An intro to
A commodity is a raw material used in the manufacturing of more complex products. Commodities can either be soft (ie, grown or raised, such as agriculture and livestock) or hard (i.e., those that can be extracted or mined, such as metals and energy).
A quick history lesson: commodities trading dates back to ancient civilisations, who used to physically trade metals, spices, seashells, agricultural products and animals. In fact, commodities trading originates from Sumerian innovations such as maths and ‘bulla’, a hollow clay ball used as a verification device. The bulla is the earliest equivalent of futures contracts (i.e., buying and selling an asset at a specific time in future at a pre-agreed price and quantity).
Since then, commodity markets have become more complex, although the basics around commodities trading have remained the same. Today, commodities trading is performed both physically and virtually in various trading ways, one of which is via contract for differences (CFDs). With commodities CFDs, you speculate on the rise and falls of commodity prices.
From transportation and housing to our big cup of morning coffee, our everyday life relies on commodities. What separates commodities from other goods is their interchangeability with other assets of the same type. Take gold as an example: the location where your gold was extracted plays no role in its value. What’s more, some standards are put in place to guarantee the quality of the commodity (such as the Gold standard).
Metal commodities are primarily used in manufacturing, construction and jewellery. Gold and silver are, of course, among the more precious metals you can trade.
Energy commodities play a crucial role in keeping the global economy ticking over. Examples include crude oil, heating oil and natural gas.
Agricultural commodities are crops and animals that are grown or raised. Most agricultural commodities are used to produce food, with examples including cocoa, coffee and wheat.
The law of supply and demand
Every type of commodity is affected by unique factors, but, in any case, the main driver of their prices is supply and demand. Higher demand means a higher price for a commodity, while a commodity surplus will result in a price decrease.
Let’s explore the major factors that may affect supply and demand.
Economic performance around the world
Economic growth boosts the demand for commodities while recession reduces demand.
Additional demand is created during the economic expansion of emerging markets, driving the respective commodities’ price.
Consumer & manufacturing trends
The growing popularity of avocado – the king of Instagrammable brunch – and its superfood qualities has set a high demand for the fruit (yes, it falls under fruits the same way the tomato does). As a result, the price of avocado has rocketed in recent years, showing that consumers can significantly affect the demand and supply of commodities and, respectively, their prices.
Furthermore, when a commodity becomes more expensive, buyers will look for suitable and less costly alternatives. Buying the substitute reduces the demand for the original commodity, decreasing its price.
Crop failures, health crises such as the COVID-19 pandemic or natural disasters such as an earthquake may significantly affect demand.
Production constraints, such as oil supply cuts, can play a part in commodities price movements.
Wars, trade wars, conflicts, financial crises, terrorist attacks, and climate change can impact commodity supply and demand.
Trade commodities CFDs with Eurotrader
We offer a range of popular commodities CFDs for you to choose from, including gold, silver and Brent crude oil. Head over to our product page to have a browse!
Here are some reasons why you might like to trade commodities CFDs.
Inflation is the rate at which currencies depreciate, meaning that today’s money will have less purchasing power in the future. In other words, it will cost more money to purchase the same amount of a given commodity at a later date.
Hedging is a risk management strategy carried out by taking a position in one market to reduce losses in case of an adverse price movement in a contrary market. Investors usually invest in precious metals as a hedge against periods of high inflation.
Diversification is another risk management strategy carried out through the allocation of funds into multiple assets, and is essential regardless of the trading strategy that someone follows. Traders need a diversified portfolio beyond traditional securities. As commodities prices tend to move in opposition to stock prices, some traders also rely on commodities during periods of market volatility.
CFDs provide an efficient way to trade popular commodities due to higher leverage, enabling a trader to use less capital to gain greater exposure. Speculating on the price movements without taking actual ownership of the commodity itself is also an advantage.
CFD trading typically comes with leverage too, which means you can open a trade with just a fraction of the asset’s total value. However, leverage is a double-edged sword: while it can magnify your gains, it can also magnify your losses.
You can use commodities as a way to diversify your portfolio and manage risk better, although you should keep in mind that commodities can be high risk.
Commodities are associated with the highest level of volatility when compared to other major asset classes, largely because the commodities market is impacted by unforeseeable events, both natural and human-induced. So, be mindful of the potential for significant volatility and large price fluctuations!
Commodity CFD trading: an example
Once you’ve made a trading plan and have carried out all your research and studying, you might just be ready to make your move! See how a commodities CFD trade plays out with this example below.
In this trade, we are speculating that the price of gold (XAU) will rise against the US dollar (USD).
XAU price rises to 1795.64 & you close your trade. You make a profit of USD 1000.
Subtract spreads, swaps & commissions (depends on account type) for the final profit.
XAU price falls to 1775.64 & you close your trade. You make a loss of USD 1000.
Add spreads, swaps & commissions (depends on account type) for the final loss.