Commodities like sugar, soybean and wheat are an asset class that you may have thought out of your reach but given spread betting there might never have been a better time to start trading commodities. In these volatile times you can use spread betting, futures, options and CFDs to access commodities trading and make money out of trading them in much the same way that you do spread betting on gold or crude oil. It is also worth noting here that sugar is one of the most liquid soft commodities you could spread bet on with a bid-offer of about $1.70.
Commodities are simply goods which are interchangeable. For example a 1 ounce piece of pure gold is the same whether you buy it in the UK or the USA. It doesn’t matter where you get it or who you get it from, there is nothing to distinguish the two pieces from each other. They are therefore said to be ‘commodities’. This is unlike, say, beer – there are loads of different types of beer with different strengths, tastes, bottles and so on. A bottle of home-brew is not the same as the premium stuff you can get in a bar. These are therefore not commodities.
Trading any market puts you up against a variety of players, including buy and hold investors, day traders, institutions and major share funds. Stepping into the commodities arena will introduce extra factors, because commodities like cotton or coffee, which are used by end producers who need to hedge their outcomes, drive many of the world’s commodities markets. This answers a question commonly asked by new traders: ‘Why would someone want to sell if the prices are going higher’? It can be as simple as the fact that they are a producer or user of the commodity and they are looking to lock in a future price, that is, to ‘hedge’ their exposure to price movement. There will always be participants buying and selling, for a variety of reasons.
Trading Soft Commodities
Over the past year, soft commodities like wheat, corn, soybeans, soybean oil, sugar, cotton and coffee have been rising. So you might ask what is driving this seemingly sudden food crunch?
Simply put, the world population is increasing – currently standing at 6.7 billion and that’s a lot of zeros – 6,700,000,000 and this is expected to reach 9 billion by the year 2050) – which means that every year the population is increasing by some 50 million! There is also an ever increasing demand from China and other developing countries for a greater variety of food stuffs [no, Chinese don’t content themselves with just rice these days ;)], as they can increasingly afford cereals and red meat. The average Chinese consumer ate 20 kg of meat a year in 1985 and now eats 50kg. It is also interesting to note that 70 per cent of all grains are already used for animal foodstuffs – and that it takes two to three kilos of grain are needed to produce one kilo of chicken, while six to eight kilos are needed for one kilo of beef!
Spreadbetting Sugar, Soybean, and other Grains
US crops have become established as an asset class in their own right: corn, wheat and soybeans are all traded daily across the globe. UK traders can access the market in a number of ways, through exchange-traded commodities to over the counter derivatives.
Good to Know:
- Do look at seasonal factors because they dictate when products like wheat, corn or soybeans can be planted and harvested, and when they can be delivered to the physical market.
- Such crops are also affected by uncontrollable variables like weather, droughts, freezes, quality of harvest.etc. These non-quantifiable variables have a considerable effect on commodity prices as such factors can affect both the quality and the quantity produced by farmers. According to the US National Climatic Data Center, the three-year drought in the late ‘80s cost the country $36bn and is ranked as its worst natural disaster. However, it is not possible to quantify droughts and correlate them to Soybean or Corn prices for instance. In such cases the fundamental law of supply and demand controls these outcomes. This also makes it harder to trade a system.
- Most commodities are very extended in price and hard to make accurate cycle forecasts because even if you are one or two days ‘off the swing in one’s account its very sizeable, and volatility is supreme! Increasing your position size after a string of losses in commodities is not recommended. Perhaps soybeans had four losers in a row and you decided to double your position size on the fifth trade. After all the market has to give a winning signal now, right? Wrong. Each trade you take at double position size shortens the life of your trading career! And remember there is no better feeling than taking out your initial capital and playing with profits only.
- Some exchanges also set daily trade price limits and you can find yourself trapped in a losing position with no immediate way of closing out. This means that its vital to set stakes at a sensible level and make use of stops (in such cases guaranteed stops are even better!).
- Trading in commodities can lead to bountiful profits as well as cruel losses, so ensure you do some research and make sure the plan you are using involves strict risk management guidelines.
- Trading on equities connected to the commodity industry is also possible as these will directly or indirectly benefit from any increase in demand. Possible candidates include:
- Asian Citrus Holdings (ACHL:AIM) – China’s largest orange plantation owner
- Plant Health Care (PHC:AIM) – Organic plants
- D1 Oils (DOO:AIM) – Biofuel plant breeder and refinery
- MP Evans (MPE:AIM) – Palm oil plantation and refinery
- Genus (GNS:AIM) – which specializes in animal genetics (highly-fertile semen to improve yield quality from pigs and cows!)
