Commodities are natural resource that are used by consumers in their every day lives. The price of commodities, which are generally raw materials, fluctuate in an active market environment. Liquid commodities such as oil, gold and corn are traded on vibrant exchanges allowing both consumers and producers to hedge their exposure. Speculators also play an active role generating liquidity for these markets. Without speculators, commodity markets would become illiquid, reducing the ability of producers to lock in future cash flows.
How are Commodities Traded
The list of active liquid commodities is broad and each are traded differently. While petroleum, agriculture and base metals are driven by supply and demand, precious metals trade more like currencies that are quoted against the U.S. dollar. There is a plethora of assets transacted through commodity trading which include crude oil and its byproducts like gasoline and heating oil. Commodities also include precious metals such as gold and silver. Base metals such as copper and aluminum are actively traded. Agricultural products such as corn, wheat and soybeans along with soft commodities such as coffee and cocoa fall into the liquid commodity spectrum.
Precious Metals Trading
Gold and silver are the most actively traded precious metals. Both are quoted in U.S. dollars and are treated like currencies. Both gold and silver have forward curves like currencies where interest rates are added to generate future prices. Silver is considered a precious and industrial metal. It is used widely in solar panels. Gold is viewed as a safe-haven commodity that protects investors against rising inflation. When geopolitical risk increases, traders generally purchase gold to protect against risk aversion.
The most liquid petroleum is crude oil. WTI (West Texas Intermediate) and Brent crude oil are the global benchmarks. WTI is U.S. crude oil delivered in Cushing Oklahoma. It’s considered a light sweet crude oil that is good for refining into gasoline. Brent is crude oil delivered at the Sullom Voe Terminal in England. Since there is easy access to this terminal from ports all over the world, Brent is considered to be more of a global benchmark than WTI which is landlocked.
Petroleum trading is based on the supply and demand of oil. There are several groups that estimate inventories. The U.S. Department of Energy, OPEC, the International Energy Agency (IEA) and the American Petroleum Institute (API) are the agencies that report on inventories and demand. The U.S. Energy Information Administration (EIA) and the API release reports on a weekly basis forecasting inventory levels of U.S. crude oil, gasoline and heating oil. The IEA and OPEC deliver a monthly outlook on both global supplies and demand.
Corn, soybeans and wheat are the most actively traded commodities. The largest producers are Brazil, the United States and Russia. Consumption is generally stable, so traders rely on supply to determine price levels. The United States Department of Agriculture delivers several reports on planting, harvests, and sales that help drive prices. The weather also plays a large role in determining future price movements.