Commodity Trading Guide – Forbes Advisor UK

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The last few months have been difficult for investors. US growth tech stocks were the first to falter, followed by a broader stock market slowdown and a crash in cryptocurrency prices.

However, the materials sector bucked the trend by posting a positive return over the past year, helped by record oil and gas prices.

So why do investors buy commodities? Well, they provide an opportunity to diversify between different assets and have generally generated higher returns than equities during times of stock market volatility.

And with inflation at its highest level in 40 years, commodities also offer investors the opportunity to earn a “real” return – above inflation – on their assets.

However, the wide range of commodities and products available can seem overwhelming to investors, so here’s what you need to know if you’re considering trading commodities.

Remember: investing in commodities is speculative and returns are not guaranteed. Your capital is at risk and you may not get back the money you invest.

What are raw materials?

Commodities are natural resources or agricultural products that are extracted, grown, raised or processed.

The so-called “soft” products are cultivated or raised, such as meat, coffee, wheat and cotton, while the “hard” products are mined or mined, such as coal, ore, precious metals, oil and gas.

The price of raw materials varies according to supply and demand. If demand increases and/or supply decreases, the price of the commodity will increase.

For example, growing demand for electric cars has driven the price of lithium (a key component of batteries) up more than 400% over the past year, according to Trading Economics.

Similarly, the price of oil and gas soared due to a reduction in supply due to the Russian invasion of Ukraine and operational problems in Norway and Libya. Combined with a post-pandemic resurgence in demand, wholesale gas prices in the UK have risen by more than 270% in the past year.

What is commodity trading?

As with stocks, commodities are bought and sold on exchanges such as the Chicago Mercantile Exchange (CME), the New York Mercantile Exchange (NYMEX) and the London Metal Exchange (LME).

There is a wide range of commodities traded, including agricultural products, oil and gas, industrial and precious metals, and timber. Products of the same quality or class are described as “fungible”, which means that they can be priced on the basis of standardized quality and quantity.

Although it is possible to trade physical commodities, it is much more common to trade financial contracts based on commodity prices, called derivatives. The most common type is futures, but investors can also trade via spot commodity prices and options.

Commodity traders bet on the future value of a particular commodity. If they think the price will go up, they will buy certain futures contracts, known as “longs”, or if they think the price will go down, they will sell futures contracts, or “take a short position “.

How can you trade commodities?

The most popular way to trade commodities is through futures contracts, which are an obligation to buy or sell a commodity at a set price on a specified date in the future. Trading commodities, and futures in particular, is generally a shorter-term investment than investing in stocks.

Commodity futures contracts are described by the month in which they expire, which means that a contract ending in November is called a November futures contract.

Futures contracts are used by buyers and sellers to “lock in” the price of a commodity now, for delivery in the future.

If an airline thinks fuel prices are going to rise, it could mitigate or “hedge” that risk by buying an oil futures contract. If the price of oil increases, the buyer benefits from a lower price than he would have paid for oil on the “spot” market on that date.

However, financial investors also use futures contracts to speculate on commodity prices. Some commodities have a high level of price volatility, i.e. their price can fluctuate significantly over a short period of time. This creates the possibility of big profits (or losses).

Here’s an example of how they work: An investor buys a futures contract for 100 troy ounces of gold at a price of £1,400 per ounce, for a total value of £140,000.

If the spot price of gold is £1,410 per ounce on the expiry date, the investor has realized a gain of £10 per ounce, or a net profit of £1,000. At this point, the investor would close their position and receive the net difference in cash.

However, if the spot price of gold fell to £1,380 per ounce, the investor would suffer a net loss of £2,000, although they could close their position early to try to reduce their loss.

If you are looking to trade futures, you will need to create an account with a trading platform that offers commodity trading. Due to the number of exchanges, commodities can be traded almost around the clock.

Another option for trading commodities is to buy and hold the commodity in physical form. This can be an option if you’re looking to buy gold or other precious metals, but it’s not practical for most commodities.

What is Leveraged Commodity Trading?

The use of leverage is more common when trading commodities rather than stocks.

Leveraged trading is a high-risk proposition that exposes the trader to the risk of high losses and is not recommended for non-professional investors.

Leverage, or margin trading, allows investors to fund only a percentage of the contract value.

In the example above, you might only need to deposit 10%, or £14,000, of the full £140,000 gold futures contract. However, you will need to maintain a minimum balance based on the expected value of your transaction.

If the price moves against your position, this will result in a “margin call” in which you will be asked to deposit additional funds to cover the agreed margin.

Margin trading can be tempting due to the potential for higher profits. However, the reverse is true and your loss potential is also increased.

How can you trade commodities indirectly?

There are several ways to invest in commodities, without directly trading the underlying asset itself:

  • Exchange traded products: Exchange-traded funds (ETFs) and exchange-traded commodities (ETCs) are an inexpensive way to invest in commodities. ETFs typically track the performance of an index, while ETCs track commodity prices.
  • Collective investments: commodity funds and investment trusts invest in a portfolio of companies that produce or mine commodities, including agriculture, precious metals and energy.
  • Stocks in commodity-based companies: companies that produce, mine or process commodities benefit from rising commodity prices because they are able to sell their products at a higher price.

Should you invest in commodities?

Investing in commodities can offer investors a potential hedge against inflation, as well as a way to diversify their portfolio across different assets.

Commodities are also considered a “safe haven” in the event of stock market declines, which can result in higher returns than equity-based investments.

However, trading commodities should only be considered by experienced investors due to high price volatility and the potential for large losses.

Before making trades, investors should research the underlying factors affecting the price of the commodity and be comfortable with short-term losses in pursuit of long-term gains.

Due to the riskier nature of commodity trading, it is expected to represent only a small proportion of investors’ portfolios. Investors should also consider diversifying their investments into commodity-based stocks, funds and ETFs, as well as commodity futures.

Your investment can go down as well as up, and you might not get your money back. If you are unsure of the best option for your personal situation, you should seek financial advice.


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