- Wilmar Int. (EZYH:Singapore) – Asian palm oil plantation/refinery
- Clean Energy Brazil (CEB: AIM) – Investment company focused on Brazil’s sugar/ethanol industry
- Syngenta (SYT:Zurich) – Largest producer of commercial seeds
- Tate & Lyle (TATE) – UK sugar refinery
- On the other hand if you envisage the commodity prices to continue rising you should steer away from the highly competitive world of food manufacturing, with companies like Cadbury Schweppes (CBRR), Real Good Food (RGD), Northern Foods (NFDS), Associated British Foods (ABF) and Nestlé (NESN.VX) likely to be squeezed further as the raw materials keep spiraling.
Why are commodities traded? Mainly, because there are fluctuations in demand and supply and both the producers, and the consumers, will want to iron out these fluctuations to provide financial certainty.
Tip: The commodity markets seem to love bailouts. This is a little known fact and not written in any book . Go back in history and look at every major bailout and look how commodities performed after it happened. More money sloshing around in the system is great for them and devaluing currencies helps too.
The evolution from an agricultural, event-driven cash market (you raise pigs; you bring them to market; you accept the cash price) to a highly evolved commodity exchange where date ranges for futures head out into the coming year and beyond, and where there are options to be traded as well, is a function of competitive success.
Because Chicago was the biggest cattle market in the 19th century, it made sense that its bourses developed a pre-eminent role in aligned commodities too.
Now, the giant Chicago Mercantile Exchange Group, which includes the Board of Trade exchange (CBOT) as well as the CME, the New York Mercantile Exchange (Nymex) and well as the Commodity Exchange, Inc. (Comex), offers a range of hard and soft commodities, energy, weather, and financial futures and options and each of them – and indeed all similar offerings around the world – provides the same thing to market participants: formalised risk management.
Spread betting on these markets means that any profits are tax-free. There is greater flexibility over the size of the exposure than there is when trading the futures contracts directly.
In fact, while other may pip Chicago for esoterics, there is no bigger range of soft, hard and energy (as well as interest rates, weather, and so on) contracts anywhere in the world. Rough rice (hangs out in sleazy bars, we presume), cattle, and lean hogs (there must be a market somewhere for fat hogs, this is America) and milk contracts are all available to trade – think Randolph and Mortimer Duke explaining the ‘breakfast table’ to Billy Valentine in Trading Places.
- Spread betting on commodities is one of the easiest ways to access the commodities market. Commodities are very much sensitive to the state of the global economy which makes for a volatile situation which many spread betters love since it means that they can normally make substantial gains from relatively small bets.
- When betting on commodities make sure you are aware of the type of contract the provider is using to base their price (futures or spot? UK or USA based, currency..etc). Also, make sure you are aware of the bet size which is normally based on the underlying contract.
- Spread trades are normally based on the pricing in the futures markets for the commodities. While most users of spread betting who trade commodities tend to focus on gold and oil, it can be worth following other commodity markets as well. Some of the more common commodities that you can trade with most spread betting providers are Cocoa, Coffee, Corn, Lean Hogs, Live Cattle, Oats, Soybean, Soybean Meal, Soybean Oil, Wheat and Sugar. Note that there is a quote for Soybean (US) and one for Soya bean (UK).
- In the physical market, commodities are often traded in lots or contracts, which can take some getting used to. Buying one lot of oil contracts is effectively $10 a point. But some investors may not want to do $10/£5 a point on such a volatile market. With spread betting this problem is eliminated, for instance if you wanted to bet £3.35/point, that would be perfectly acceptable – you do not have to deal in multiples of the minimum bet size.
- Spread betting allows you to start with both a lower initial deposit requirement and lower minimum trade sizes; for instance bets on aluminium start at just £1 a point. Most commodities are usually traded in Dollars (although of course you can always spreadbet in the currency that suits you), one of the notable exceptions being Cocoa (London) which is traded in Sterling.
- Other obvious advantages include not having to worry about physical delivery of the actual assets (would you really want a truckload of coffee?) and the ease of settings up stop losses/limit orders.
- Spread betting on commodities also removes the currency risk exposure as you spread trade in the currency you chose when opening your account.
- When spread betting it is crucial that you have access to some historical charts to see just how volatile it is before risking any money: like with other financial markets, some commodities can be very volatile and may be prone to sudden price movements should there be, say a flooding or a weather change impacting crops. This also means that some commodities may move through wider price bands than others – if starting out with a limited balance you need to stay away from markets which are very volatile like lumber or strictly limit your bet size to a minimum.
