Commodity markets have their roots in trading of agricultural products. Commodities are the same no matter who produces it. Typically they usually comprise of raw materials that are traded, including precious and industrial metals, crude oil, natural gas, gasoline and agricultural crops, such as coffee, cocoa, corn and wheat.
There are two types of commodities:
- Soft commodities – goods that are grown
- Hard commodities – those that are extracted through mining
Having a good commodity portfolio offers many benefits and can be utilised to reduce risk, diversify an investment strategy and potentially enhance returns. There is always one continuous price with no expiry date, and up to 5 years price history so you are guaranteed consistent and competitive pricing. In addition there is the flexibility to buy and sell, spreading your bets amongst those markets that are going up or down. Finally, there are a wide range of products to choose from, giving you access to global commodity prices.
Traditionally commodities have demonstrated very little correlation with popular financial products, such as shares and bonds. Historically they have performed with considerable volatility and the future looks favourable for further growth.
The main causes of commodity prices are supply and demand. With the ever increasing population and resource hungry emerging markets, such as China and India, there is more demand than ever, causing much of the fluctuations in commodity prices seen on today’s market.
When looking at the movement of the commodities prices, there are many factors to be taken in to consideration; weather conditions, amount of acres planted, production strikes, crop diseases, technological developments and international trade unions account for example. Additionally, commodities are capital intensive products to produce and have considerable lead times. In many cases, they are also politically controlled through subsidies, taxes or trade restrictions. All of these are important and have considerable influence on cost of production, export potential and therefore prices.
The key to commodity price movements is closely tied to inventory and storage capacity. Firstly, inventories serve as a bridge between physical supply of a commodity and the current global market demand. Inventories in themselves are heavily constrained by storage capabilities, whereas metals and agricultural products do not run into storage capacity constraints as quickly, as do oil or gas. Any incapability in managing either of these through sudden supply and demand requirements, such as drought, production strikes, etc., can force prices to react quickly and sharply.
When considering the storage of commodities, there are large and expensive constraints. If one were to create an infinite storage of excess supply, there would still be very little in the way of price fluctuation of many commodities in the short term. The easier a commodity is to store, the less volatile the price will most likely be. So agricultural commodities can have the additional constraint of being perishable, adding a further time constraint on storage. When a commodity has low inventories then consumers are more likely to pay a premium for the scarcer commodity.
The current commodity environment
Over the past few years, there has been a certain amount of predictability with commodity prices. Whilst there has been somewhat of a constraint on developing markets, the demand from emerging markets trying to grow has subsequently pushed prices higher to see supply meeting demand. It is fair to say therefore that the market is now paying for the lack of investment needed behind the scenes for production, distribution and storage. Then add in decreasing supplies, environmental pressures, political constraints and continuing uncertainty in the equity markets, and it is not hard to see that commodities are now a very real and interesting alternative to traditional investment products.
If you are thinking of trading on a commodity, or would like further information, speak with a qualified Holborn Assets adviser or call us today.