You can’t make something from nothing—and the inventories that fuel industry and our own hunger are comprised of commodities. If it’s mined, extracted, raised or grown from the land, it’s a commodity and potentially has value.
Volatility characterises the trade in commodities, because supply and demand for different staples waxes and wanes depending on a huge range of factors.
It’s also true to say commodities are a constant—after all, demand for foodstuffs, energy sources or manufacturing materials will never completely recede.
So how do you know:
- Which commodities to trade?
- How to place trades?
- How to spot an opportunity to capitalise on price movements?
(Related: Australian Dollar Forecast For 2024).
What Are Commodities?
Commodities are the essential raw materials that keep society functioning
They include fuel for our cities’ energy requirements, food for our bodies’ energy requirements, and the supplies used to create our buildings, clothes, cars, electronics and jewellery.
Unlike the end product of manufacturing processes — like TVs, which can vary in price depending on branding and features — commodities are interchangeable in nature.
Commodity markets are global, with buying and selling facilitated through commodities exchanges (e.g., ASX 24 in Australia).
Because commodities can be standardised for quality and quantity, any raw goods that meet a certain standard can be bought and sold globally for the same price via these international exchanges.
What Is Commodities Trading?
Just like shares, bonds, currencies and other listed products, commodities and commodity derivatives can be bought and sold on exchanges using an online brokerage with the goal of making a profit.
Some of the key ways to trade commodities in Australia include:
- Directly buying and selling physical commodities.
- Owning stocks of companies that produce or sell commodities.
- Buying ETF or mutual fund units where the underlying assets are commodity-based.
- Derivatives such as futures, options and contracts for difference (CFDs) (which CFD platform is best for you?).
Obviously, some organisations buy and sell physical commodities because it’s a critical part of their business operations.
Major miners and agricultural producers enter commercial agreements to sell their products to manufacturers and food processing companies.
(Related: Is MetaTrader 4 Good For Commodity Trading?)
They can include futures contracts organised over-the-counter or through commodities exchanges:
- A futures contract locks in a set price for a seller, which the buyer agrees to pay at a specified future date when taking delivery of the specific quantity of a commodity stated in the contract.
Futures can also be used as a hedging strategy by commodity sellers and buyers, in case the market price of goods changes in ways that adversely impact their business.
However, retail traders usually have no desire to actually own the commodity.
Instead, it’s more common for individuals to trade in futures with cash settlements and close their trades before a contract’s expiration (time of delivery) — to either take advantage of a favourable price movement or cut their losses.
(Related: What Is Futures Trading?)
While you probably don’t want to store 1,000 barrels of crude oil or 40,000 pounds of pork, having physical ownership of an asset can be reassuring. One popular way for individuals to directly own commodities is by purchasing precious metals like gold, silver and platinum in bars, coins and other collectible items. Read our guide to investing in gold in Australia.
Commodities vs Derivatives: What Are The Key Differences?
People who trade commodities via derivatives like CFDs, futures and options contracts typically seek short-term profits by predicting daily or week-to-week price movements.
However, trading derivatives lets you take either a long or short position, so you can potentially profit from both rising and falling prices.
Knowledge of a commodities’ market and great timing are critical to making this work — which makes it challenging for beginners or those without an aptitude for market or technical analysis.
Derivatives are more complex and involve the use of leverage.
While leveraged trades can boost your profits, you can easily and quickly lose everything if you speculate incorrectly — so having robust risk management strategies is vital.
(Related: What Is Leverage In Trading?)
Conversely, investing in company shares or ETFs/mutual funds backed by commodities may provide a simpler option for trading commodities.
Shares and funds are not without risk of capital losses, but they can make it easier to:
- Understand the drivers of a commodity’s value in relation to a company’s performance and long-term potential, rather than predict what will move commodity prices short-term.
- Diversify your portfolio and spread your risk through investing in multiple commodities-based companies with one trade via an ETF or managed fund.
- Benefit from commodity price increases without owning assets or managing complex trades, such as by buying an ETF backed by physical gold bullion.
Let me give you an example.
Perhaps you strongly believe that electric vehicles (EVs) will dominate in the future.
- Trade derivatives and attempt to capitalise on changing supply and demand for commodities like cobalt, lithium and nickel that are used in the construction of EV batteries. Disrupted supply chains due to the Russian invasion of Ukraine saw cobalt prices surge last year.
- Buy lithium stocks by investing in ASX-listed resource companies like Rio Tinto (ASX:RIO), Pilbara Minerals (ASX:PLS), or Core Lithium (CXO).
- Invest in funds that give you exposure to a basket of companies involved in lithium mining, developing battery technology and manufacturing EVs, such as Betashares Electric Vehicles and Future Mobility ETF (DRIV), or the Global X Battery Tech & Lithium ETF (ACDC).
Pros And Cons Of Commodities Trading?
By trading commodities, investors may seek to benefit from:
- Breadth of assets and trading opportunities to choose from, given the variety of commodities markets.
- Diversification of your portfolio and risk mitigation, as commodities prices often move differently to share prices and commodities equities can also respond differently when broader markets decline.
