If you really want to know what drives the global market of commerce, you must obtain an innate understanding of commodities and the facts behind investing in commodities. Commodities and their prices have long dictated the laws of supply and demand, determining imports and exports and attracting innovators who dare to make things more efficient or valuable.
In simplified terms, commodity prices move and the stock market reacts to those movements. Yet it’s interesting, most books about investing don’t broach the topic of commodities. So how are these investors able to be successful?
Well in the same sense that you don’t have to be a mechanic to be a great car dealer, those who are good at picking stocks don’t necessarily have to know how commodities prices are affecting long term prospects.
But it couldn’t hurt to learn. In fact, it can very well give you an advantage in a world where quarterly earnings are dissected excessively.
Here’s the definitive guide to investing in commodities: its various methods, the background and applications in the real world, and how to help it benefit you.
The commodity market was created out of a basic need for stability. You see, a long time ago farmers and other merchants were extremely dependent on the price of their goods and services. This dependence was not a good thing for everyone involved.
Just one bad year could completely wipe a farmer out. Consider a year where crops weren’t very plentiful. A lower supply of corn, let’s say, would drive the price of corn higher. This would make the farmer very rich, assuming he had plenty of corn to sell.
But consider the reverse situation. Say that there was a year where harvests were bountiful all across the world, so much so that there was too much corn to sell. This oversupply would’ve driven the price of corn lower, making it harder for the farmer to turn a profit on his labors.
A farmer can’t survive in an environment such as this. He has annual expenses that don’t care if he had a great harvest or not. The farmer needs to constantly buy or repair equipment, buy inventories and seeds, and pay for his own rent as well as feed his family.
And what if he was the only game in town? Now he’d have a whole city of people who are depending on him to stay in business, or else the whole economy could collapse.
It was these unfavorable conditions that led to the creation of the commodity market. What the market did was allow anyone to buy or sell contracts on commodities like corn. This was fantastic news for the farmer. He could now “hedge” his bets, by buying or selling contracts that would bring him profit if the price of corn fluctuated.
The way to buy hedges was through an instrument called futures. Futures trade on the current price of a commodity, and fluctuate daily like the stock market. The flashing quote screens and charts you see in the movies represent commodities and the futures market.
Now the farmer could bring in enough profit no matter what happens to the price of corn. By buying the right number of contracts, his bottom line would be covered and allow him to stay in business no matter what happens in the market.
Author’s note: You can also use options for similar hedging purposes but that is for a different topic and blog post
Companies today do the same thing with derivatives. Business owners are able to use the commodity market to hedge themselves just like the farmer used to. Commodity investing, trading, speculating, and hedging draws more attention now than ever before.
Investing in Commodities: Application
Now that we know the basics of commodities, we need to learn how to apply them. After all, this information is of no use if it doesn’t make you money.
There are several major commodities that drive the world economy. You can find their charts by their ticker symbol. Here’s what they are, with their tickers: [click to continue…]