechanisms that include:
Producers: These are the entities responsible for extracting or cultivating commodities. This includes mining companies, agricultural producers, and oil & gas extraction firms.
Consumers: These represent the individuals and businesses that utilise these raw materials in their operations. Examples include bakeries requiring wheat, manufacturers reliant on oil, and jewellers using gold.
Speculators: These market participants focus on price movements rather than physical commodities themselves. They aim to capitalise on their predictions regarding future price fluctuations.
A History of Commodity Trading
The roots of commodity trading stretch back millennia! Even ancient civilizations bartered essential goods like salt and grain. Formal commodity exchanges emerged centuries ago, with one of the oldest being the Amsterdam Stock Exchange, established in the 17th century for trading spices and other goods. Commodity market is older than stocks or forex by centuries. It has undergone changes and growth over the years with the advent of exchanges and derivatives markets.
The Two Sides of the Market: Spot or Speculate?
Roman Zenon Dawidowicz says there are two main avenues to navigate the commodity market:
- Spot Market (Cash Market): This is all about immediate delivery. You buy or sell a physical commodity, like a truckload of wheat, for cash on the spot. Producers directly sell their commodities to consumers in a fast-paced environment. The price is determined by the prevailing forces of supply and demand at that specific time.
- Derivatives Market: This market deals in contracts based on the future price of a commodity, not the physical good itself. This allows for speculation on price movements.
Futures Contracts: These are agreements between a buyer and a seller to exchange a specific quantity of a commodity at a predetermined price on a specific future date. Essentially, they lock in a price today for a delivery to occur later. For instance, An airline concerned about rising oil prices can utilise a futures contract. By entering into this agreement, they secure the purchase of oil at a specific price, say, six months from now. This protects them from potential price increases in the future.
Is the Commodity Market Profitable?
The commodity market can be profitable, but just like any other investment, it also carries significant risk. By correctly predicting price movements, you can potentially buy low and sell high, profiting from the price difference. Some companies also use commodity markets to hedge against price fluctuations in the raw materials they use. However, there are risks involved. For one, commodity prices can be highly volatile, meaning you could experience significant losses if the market moves against you. Future contracts also involve leverage, which can amplify both your gains and losses. Roman Zenon Dawidowicz says you need to consider these steps before you venture in:
- Educate Yourself: There’s a wealth of information available online and in libraries about commodity markets.
- Start Small: Don’t invest more than you can afford to lose.
- Know Your Risk Tolerance: Commodity trading can be volatile, so be sure you’re comfortable with the potential for losses.
Overall, you need to consider the level of your knowledge of the market, risk tolerance and have a well-informed strategy before venturing into this ever-changing marketplace.
