- Date : 17/08/2021
- Read: 7 mins
Commodity trading is slightly different than investing in share market. If you have patience and wish to diversify your portfolio, commodity is a great place to start with
In India, equity trading forms the bulk of overall trading. But did you know that commodity markets are even bigger than equity markets globally? But what are commodities? Let us start with the basics. Commodities are products that can be:
Consumed (agriculture commodities)
Used as raw material to make finished goods (metals like aluminium or copper converted into usable finished goods)
Acquired for investment purposes (gold, silver, etc.)
A commodity like gold can be used for investment purposes (buy at a lower price and sell at a higher price) or used as raw material to make finished goods (using a gold bar to make jewellery).
Types of commodities
Commodities can be of various types. Some of these include:
- Agriculture commodities: These include food items that can be consumed (tea, coffee, soya, wheat, sugar, etc.) or raw materials that can be converted to finished goods (cotton, jute, rubber, etc.)
- Industrial metals: Raw materials that can be converted to finished goods. E.g., iron used in steel production, copper used for making electrical products, etc. Similarly, there are other industrial commodities like nickel, zinc, aluminium, etc.
- Precious metals: These include gold, silver, platinum, etc.
- Energy commodities: These include crude oil, natural gas, etc.
Some commodities like silver can be classified as precious metals (used for investment purposes) and industrial metals (used for industrial applications such as photography, semiconductors, etc.).
Factors related to commodity trading
The two major factors related to commodity trading are demand and supply. It is these two factors that affect the price movement of commodities. When the demand for commodities is higher than the supply, there is a shortfall. This results in prices moving up. When the supply of commodities is higher than the demand, there is a surplus. This results in prices moving down.
- Demand for commodities: The demand for commodities depends on economic activity. When there is an industrial boom, the demand for industrial metals and energy commodities by end-user industries increases. Apart from that, there is investment demand. Demand factors and speculation lead to an increase in the prices of commodities. Traders need to track the demand for various commodities to take long trading positions so they can profit from them. Similarly, during economic downturns, the demand for commodities goes down, leading to a fall in commodity prices.
- Supply of commodities: The supply of commodities depends on investment in discovering new mines for industrial commodities or new fields for oil and gas. Once the mines or fields are discovered, they need to be developed to extract the commodities and bring them to the market. A long-term increase in the regular supply of commodities can lead to a fall in prices when supply exceeds demand. Commodity traders need to track the supply of various commodities to take short trading positions to profit from them.
Supply can get disrupted for various reasons like strike by workers, temporary closure of mines due to natural calamities like floods, terrorist attacks, etc. Supply disruptions can lead to temporary shortages, leading to prices going up. Commodity traders need to watch out for such temporary supply outages to take long trading positions to profit from them.
Related: Simple ways in which you can diversify your financial portfolio
Best commodities for trade
Some of the best commodities to trade in are crude oil, gold, copper, etc. Read on for details.
1. Crude oil
Crude oil is one of the highest traded commodities across the world. In the last one year, the prices of crude oil have moved up from $40 to $73, which is a return of more than 80%. Commodity traders who went long on crude oil in the last one year made very good returns.
In 2020, the prices of crude oil fell due to COVID-19 and the resulting lockdowns across the globe. But in 2021, the pace of vaccinations picked up. This has led to many economies opening up, resulting in increased demand for crude oil and a run-up in prices.
Chart: One-year crude oil price chart
Related: Crude oil stocks: Are they a good type of investment?
Like crude oil, gold is also one of the highest traded commodities. The price of gold is influenced by many factors such as demand and supply, movement of the US dollar, inflation, global uncertainty, demand by central banks, etc.
The prices of gold and crude oil usually have an inverse relation. Just observe the 1-year price chart of both. In the second half of 2020, when crude oil was down, gold was trading up. Similarly, in the first half of 2021, when crude oil is up, gold is down. Commodity traders who went long on gold last year at prices above USD 2000 are sitting on losses as the current price is hovering around USD 1800.
Of industrial metals, copper is one of the most traded commodities. It is also considered the barometer of economic activity in the industrial world. In the last year, copper prices have rallied by around 80%, giving very good returns to commodity traders who went long on this metal.
Chart: One-year copper price chart
Best commodities to invest in 2021
Let us look at the best performing commodities for the first half of 2021
Note: The above data is for the 1st half of 2021 (Jan to June).
As seen from the above chart, in the first half of 2021, crude oil was the best performing commodity with a 50%+ return. Corn and natural gas with 30%+ returns are in the second and third position. Gold and silver are at the bottom of the table with negative returns. In 2020, Silver (48% returns) was the best performing commodity and gold (25% returns) was the fourth best performing commodity. After a spectacular run in 2020, the precious metals are seeing some cooling off in 2021.
How to open a commodity trading account?
Commodities are traded on commodity exchanges like Multi Commodity Exchange (MCX) or National Commodity and Derivatives Exchange (NCDEX). To trade in commodities, you need to open a commodity trading account with a commodity broker registered with these exchanges.
A commodity broker can provide you a 3-in-1 (trading, demat, bank) account. To open a commodity trading account, you need to submit your KYC documents along with a duly filled account opening form (AOF). These days, many commodity brokers will provide you an online facility for opening a commodity trading account.
Once you open an account, you can log in to the web trading account on the commodity broker’s website or mobile app. You can place buy and sell orders from your trading account. The broker routes the orders to the commodity exchange.
Commodity brokers in India
You can open a commodity trading account with either a full-service commodity broker or discount broker.
Some of the full-service commodity brokers include:
- Kotak Securities
- Angel Broking
- ICICI Direct
- HDFC Securities
Some of the commodity discount brokers include:
If you are looking to diversify beyond equity trading, commodity trading is your best option. What's more, commodity trading is available for much longer hours as compared to equity trading; it can be done from 9 AM to 11:30 PM.