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Lesson 2: Aspects of Commodities

commodity, commodities, commodity for beginners

commodity, commodities, commodity for beginnersIn the first article of this Commodity Course, we have seen the history of commodities; now we will see the aspects of commodities. Commodities can be found every day on our table or however, even though they are not foodstuffs, we make a daily use of them. For this reason, the price of commodities will never drop to zero (which can happen, for example, for a stock). This is because we would never deprive of certain goods such as corn or wheat that we eat every day and that they feed the world.

The first aspect very interesting about commodities is determined by the cost of production. I will give you an example. We take the wheat; it is a commodity widespread all over the planet. It is consumed every day, and we find it, for example, in the form of bread. This means that there will always be someone willing to produce it for a profit.

Produce wheat, however, has a cost and if the price of wheat is too low and fails to compensate it, the farmer will stop producing. This will lead to a reduction in supply because there will be fewer farmers in the world willing to produce wheat. As a result, the price of wheat will back to rise.

So, if we know the cost for the production of a commodity, we can purchase that commodity at a low price because we know that below a certain level, that particular commodity is no longer convenient produce it. All of this will affect the price, due to the decrease in supply, and therefore it will back to rise. And, it is worth to emphasise this, with very low risk.

This is a first interesting aspect that only the commodities can offer us. Let's see now what are the reasons that underlie an investment in commodities.

Inflation. Commodities have, by their nature, a role of coverage and they do it very well against inflation.

Generally, when the demand for goods and services grows, also the prices of these goods and services rise, and, of course, the prices of commodities that are used in the production tend to grow too.

Since the commodity price increases during periods of prices grow, investment in this asset can provide the investor with coverage of the portfolio against the pressure of inflation. In even more severe situations, such as during the geopolitical and macroeconomic upheavals, commodities have often proved more robustness than other instruments.

Diversification. Diversify, protect and balance the portfolio should be the first rule of every investor. Reduction of the risk always passes through the choice of instruments and different markets, and in this, the commodities play an important role.

It is well known that, very often, when the value of certain assets drops (e.g. stocks or bonds), commodities provide very attractive returns for investors. That is why diversify.

Seasonality. Only with the commodities, we can exploit a seasonality, a cycle that is repeated year after year. Just think about heating oil. It is clear that we will have a much larger consumption of it in winter, while it will be little used during the summer. Similarly the production cycle of the various crops, with planting and harvesting occurring every year.

This is a statistical advantage that we only have in the commodity market: if you know in advance which is the seasonality of various goods you can anticipate price movements. Some data are sufficient, some analysis, nothing complex and you can make very interesting profits from this market.

In the next article, we will see which are the main treated commodities in the markets.

Seasonalgo, seasonal trading, spread trading, commodity market

 

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