Trading Commodities
Using Spread Trading to Trade Commodity-Related Markets
One of the most powerful features of spread bets is the ability to trade different investment products through one trading platform and one account. This feature is particularly useful for investors that like to trade commodities and commodity related equities and indices. Of course with spread betting you can also trade commodities and shares in the companies that produce them using leverage which can produce sizable gains (or losses) for a small capital outlay.
Trading precious metals, agriculture, energy or ‘softs’ sounds simple in practice; you ‘just’ have to pick which direction the price will move, and place your trade. If you get it right, you profit; if you get it wrong, you book a loss. It sounds simple, but in reality spreadbetting on commodities can be a complex proposition. However, commodities trading has always been something of a specialised activity for the average trader in the United Kingdom, particularly where soft commodities are concerned, with most traders and investors preferring to stick to the traditional heavyweights like gold and oil.
Thanks to gold and oil, commodities are now seen as volatile and the spin-off of that is that we are seeing more and more people looking at the soft commodities [foodstuffs such as cocoa, sugar, and Coffee] and trading in other precious metals such as platinum and palladium.
Commodities
The modern financial markets allow the buying and selling of more items than ever before; shares and bonds, the staples of the stock exchange for decades remain the largest portion of trade, but there is an ever-increasing market in commodities, to such an extent that some people think commodity trading may become as important as bonds or properties.
Commodities are things like oil, wheat, silver, copper, gold etc, they come in two categories: soft, which is generally foodstuffs, and hard, which is generally metals and oil. These are goods which are interchangeable meaning all produce is homogeneous in nature. For example, gas acquired in the UK would be of a similar nature to that bought in the USA. Likewise, there would be no difference between pork bellies bought in either the United Kingdom or Australia.
Prices of commodities are driven by global supply and demand. It follows that when supply is low and demand high, prices go up, and vice-versa. The price of commodities is, however, relatively difficult to predict, and perhaps this is why some people think there is a lot of money to be made in their trade. Poor crops can lead to a bumper price in wheat, for example, with the basic rules of supply and demand dictating the price of the commodity, but at the same time, when the price of raw materials go up, this encourages producers to increase production, and when they go down, the producers tend to cut back in order to force the price to rise.
Recently there has been a large variation in the price of gold, with the stock markets being so uncertain, people have looked to put their money into substances of more fixed value, this has led to the price of gold rising, although in recent days it has come back down. This is not just on the stock market, anecdotal evidence suggests that people are choosing to put their money into buying jewelry as they believe it is a secure asset.
The world’s major commodity, however, is not a precious metal like gold, but is in fact oil. Oil is one of the major factors in the world economy, when the price of oil goes up it sends shock waves around the global markets. It recently reached a new high, but then dropped by nearly $50 a barrel, before once again rising. Those in possession of the oil monitor the prices carefully in order to suit their own ends, but it has recently had large price swings suggesting the kind of volatility that some people can make a lot of money from.
The latest run on oil has been based on the geopolitical tension and has certainly added a convincing reason to hold. Ultimately though, the price is still underpinned by the understanding that there’s going to a strong demand for its use. There may be as much as a $20 geopolitical risk premium attached to the current price, which is likely to rise if tensions remain this way and retail investors/speculators jump on board.
But if you’re convinced that the US economy is in a no hope situation, and will be dragged down by higher energy costs, oil will correct downwards. During the August shock, oil fell from $100 to $75 high/low within a fortnight on the fear of slowing global growth.
One other thing to note is the USA fuel reserves which can be released at the will of the President to avoid shocks to the economy from oil price hikes. Obama exercised this last year and could do so at a moment’s notice. We’re in an election year, and this is the kind of nettle that needs to be grasped before the recovery is truly compromised, so I wouldn’t be surprised if the US Government did something to curtail prices. Just something to be wary of!
But just like just about anything else connected to the stock exchange, commodities can be bought and sold by those without masses of capital through spread betting. Spread betting is a leveraged form of trading which means that large amounts of money can be won, and accordingly lost, and the companies who operate spread betting markets, like Capital Spreads, are keen to make sure that those who gamble with them are aware of all the potential risks. One thing that is very important is to make sure that you know the market that you are playing, and a commodity is just as good a market to understand as any other. It is important, however, to know what you are doing, due to the risks of losing large sums of money very quickly.
One Trading Platform, One Account
Traditionally, investors wishing to trade commodities would need to open an account with a futures broker. Investors wishing to trade equities and indices would then need to not only open a separate account for their commodity-related equities, but a separate account for each currency that their investments are listed in, a Canadian Dollar account and a US Dollar account for example, and separate accounts for long and short positions.
With spread trading, however, investors have the ability to manage all of their commodity related positions through one account, making position tracking and risk management mush more efficient. Also, it is just as easy to initiate or close a long position as a short position, increasing investors’ flexibility.
