What is Commodity Trading and How is it Done?

A commodity is a group of goods or assets vital in everyday life, such as food, energy, or metals. Any commodity is alternate and can be exchangeable by nature. A commodity can be categorized as every kind of movable goods bought and sold, except for actionable claims and money.

What Is Commodity Trading?

In simple terms, commodity trading is the activity of buying and selling raw materials, which means it is the basis of the primary global economy. Commodity trading can be split into two types. The first is physical commodity trading, which involves moving materials from point A to B. And the second is financial trading, which involves exchanging commodities on popular exchanges. 

Commodities trading decides the prices of all commodities. As a result, the essential items you consume every day are volatile. In some cases, like gasoline, they change every day.

Commodities prices continually shift as supply and demand change in a single economy worldwide. Investors in the commodity market seek to profit from supply and demand trends or reduce risk through diversification by adding different types of asset classes to their portfolios.

The advantages to commodity trading are differentiated exposures from the stock markets and the potential for inflation protection.

Types of Commodities

Agriculture, energy, and metals are the three main categories of commodities.

1. Agriculture

Agricultural commodities include things you drink, such as sugar and cocoa. These are called the “softs markets.”

Grains such as wheat, soybean oil, rice, oats, and corn also come under agricultural commodities. Things such as cotton and lumber also come under this category.

2. Energy

The energy category includes crude oil, natural gas, RBOB gasoline, and heating oil. Commodities trading is a significant determinant in setting oil prices.

3. Metals

Commodities such as gold, silver, copper, and platinum come under this category. 

4. Livestock. Livestock includes all animals, such as cattle and hogs.

What is Physical Commodity Trading? 

Physical trading of commodities is moving them from one place to another. Nevertheless, moving millions of materials across seas (As almost all commodities are transported by maritime vessels) is not easy. Since commodities are natural resources and more in some parts of the world while scarce in others, they are usually more valuable to the economies of their source countries when traded internationally.

Complex international relationships can give challenges to efficient cross-border trade. It is not as usual now, but before the World Trade Organization (WTO) was created, tensions between the nations could lead to heavily tariffed goods or rejection at port destinations. 

Transportation shortages and volatile interest rates still cause a lot of problems at ports. But the WTO’s jurisdiction has made physical trading more efficient. Trade policy can even reflect foreign policy. 

How Physical Commodity Trading Works 

How Are Commodities Priced? 

Producers and consumers of commodities trade them and hedge their exposure. Speculators trade to profit and usually take a long or short position on a derivative or stock. If they predict the value of a commodity will rise or fall. It means that speculators add liquidity and can influence how a market moves without physically owning the traded commodity.

However, sometimes governments can set the price; this is very popular in agricultural markets to protect farmers’ returns.  

Things to know before you start trading commodities: 

1. Location of the commodity produced.
2. Find out factors that are moving the price. Significant factors for agricultural commodities’ price movements include climate, geopolitics, freight rates, currency strength, and global health.
3. The volatility of the market.
4. Having a strategy for the commodity which you trade.

Freight forwarding

Freight forwarding is the service of moving loads between different stages in the supply chain. Most of the time, commodities are moved by sea freight, mainly because it costs very little than air freight. Sea freight can be split into bulk and containerized categories.

Unpackaged raw materials are moved in bulk ships loaded directly into the vessel, and container ships move goods stored in intermodal containers. 

Before they reach ports, commodities depend on land freight like trucks and trains to move around. While an important link in the logistics chain, Trucks are usually outshone by ships. But with the dazzled trucking industry in 2020-21 leading to delays at ports, it is gaining more recognition. Still, trucks are very popular than rail freight. They are more energy-efficient counterparts because of lower handling and fuel costs. 

Airfreight is the priciest and fastest choice because planes are expensive to maintain. Unlike the cost of maritime freight, which is based on volume, air freight costs are based on climate conditions.  

The relationship between commodity prices and freight rates

In 2021, the cost of seaborne freight had surpassed the cost of the commodity being shipped in a few cases. Such events are infrequent.

Government stimulus to reduce the breakdown of the 2020 coronavirus crisis has increased demand for dry goods such as coal, grains, sugar, and iron ore shipped on bulk vessels. Therefore, competition for bulk and container vessels has skyrocketed, sharply driving up freight costs with seaborne trade volumes off the scale.  

It is taken for granted that more increased demand for commodities will increase the demand for transportation, thus making the commodities and freight rates more expensive. 

While freight demand is growing, supply is limited as vessel manufacturers are currently overwhelmed with orders more than they can produce. 

More than 80% of the vessels were produced in the second half of 2020 than in 2019. Higher returns on products can incentivize producers to increase their output which means the positive feedback loop is maintained. This year, more grain exports from significant exporters like the USA have called for an extra 227 Panamax shipping vessels – learn about the different types of maritime vessels here. Since the freight cost contributes to the commodity’s total cost, they are passed onto the end consumer.  

Changes in commodity consumption have and will continue to dictate the frequency of trade flows and profitability.