A vital part of our everyday existence are commodities, which give us the food we eat and the electricity to drive our cars. A commodity is a basic good that is interchangeable with other goods of the same kind and exchanged in large quantities. When commodities are traded as futures, they are either for delivery later or for immediate delivery in spot trading. Commodity markets trade agricultural products and metals.
For investors, commodities provide an additional means of diversifying their portfolios outside of standard securities. Some investors rely on gains from commodities during times of market volatility because the prices of commodities typically fluctuate in the opposite direction of the equity market.
Trading commodities used to be exclusive to professional traders and required a substantial investment of time, capital, and experience. Today, there are vast options for participating in the commodity markets.
Special Characteristics of the Commodities Market
Commodity markets are driven by the fundamental concepts of supply and demand. Demand is impacted by changes in supply, and low supply leads to higher price. Thus, a surge in demand for a product might result from any disturbances in the supply of that commodity. Changes in weather such as El Nino can affect crop yields and thus impact the commodity price.
Investors who have exposure to the energy sector need to understand how economic downturns, shifts in production enforced by the Organization of the Petroleum Exporting Countries (OPEC) and advances in alternative energy sources such as solar energy and biofuels all have a significant impact on the market prices for energy commodities especially as crude oil.
Technological advancement and global economic development can also have a significant impact. For instance, the rise in the manufacturing power of China and India has resulted in a massive rise in demand for industrial metals, making them more elusive in other regions of the world.
Futures For Commodity Trading
Futures contracts are a prominent way to engage in the commodities market. A futures contract is a legal agreement to buy or sell a particular commodity at a predetermined price at a specified time. In addition, some of the futures contracts are shariah compliant due to the unique characteristics of the contract.
The buyer of a futures contract is taking on the obligation to buy and receive the underlying commodity when the futures contract expires. On the flip side, the seller is obliged to deliver the underlying commodity at the contract’s expiration date.
The beauty of a futures contract is that you can have a long position if you are expecting the commodity price to go up or you can short position if you are expecting the commodity price to go down.
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