Commodity Spreadbets
You can trade spread bets on commodities such as gold, silver, crude oil and copper. Spreads start at 0.3 points for gold. But investors can trade spreadbets on many different types of commodities including:
- Metals such as Gold Silver, Copper and others
- Energy such as Oil, Natural Gas, Gasoline, Heating Oil
- Agriculture such as Corn, Cattle, Hogs Oats, Soybeans, Wheat and others
- Fibres and Timber such as Cotton and Lumber
- Soft Commodities such as Coffee, Sugar, Cocoa and Orange Juice
Investors should note that not only are North American commodities available for spread trading, but also overseas listed commodities such as UK (Brent) Crude, providing additional trading options.
In general, spread betting companies do not charge clients anything directly, apart from financing costs on long (buy) bets, making their money by adding to the market spread on individual shares, indices, commodities and currencies. Silver has been so volatile for a while that some spread betting providers were forced to widen their spreads to compensate for its effects.
Apart from spread trading you can also trade commodities via ETFs and ETCs which can be convenient given their liquidity, transparency and relatively low
costs. ETFs are backed up by a basked of shares and bonds while physical ETCs (say, gold or silver) are backed by the underlying commodity which is itself held with a custodian. One point worth mentioning is that spreadbetting on future commodity prices – say, gold, oil or agricultural products is not equivalent to trading futures. Spreadbetting is a method of trading without taking physical ownership, while futures are traded products in themselves.
Advantages of Trading Commodities Through Spread Trading
Commodity spread bet pricing is based on the nearest month futures contract. When the underlying futures contract expires, the spread bet is automatically rolled over into the next near month. If there is a difference in price, however, the trader’s account would be credited or debited depending on whether that particular market is in backwardation or contango. So spread trading investors not only don’t have to worry about being forced to settle accounts on a certain date, they also don’t have to worry about the possibility of a commodity being delivered to their front door as spread trades always settle in cash.
While margin rates for Commodity spread trades are currently the same for an investor as trading the futures contract, one key advantage for traders that spread bets provide over futures is their increased flexibility in position sizing. The minimum size of a spread betting contract is one (barrel of oil, ounce of gold, etc.), unlike futures contracts. This flexibility enables new commodity traders to learn the markets, without having to put large amounts of capital at risk initially.
Commodities and Share Spread Bets
In addition to trading commodities directly, spread trades enable investors to participate in the price movements of shares that are sensitive to commodity price movements such as gold and energy producers. Through one account, investors can not only trade Share spread trades based on North American listed companies, but also on senior companies that are not listed on this side of the pond such as Xstrata PLC, owner of Falconbridge, Johnson Matthey, and Tullow Oil, which is partnered with some Canadian energy companies in Africa. In addition, spread trades enable traders in Canada to trade senior companies listed in London such as Rio Tinto and BHP Billiton as easily as a Canadian company.
Commodities and Index Spread Bets
Investors who want to participate in equity sector price trends but don’t want to take on specific company risks can also consider trading Index and Sector spread bets. For example, in Canada, one can also trade spreadbets based on the Gold sector, the energy sector and the broader Materials sector, while in the US, a Sector spread bet for the oil and gas industry is available.
Best Left for the Experienced
The risks mean oil is a market best left to the professionals. ‘We have a couple of dozen professional traders who have done very well out of it this year but there has also been a trail of devastation among the amateurs,’ says one spread betting dealer. ‘Traders need to watch the derivative markets to see where the weight of money is so that they know when to take profits.’ To highlight the danger, the release of news in early December that US inventories were higher than expected saw US light crude close down $3.64 in the biggest one day drop since years, and the fall has since continued.
With the January Nymex crude future quoted at 48.79-48.87 at CMC, someone who was bearish could have sold the spread at 48.79 for say £10 per point, a position requiring a margin deposit of £1,400. The subsequent collapse in the price took the spread to 43.21-43.29 so that the bet could have been closed at 43.29 for a profit of £5,500. As an alternative to the normal spread betting markets, IG Index has recently launched daily binary option bets on Nymex crude as well as on the Comex gold and silver markets. ‘People can use the binaries to bet on whether these prices will finish the day up or down,’ says Imre. ‘The unpredictability of these markets makes them a popular choice for binary options.’
The main Nymex trading session begins at 3pm UK time and closes at 7.30pm, although electronic trading is possible ahead of this period. The binary was recently quoted around midday at 40-45 to finish the day up. Betting £10 a point meant that if the market had finished higher the bet would have yielded a £550 profit. The maximum loss, which would have been known when the bet was placed, was £400, though the position could have been closed at any time during the day to restrict this.
There has also been a huge interest in the copper and palladium markets in more recent times. ‘Palladium has recently been trading higher because of Russian supply worries, while the price of copper has been pushed up by the massive demand from China,’ Hougaard explains. ‘Traders can use technical analysis on the commodity markets but they need to understand the factors driving the demand: the hedge funds are big players and have been a big factor in pushing up the prices.’