Commodities are basic materials used as inputs in the process of producing refined goods. Commodities are typically interchangeable with other materials of similar type. Differences might exist in quality if you compare commodities from different sources, but the materials themselves are uniform, for the most part, even though they come from different producers.
Types of Commodities
Commodities that are tradeable can be categorized into 4 main groups:
– Metals including silver, gold, copper, and platinum
– Agricultural including sugar, coffee, soybeans, cocoa, corn, cotton, rice, and wheat
– Meat and Livestock including feeder cattle, live cattle, pork bellies, and lean hogs
– Energy including natural gas, crude oil, gasoline, and heating oil
How Do You Trade Commodities?
Commodities are traded in either futures markets or spot markets.
Spot markets are generally associated with real-time process. For instance, spot silver prices might show current as $20 per ounce. This means that silver for immediate delivery can be sold or bought at that price. Producers and businesses looking to use the materials in questions are the ones that generally use spot prices.
Commodities can still be traded in the futures markets commonly used by investors and speculators. Here, it is not the actual commodities that are being traded, but rather investors enter into contracts to sell or buy the commodity at some time in the future.
Futures contracts outline a specific time and price that will be used for competing the transaction at a later date. No actual delivery of the physical commodity happens in most instances since investors often rollover or close out their positions to capture unrealized profits on their positions.
If commodities are traded using futures contracts, there’s much greater potential for large price fluctuations and significant volatility. The reason why this is the case is that it is much harder to get an accurate sense of where the market prices should be at a later time in the future.
How to Get into Futures Markets
The first thing to do when Investing in a commodity futures contract is to open a brokerage account. Each commodity contract will require a different minimum deposit and this will depend on the broker. The value of the account either decreases or increases depending on the contract’s value.
If the value of your contact goes down, you will be subject to a margin call and will be required to deposit more money into the account to keep your positions open. Since huge amounts of leverage are typically used in futures contracts small movements in price can translate to large profits or losses.
The Bottom Line
Novice and experienced traders have a variety of commodity investments at their disposal. While the spot markets provide an opportunity for investing in commodity markets, futures contractors are ideal for speculators an investor looking to get involved with the commodities market.
However, commodities can become risky investments rather quickly since they can be affected by circumstances that are hard to predict such as political uncertainty, disasters, unusual weather patterns, etc. It is thus advisable not to allocate over 10 percent of your investment portfolio to commodities.