Commodity-Trading in the Exchanges involves predetermined standards so as to ensure that trades can be completed without recourse to visual inspection of the underlying assets. Trading and/or investing in commodities can be very different from trading and/or investing in equity [share] instruments or debt [bonds] instruments.
Commodity prices are very sensitive to global economic conditions. Demand and Supply are factors that directly influence the commodity prices. For example, empirical evidence points to lower commodity prices in supply-glut situation. It is equally accepted that commodity prices shares a negative co-relation to inflation and currency exchange rates.
Trading in certain commodities requires special attention. Sometimes investing in certain commodities could be dangerous in terms of return in investment. The investments could be highly risky and the distinction between well-thought investment decision and speculation could be very thin.
Here are a few options where investors can look at parking their surplus funds vis-à-vis commodity trades
Gold
An asset traditionally considered as a very reliable and sensible investment avenue, Gold is first choice in times of volatile market conditions. Generally speculators in capital markets tend to use Gold as an alternate investment destination to compensate possible losses in the stock markets. It is more often than not, used as a hedge to counter high inflation. Trading in Gold Futures is another avenue of commodity trading
Crude Oil
Trading in Energy Commodities is equally risky. Investment or trading in Energy Derivatives like Crude Oil Futures could be as challenging . Global demand-supply imbalances like declining demand for petrol/diesel world over, supply glut from the OPEC and Russia, coupled with ever strengthening dollar and the Iran Nuclear Deal, have all acting together dented the crude oil market. While investing in Crude Oil futures one should keep in mind the economic condition, demand supply imbalances and new technology-driven alternates to Energy. For the record, trade pundits believe that recent events associated with Crude Oil could see the Crude Oil Prices touching an all-time low of $10 per barrel.
Risk Management in respect of Commodities
Commodities are most often than not considered as a risky investment decision since they are very sensitive to the vagaries of weather, natural calamities and other man-made catastrophes. These are beyond the immediate control of the investors and are hard to predict. It is advisable to be very cautious when allocating funds to the commodity investment portfolio.
Risk is mitigated to a large extent through the intermediation of the Commodity/ Futures Exchanges operating from around the world. These Exchange trade in one, few or many commodities as the case may be. Trading in commodity futures can relatively less risky with the intervention of the Commodity Exchanges but yet trading in commodity is risk-sensitive/
Derivative Products like Forward Contracts, Futures and Options have in significant manner reduced the manifestation of risk in commodity trading. Hedging is another vehicle of risk management. Futures and Hedging have helped businesses from insulating themselves from financial liquidation.
In the ultimate analysis, it can be stated where businesses trade in commodities based on uninformed or inadequate information, that exercise can turn into plain speculation. As stated above the use of commodity derivatives and through hedging one can insulate oneself from losses due to volatility in commodity prices. Remember when markets are unexpectedly volatile, investment in commodity-derivatives is a prudent investment decision.
Visit Presidency University Blog for more information
