By: Hillel Fuld
The commodity market has proven to impact the world throughout the generations. Some suggest that rice futures were traded in China as far back as 6,000 years. Critical shortages of basic commodities have sparked world wars and oversupply of certain resources has had a devastating effect on countries' economies as well.
While the average person in a Western civilization will suffer from high oil prices when pulling into a gas station, countries, particularly in the Middle East will collapse under the extreme reduction of global oil prices. If we are focusing on oil as an example, it is interesting that the oil prices are monitored closely by consumers, corporations, as well as countries, all with the same level of urgency.
To categorize the commodity market, you would find four main groups of resources:
1: Energy: Heating Oil, Crude Oil, Gasoline, and Natural Gas
2: Metals: Silver, Gold, Platinum, and Copper
3: Livestock and Meat: Lean hogs, Pork Bellies, Live Cattle and Feeder Cattle
4: Agricultural: Corn, Soy, Cocoa, Coffee, Cotton, and Sugar
In ancient times, civilizations would trade a wide variety of commodities, including seashells, spices, gold, and many more. While, in those times, the quality of the product, date of delivery, and transportation methods were often unpredictable, most ancient economies were based on the commodity market. Empires built their perceived might upon their ability to accommodate complex trading system and facilitate commodity trading.
The commodity market differs in many ways from the traditional buying of stocks and bonds. For starters, there must be a set of agreed upon standards before a commodity market transaction. If for example, you are selling a large amount of corn, the buyer must be satisfied that the corn meets the required level of quality when receiving the product.
In addition, the value of commodities is affected by a wide variety of factors such as global developments in the political, financial, and political realms, as well as drastic weather conditions or disasters.
The principles that guide the commodity market are pretty basic and elementary. It is all a matter of supply and demand, which is the name of the game. However, the commodity market has been known to be a little tricky. Obviously, no one really knows what tomorrow will bring in terms of pricing of gold or oil, but the experts want to believe that they have some basic indication of what to expect. This has not been the case on many occasions especially in regard to oil prices and specifically in 2008-2009. The volatility in the commodity market in those years was unprecedented and unexplainable by the experts. You would have expected such sharp movements to show itself during times of war, such as the Gulf Wars, or perhaps during the Iranian revolution, but while those events did affect oil prices, they did not have as much of a drastic effect as we have seen in the last two years, and no one can explain why.
The basics of the commodity market can be summed up in two words “Hedging” and “Futures”. The global economies depend on the commodity market to survive. Take airlines for example. Airlines would not last without the constant supply of gasoline at a minimum risk of price volatility. If every airline had to cope with the risk of extreme price increases, none of them would last. They therefore use a set price by means of futures trading and insure themselves by using the technique of hedging.
In conclusion, just like Forex and many other markets, the commodity market can become very similar to gambling, and can lead to devastating losses. If, however, the trader educates themselves, understands what drives the commodity market, implements futures and hedging methods, traders, investors, corporations, and countries can benefit from a security net that will protect them from volatile markets and fluctuating prices in the commodity market.
By: Hillel Fuld