- You can bet on commodities as a hedge against the possibility of further inflation as the economy gradually recovers (and say, the effects of quantitative easing start being felt in the economy). Commodities such as oil increase in price as inflation goes up – you can even hedge the price of petrol by taking a spread bet; this involves some maths to determine the bet size but may be well worth the effort. Thus if you go long on oil and the price keeps going up this will inevitably lead to an increase in the price of petrol but the extra cost would be offset by the gains from your spread bet. On the contrary if the price of oil goes down, so will the price of petrol.
- Commodity traders do need to be aware of key economic release/events with analysis and forecasts on how it is likely to affect the commodity markets. Commodity prices tend to react negatively to persistent negative economic news or uncertainty like the eurozone crisis or any signs of a slowdown in China. If the global economic outlook is uncertain, then usually the demand for most commodities is going to fall and as a result, their price. Often, information on soft commodities in particular is not talked about until it is too late. For example, crop reports, shipping costs, weather forecasts and inventory data are all hugely significant influences, whether you are a long-term trader or an intraday trader. Other factors affecting most commodities include restrictions over imports and exports as well as the strength of the dollar since many commodity producers report profits in dollars.
- How much of the drop in commodity prices is due to the strong and rising dollar? If the USA dollar appreciates in value, the price of any commodity tends to fall. The producers themselves look at the present prices and are very happy as the dollars that their commodity is exchanged for buys them more European/Asian goods. Producers as such are encouraged to further increase production. Consumers of the commodity are negatively affected, however. Suddenly, it costs them more Euros or Yuan or pesos to buy the same quantity of a particular commodity because the USA dollar has risen so much. As a consequence we have two trends – rising supply and lower demand which seeks a new balance and is likely to bring down prices.
- Of course, the wider the spread and the more unusual the trade, the more risk the trader takes. For this reason providers may impose restrictions on the markets available to certain clients, for instance clients who have ordinary accounts with City Index will have access to more than 20 different commodities but clients with limited-risk accounts will find that they are limited to 3 commodities (gold, silver and oil). Also, there is a limit on to how much you can bet using a limited risk account – this is checked at £25 a point unlike a normal account where you can bet up to £500 a point on gold. Controlled risk accounts also come with wider spreads than ordinary accounts and you would need to set a minimum stop loss of 100 for gold, 20 for silver and 100 for Brent Crude. With a standard account you would need to manage your own risks using stop losses.
- Guaranteed stop loss orders albeit expensive and not widely available in these markets can be especially useful when spread betting commodities as they can be subject to wild swings overnight and a commodity market will hardly ever open where it closed in the previous session. This is especially true with soft commodity markets which have shorter trading hours than currency markets or indices and can open at different price levels from the close of the night before.
- Beware that trading soft commodities is primarily a professionals markets. Many ‘soft’ commodity markets are dominated by food producers to such an extent that poor timing and random events can produce big losses for the unwary.
- Providers make their money by adding to the market spread on commodities and financing costs on long bets.
- Commodities are driven by supply and demand whereas shares are driven by greed. Soft commodity markets also tend to have shorter trading hours when compared to equity markets and may open at quite different levels from the previous day’s closing price.
- Unlike stocks commodities will always have some value, a company can go bankrupt but commodities do not and hedging by either the farmers or the government will always limit the downside. For instance the price of orange juice can never go to zero, because there will always be demand. In fact it might be worthwhile even for small farms to hedge against a fall in particular crop prices.
- Also, unlike equities, individual commodities trade in very small time slots, sometimes as short as five minutes, spread out over the day, and the lack of a continuous stream of liquidity makes for high volatility.
- Also, prices for some commodities can continue going up or down for several weeks followed by dramatic price adjustments – averaging down can be very dangerous when betting on commodities.
- Apart from spread betting you can also gain exposure to commodities by investing in commodity company shares or exchange-traded funds (ETFs). Exchange traded funds follow the market price – unlike investments in commodity company shares and are not subject to stamp duty.
Highly geared companies get hammered when commodity price falls but rise more when the commodity price is on the increase. This is still a very simplistic view and there are many other factors at play…
Differences between Shares Trading and Commodities Spread Betting
Spread betting can be an effective way of investing in commodities IF YOU KNOW WHAT YOU’RE DOING. Most don’t and most lose. Don’t do it unless you know what you’re doing.
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