Stock Market Guide to Investing in Commodities and Futures Trading
Commodities and Futures trading is a crucially important part of our modern economic system, on a par with the trading of stocks and bonds. Let’s look at Commodities first. Commodities are products that are produced in a standardized format, like bushels of wheat or barrels of oil, and are traded on the basis of their price. The fact that the market price for commodities varies due to a host of factors affecting supply and demand allows a speculative market to function. Some of these factors may include, as typical examples, a major diamond discovery in South Africa that puts downward pressure on the price of diamonds, or a crop freeze in Brazil that causes the price of coffee to rise. It is sometimes possible to anticipate trends in commodity prices over the longer term, but sudden shocks to the market are completely unpredictable and have led to the ruin of many a commodities trader.
The establishment of worldwide commodities trading markets has been on the whole beneficial. Farmers have a reasonable idea of what the price of their agricultural commodity will be when harvested and can therefore plan with a greater degree of certainty and security. Miners who observe the price of base metals like copper or nickel rising in response to demand from robust Asian economies may decide that a mothballed mine should be re-opened because it will now make a profit.
Trading of Commodities is conducted at major stock exchanges and at dedicated commodities exchanges. Some of the most notable of these include the New York Mercantile Exchange (NYMEX), the London Metal Exchange (“LME”) and the Chicago Board of Trade (CBOT) which in 2006 merged with the Chicago Mercantile Exchange (CME).
Futures Trading is closely associated with Commodities Trading with one critical difference: the majority of trades do not result in the delivery of the specified commodity. Rather, forward commodity contracts called Futures are bought and sold, often both as positions are hedged and calls covered. In an example of futures trading, an investor in the fall of 2006 might have noted that the prices of forward orange juice futures contracts remained steady, even though a news report he just heard indicated that an El Nino weather phenomenon was in its early stages and could possibly lead to a colder than average winter on the Pacific coast. The investor would then buy those forward contracts, and would in turn realize a healthy profit buy selling them when demand for orange juice sharply rose in response to a devastating California crop freeze in January of 2007.
Both commodities trading and futures trading are not for the faint of heart or thin of wallet. Fortunes are made – and lost – on the commodities and futures markets, but usually by large institutional investors or the individual arbitrage firms who work for them.