Understanding commodity market
What is the commodity market?
The commodities market is a physical or virtual market where market participants meet and buy or sell positions in commodities such as oil, gold, copper, silver, wheat, and barley. Although they initially started with agricultural commodities, commodity markets today trade all types of commodities such as base metals: gold, silver, copper, infrastructure such as oil, electricity and even weather forecasts. There are around 50 major commodity exchanges around the world that trade over 100 commodities.
Types of raw materials market
The raw materials market can be classified into two broad categories according to the type of raw materials
. These two categories are:
Hard raw materials are made up of the necessary raw materials manufacturing industries. These should be mined and extracted manually from the land or the ocean. They have limited reserves and are most affected by geopolitical and economic conditions. Possible examples of these types of raw materials are gold, petroleum, silver, rubber, copper, etc. Most of the price is due to the process used to extract them.
Commodities are products mainly related to agriculture or breeding. Unlike hard raw materials, they are not mined or mined but are produced using proper procedures. They have virtually unlimited reserves and are not affected by geopolitical conditions but by weather or natural events. Possible examples of such products are corn, wheat, barley, sugar, pork, coffee, tea, etc.
Example of how the commodity market works
If the price of a traded commodity fluctuates, the price of the corresponding futures contracts changes synchronously. Take the case of crude oil, the prices of which are ideally determined by supply and demand. Countries in the Middle East, which are the major oil producing countries, have attempted to control crude oil prices by controlling supply. However, in a practical world, oil prices are affected by other factors, with geopolitical consideration also being the primary one.
For example, during the economic crisis of 2008, global growth declined, and therefore the prices of oil futures should have fallen. barrel.This was mainly due to the fact that investors all over the world took their money in stocks and bought commodities and futures. This increase in cash flow has resulted in an increase in oil and gold futures contracts.
Advantages
Hedging mechanism: The most significant benefit of investing in the commodities market is for producers, importers and exporters as it provides them with a tool to hedge price fluctuations. For example, a farmer can protect himself from fluctuations in the price of wheat by selling his three-month forward contract. On the other hand, a dealer can protect himself by buying a futures contract.
Fewer manipulations: Compared to the financial market, the raw materials market deals with suitable tangible products which are raw materials for manufacturing industries. Therefore, commodity markets are governed by supply and demand and are less subject to manipulation than financial markets.
Disadvantages
Risky: Commodities investments are very volatile because the geopolitical elements play an essential position in their pricing. For example, any suspicion of a political disaster withinside the centre east ends in a surprising spike in crude oil prices. Because of one of these systematic risks, commodity markets are very vulnerable to operational screw-ups and want to be frequently monitored to keep away from any adverse circumstances.
Leverage: Unlike monetary markets, commodity markets thrive on low-margin necessities and excessive force. Though it facilitates higher capability profit, excessive leverage ratios in instances of financial recession or sudden risky actions can result in extended losses.
Important points
The commodity marketplace is tons older than the monetary cash marketplace and has developed over time. The first actual buying and selling regarded to mankind become barter buying and selling, in which commodities like meals and grains could be traded among farmers and consumers. The earliest regarded complete useful commodity marketplace become installed in Amsterdam in early 16th
The pricing of commodities traded withinside the commodity marketplace is pretty complicated and relies upon their man or woman traits. For example, for items like wheat, and barley, there’s a garage value concerned similarly to the forces of call for and supply. The garage value is needed as those commodities require proper garage mechanisms to keep them at some stage in transportation or from herbal calamities.
There are positive criteria that a commodity should own to be in shape for buying and selling withinside the commodity exchanges. These traits are homogeneity, rate fluctuations, open supply, and durability.
The commodity marketplace, though, differs from cash markets in phrases of the underlying instrument; the underlying ideas of buying and selling are quite tons the same. The idea of spot rate, destiny rate, expiry, and strike rate is quite tons the same.
The commodity marketplace, though, in general, is ordinary trade-in commodities like espresso or wheat, however with time has developed to encompass positively differentiated merchandise too. These differentiated merchandises are ordinary commodities however with positive strange traits. Example of excessive octane fuel for which an ordinary thing could be fuel.
Commodities are exceptionally risky property in comparison to monetary property. They are ruled now no longer effectively through geopolitical tensions, financial expansions, and recessions but additionally through herbal forces like floods or calamity.
Conclusion
The trade in goods and therefore the market in goods dates back to the time when human civilizations began to evolve. They are just another
asset class just like stocks or bonds. The difference lies in the origins because they are more tangible. The similarity is that they both have their complex and evolved
derivatives which act as hedging mechanisms for hedgers and quick money for speculators.
