Commodities Courses

Post on: 16 Март, 2015 No Comment

Commodity- Meaning

In trading a commodity is a raw material which can be bought and sold. A Commodity has and derives its value. The main emphasis here is that commodities are bought and sold.

Commodities that are traded are generally of two types’ i.e. hard commodities and soft commodities. Hard commodities generally includes variety of natural resources like gold, rubber, oil, etc, and soft commodities are generally agricultural products like corn, wheat, coffee, sugar etc.

The common four categories of commodities include-

What are the basics of Commodity Trading?

This process of commodity trading does involve an Investment strategy. The process of trading revolves around the buying and selling of commodities that are well classified. The trading process necessitates one to participate in the transactions of the commodity exchange.

Evolution of Commodity Market-

For future use rice was stored in the warehouses by Japanese merchants. The warehouse holders raised receipts against the stored rice, which were known as rice tickets. This rice tickets were eventually accepted as a kind of commercial currency.

Chicago (USA), in the middle of the 19th century, budded as the location for organized trading in commodities. In Chicago, the farmers and dealers started to make promises. These promises were to exchange the produce for cash in future. This led to the emergence of the contract for “Futures”. In short the commodity producer agreed to sell the produce to the buyer. This contract had a future delivery date and a specified price.

Who are the Participants of commodity market?

The process of commodity trading requires a large number of participants. For the process of trading the participants must have diverse risk profiles. Trading participants generally includes hedgers, speculators and arbitrageurs.

Speculators:

They are traders who trade for making money. Generally the trends and direction of the futures prices is used by them for speculation purposes. For speculators it is an investment option.

Arbitrageurs:

They are traders who buy and sell commodities based on the difference in commodity prices across various exchanges. They try to make money based on the price difference across different markets. Arbitrageurs involve themselves in concurrent buying and selling of the same commodity in different markets.

Hedgers:

Hedgers, who generally are the commercial producers and consumers of the commodities, participate in the market to reduce their price risk in the spot market. They participate in the futures market to hedge or protect themselves against the risk of losses from fluctuating and volatile prices.

How does the Commodity trading works? (Example)

Let’s understand this with help of an example-

Suppose if a sugarcane farmer wants to protect himself from possible declining future prices at the harvest time.

The farmer has and will incur a specific cost for planting, growing and harvesting his sugarcane crop. He wants to make profit during the final sale, which includes all the cost incurred by him plus the extra profit.

But the fact is that his sugarcanes cannot be harvested and sold for yet another seven months.

Weather conditions like temperature, rain, drought, etc could impact his crop as well as the final price that he expects to get in return.

So keeping in mind this whole scenario and to reduce his risk, the farmer agrees to sell his sugarcanes in the future markets today. In the future Market the product (Sugarcane) will be sold to a Commercial Producer at predetermined price and for delivery seven months later.

Now, if theres high demand of his Sugarcane at the time of the harvest season, farmer’s crop would be worth even more money in the future market

And even if there was not enough demand for the sugarcane during the harvest time, he is still able to protect himself by securing a pre-determined profit for his Sugarcanes.

Segments in commodity market:

Over-the-counter (OTC) market and Exchange-traded market are the major segments involved here.

Over-the-counter (OTC) market:

In Over-the-counter market the involved parties trade on the basis of mutual understanding between them. OTC market is also referred to as “customized market because of no formal structure.

Mostly delivery based trading takes place in these markets. Such markets are entirely unregulated with respect to disclosure of information between the parties which may lead to counter-party risk. Mostly farmers, processors, wholesalers, etc. trade in such market.

Exchange-traded market:

This is a place where the commodities are traded over the exchange. These markets are standardized and regulated. The exchange here acts as an intermediary to all commodity transactions.

Commodity trading Risks-

Price risk-

May result from fall in the exchange rates.

Geopolitical risk-

For access to the large deposits of oil located in the Gulf region, so the companies wanting to extract this oil have to deal with the respective countries of the Middle East to have authority over this oil.