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27
Sep,18

Commodities Market – Introduction & Advantages

Three Risks that can harm your Profits

To understand the Commodities Market, we should know what type of commodities are traded in India.Let us have a look at the various types of traded commodities in India. When you invest in the commodity market, you may be spoilt for choice. There are various types of commodities which are available for trading in the market. Broadly, they are categorized as Soft and Hard commodities.

Soft Commodities:

A soft commodity is a general term that is used for commodities grown on agricultural farms, rather than mined from the earth or extracted from other substances.

Corn, Wheat, Soybean & Sugar are some examples of soft commodities.

Soft commodities have a limited shelf life and they are highly prone to damage due to bad weather. As such, their prices tend to be volatile in the short term. In fact, the weather plays a huge role in determining the prices of soft commodities. The prices of soft commodities can move sharply with sudden changes in a weather forecast.

Hard Commodities:

A hard commodity is a type of commodity that is either mined from the earth or extracted from natural resources.

Gold, Silver, Crude Oil, Copper, Nickel & Aluminium are examples of hard commodities. Some hard commodities are also produced by refining other commodities. For example, gasoline is produced by refining crude oil.

Hard commodities are easier to store than soft commodities because they are not perishable. Besides, the weather does not have a direct impact on their production and supply. As such, the market for hard commodities is generally less volatile in the short run than the market for soft commodities. The prices of hard commodities depend more on global macro-economic fundamentals, such as GDP growth, industrial production, and interest rates.

The types of commodities you choose to trade definitely affects how you trade and what yields you can expect. This is because time is often a big factor in such decisions.

Advantages of Investing in Commodity Markets:

Many investors regard trading in commodities as risky. The complexity and volatility of commodity markets deter people from investing here. However,a well-planned commodity investment can be beneficial for your portfolio. It also offers a host of benefits. Here’s a look at some distinct advantages:-

1. Diversification

Commodities can give the much needed diversification to a portfolio. Commodity returns usually have low or negative correlations with the returns of other major asset classes. So often, when bonds and stocks fall, commodities rise. Sometimes, there may not be any connection between the returns at all. Factors that affect returns on stocks and bonds, for example, do not affect returns on commodities in the same manner. Besides, commodities may react differently from other assets in various economic and geopolitical situations. For example, the prices of stocks may fall during a financial crisis. But gold prices may rise as demand for this safe asset increases. A diversified portfolio with a low correlation between its assets tends to have less volatile returns. Thus, investing in commodities ensures diversification and improves risk-adjusted returns.

2. Inflation protection

Inflation has a different impact on commodities as compared to financial assets like stocks and bonds. This is because inflation causes currency to depreciate. This erodes the real value of financial assets like stocks and bonds. Commodities, however, maintain their value and price even during high inflation. In this environment, investors can turn to hard assets such as gold and other precious metals.

3. Hedge against event risk

Events such as natural disasters, wars, and economic crises can lead to depreciation of an investor’s assets. This is an ‘event risk’. Such events affect financial assets like stocks and bonds negatively. They may also lead to a rise in the prices of certain commodities. For example, supply disruptions due to wars may raise the prices of commodities like oil. So, these commodities may act as a potential hedge against some event risks—a buffer against losses.

4. Liquidity

Unlike investment in assets like real estate, investment in commodity futures offers high liquidity. It is easy to buy and sell commodity futures. An investor can liquidate his position whenever required.

5. Trading on lower margin

An investor in commodity futures needs to deposit a certain amount as a margin with the broker. The margin can be close to 5–10% of the total value of the contract. This is much lower than the margin required for other asset classes. Thus, the investor can take larger positions while investing lesser amounts of capital. This also helps increase the potential for higher profits.

6. High returns

Commodity markets are volatile. They can experience huge swings in prices. For example, a war or war-like situation in a major oil-producing country like Iraq can cause oil prices to drastically shoot up. Smart investors can take advantage of these price swings to make gains. Well-planned commodity investments have a probability of generating higher returns than investments in other assets.

Though commodities markets are easy to understand, trading in Futures Contracts and Options is entirely different from buying and holding a physical commodity; trading in the commodity market requires a sound working knowledge of the transactions and traders should make informed decisions while trading. It is always better to enlist the services of a well-established reputed brokerage firm whilst dealing in commodities.

Founded in 2005, ABans Group has grown from being a trading house to a dynamic and diversified business group. We provide expertise in Broking Services, Merchant Banking, Non-Banking Financial Dealings, Gold Refining, Realty and Infrastructure. In a nutshell, Abans Group is a comprehensive Financial Services and Solution Provider, which aims to provide an end-to-end financial solution to all its clients.