Top 5 Reasons Why You Should Not Invest in Commodity Trading

Before beginning investment in any of the financial markets, you must understand a number of investment-related factors, including the product, risk involved, return you will receive, service provider, and advantages and disadvantages of the investment.

 

Knowing about the commodity you are intending to invest in in terms of the nature of the product, price driving forces, contract specification, risk-reward, expiry date, etc. is the first stage in commodity trading.

 

In this post, we’ll examine some of the key justifications for investors to reconsider commodity investments before examining various scenarios in which doing so might be justified.

 

What is Commodity Trading? 

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The buying and selling of various commodities and the derivative goods derived from them are known as commodity trading. Any raw material or basic agricultural product that may be purchased or sold is referred to as a commodity. Examples include wheat, gold, and crude oil, among many others.

 

Various Types of Commodities

 

 

  • Metals

 

 

Metals come in two varieties: precious and base, which are traded as commodities. Shiny metals known as precious metals are prized for their scarcity and great economic value. Gold, silver, and platinum are the three most typical types of precious metals. Due to their propensity to maintain value in the face of market volatility and uncertainty, precious metals are regarded as “safe haven” investments. Investors stash their money in gold and silver during times of fear.

 

The relative ease with which a base metal corrodes, on the other hand, makes it more suitable for use in commercial and industrial settings. Base metals are less expensive because they are more common than precious metals. The most widely used base metals are aluminium, copper, lead, zinc, tin, nickel, and lead.

 

 

  • Energy

 

 

Products like gasoline, natural gas, and crude oil are included in energy commodities. Since countries significantly rely on these and other fossil fuels to maintain their economies, it should come as no surprise that energy commodities play a significant role in the global economy. Production, the supply-demand balance, and even politics all have an impact on oil prices. Other financial markets, including stock and currency markets, are impacted by the price of oil.

 

 

  • Agriculture

 

 

A vast worldwide enterprise, agriculture provides food for billions of people. The global exchanges offer investors access to a variety of agricultural commodities, including soybeans, corn, wheat, coffee, cocoa, cotton, and sugar. 

 

Supply, demand, population expansion, extreme weather, droughts, and other events all have an impact on agricultural commodity prices. Soybeans, soybean oil, rapeseed mustard seed, cotton, chana, crude palm oil, turmeric, jeera, dhaniya, mentha oil, and other agricultural products are traded in India.

 

5 Major Reasons Why You Should Rethink Investing in Commodities 

 

 

  • You don’t get dividends or interest

 

 

The majority of bonds and many equities give dividends, yet neither interest nor dividends are naturally generated by commodities. Commodities’ values are solely determined by worldwide supply, commercial demand, and speculation, but stocks are ownership interests in companies whose values normally increase over time.

 

 

  • Commodities are not a good hedge in the long run

 

 

Since commodities have a low connection to other asset classes, many investors utilise them as a hedge to lower portfolio risk. The issue is that a small number of commodities, like crude oil, are disproportionately weighted in several commodity indices.

 

They frequently have short-lived crises where they outperform on a speculative basis. There has recently been a negative association between Treasury rates and gold and a positive correlation between stocks and crude oil.

 

 

  • You must pay the storage, insurance, and other fees

 

 

Commodities are physical objects that must be transported, stored, managed, and insured against loss. For example, gold bullion must be held in a vault and insured in case of theft, and crops must be insured against loss from adverse weather or wildfires. These expenses are collectively known as the “cost of carrying,” or “carrying charge,” and put downward pressure on an investor’s long-term total returns.

 

 

  • You might not be in a position to sell for a fair price

 

 

Particularly when they are traded further out on the curve, many commodities suffer from a lack of liquidity. In order to address these problems, futures exchanges boost contract values after the market closes, which leads to significant price fluctuations in the valuations of marked-to-market portfolios.

 

 

  • There are some manipulated commodity markets

 

 

The Organization of Petroleum Exporting Countries (OPEC) and its influence on crude oil prices are known to the majority of investors, but many other lesser-known cartels control the market for commodities like potash and diamonds. This suggests that a small number of traders or investors who want to keep prices steady may have a greater impact on these marketplaces than supply and demand alone.

 

Dos and Don’ts of Trading Commodities

 

Any financial investment has risks, including risks related to the market, prices, geopolitics, etc. Therefore, it is crucial to take calculated risks while choosing an investment strategy. Here are some tips for navigating the market for commodity derivatives and how you can do commodities trading properly.

 

Dos

 

  • Trade only through registered brokers
  • Assess your risk-bearing ability
  • Familiarize yourself with guidelines and rules, regulations, bylaws, circulars, etc. 
  • Take an informed decision
  • Understand the Delivery and Settlement Procedure
  • Understand and Comply with Taxation and other relevant laws
  • Pay all applicable margins
  • Collect/pay mark-to-market margins daily
  • Insist on documentation with the member such as the Member Client agreement and Know Your Client
  • Read and understand the Risk Disclosure Document
  • Insist on signed Contract Notes containing all relevant information such as Member Registration Number, Order Details, Trade Rate, Quantity, etc.
  • Insist on a periodical statement of your ledger account

 

Don’t

 

  • Don’t get misled by rumours, luring advertisements and promises, and bull/bear run of market sentiments
  • Don’t trade any contract without knowing the associated risks
  • Don’t undertake off-market transactions
  • Don’t accept/pay cash
  • Don’t sign blank Delivery Instruction Slips
  • Don’t delay payment/deliveries to Members

 

When Buying Commodities Makes Sense

For the majority of investors, commodities may not be a good investment, but there are some situations where they are. When an investor is worried about a catastrophe, precious metals in particular, like gold, maybe a good hedge over a short period of time. Gold serves as an effective short-term hedge against a decrease because its prices tend to increase when equity prices decline significantly (15% or more).

 

In some cases, investors may also identify opportunities where commodity prices will move in predictable directions. One good example would be crude oil markets ahead of an OPEC meeting where a production increase or decrease is widely expected. While prices may have already moved up in anticipation, these events usually lead to volatility that can be profitable for short-term traders or speculative investors.

 

Finally, commodities can also serve as useful hedges for other investments. One good example is a portfolio that’s highly concentrated in crude oil companies. If the investor wishes to hedge against a decline in crude oil prices, they could use futures contracts to remove commodity-related risks while still benefiting from company-related risks and rewards.

 

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