- Hedging against inflation and currency depreciation. Commodities like gold and oil in particular are seen by some as a way to counter the effects of high inflation and a falling US dollar.
In August 2023, James Cooper from Fat Tail Investment Research said commodity prices (especially in mining) were currently undervalued and due for a comeback. He argued that when commodities are undervalued against US equities, a bull market in mining stocks ensues.
He also pointed out that a portfolio with resource stocks helped investors avoid the calamities of market crashes like the one that followed the Global Financial Crisis from 2007-09.
However, we must weigh the merits of his argument against the potential downsides, including:
- High levels of market volatility, with commodity exchange prices fluctuating regularly. The value of a commodity can fall and stay low for long periods.
- Unpredictable changes in supply/demand that influence commodity prices. Armed conflict, new economic policies and natural disasters that affect production can cause steep increases and decreases in value that are hard to foresee and manage.
- Higher barrier to entry for trading commodities derivatives. While smaller contract sizes are available, generally, trading in futures requires a significant initial margin. Using CFDs is highly risky due to the speculative nature of the trades and high amounts of leverage. You also need to know more and pay closer attention to time your trades well and make profits.
It’s also important to keep in mind that changes in a commodity’ spot value aren’t always reflected by a rise in the value of commodity-based shares or ETFs. That’s because:
- A company’s valuation is affected by many factors including how it’s run and its reputation.
- Selling futures contracts relies on demand from other traders, so an ETF underpinned by futures contracts isn’t guaranteed to be able to sell those contracts for a profit even if a commodity’s spot price rises.
What Influences The Price Of Commodities?
Key factors that move the price of commodities on the market include:
1. Changing industrial and consumer demand.
For example, when economies grow more slowly, the demand for certain goods can also decline, which may reduce the industry’s need for energy commodities.
Retail demand for gold jewellery — when people are feeling prosperous — is a key driver of the commodity’s market price.
Some commodities have risen or declined significantly based on the emergence of new industries and competitors—for instance, electric vehicle technology and renewable energy production.
2. Macroeconomics and political upheaval.
Global economic decisions on monetary policy, business conditions and confidence, and how that flows through to employment and consumer spending all have an affect on demand for commodities.
Additionally, societies in upheaval through political change or conflict can lead to inflated production costs and hampered logistics in a supply chain, making commodities more scarce and valuable.
3. Seasonality, weather and climate change.
Agricultural commodities are especially cyclical due to growing and harvesting processes.
When Australian farmers have a bumper harvest of avocados, the price of avocados as a commodity can fall due to oversupply.
For instance, in addition to supply chain issues and input costs, recent floods have affected vegetable growers across Australia — which reduced supply and resulted in some retailers charging up to $12 for a head of lettuce.
Commodity Trading Strategies
You can uncover trading opportunities by learning more about commodities industries. In order to spot opportunities to make a profit, you need to know what moves the market and have a grasp of its cycles and trends.
It’s wise to:
- Investigate the use of technical charts and other analysis tools to inform your strategies.
- Research the fundamentals across the commodities markets you plan to focus on, such as industry reports, forecasts and innovations.
- Follow the news closely to better identify triggers for price changes or trends.
- Review commodity exchanges’ data on open interest (number of open short and long positions) in different markets to see how others are trading.
How To Start Trading Commodities In Australia?
The first step before you start trading or investing is to choose your market/s.
For instance, will you trade in popular and highly liquid commodities like crude oil, natural gas, gold, silver, coffee and wheat?
Pick one or two commodities to explore more deeply so you have a solid market knowledge foundation before you risk your capital.
Aside from directly buying physical commodities, you’ll need a broker to trade commodities derivatives or buy commodity-based shares or ETF units in Australia. Here are the steps to take to begin trading:
1. Choose A Commodities Broker.
Not all brokers offer futures contracts for commodities in Australia—find all brokers with access to ASX’s futures trading exchange here.
Most other popular online share trading platforms will enable you to invest in commodities-based stocks or funds — or use CFDs.
Research and compare different trading apps by considering whether they cover the markets you want to trade in, their fees, available leverage and margin requirements, and the platform/app’s features and usability.
(Related: 14 Best Share Trading Platforms In Australia).
2. Plan & Test Your Trades.
Before you open a position based on the opportunity you’ve spotted, at the very least, you need some guideposts as to:
- Whether you’ll open a long position, or short-sell? For stocks and ETFs/mutual funds consider whether you’re investing for the long-term or to take advantage of an anticipated short-term rise in value.
- What the size of your trade will be, whether that’s based on quantity, value or margin limitations?
- How many open positions will you take? More trades/shares means more positions and investments to monitor. For futures, options and CFDs you may also be able to choose the timeframe for the position.
- How will you manage your trades and your risk, including the order types you’ll use, when you’ll take a profit or close a position to avoid further losses, when you’ll top-up your account if you get a margin call, and how much time you’ll spend on reviewing your trades.
Once you’ve got a plan of attack—do a few trial runs by placing trades using your broker’s demo/practice account functionality.
This way, you can adjust your approach before you spend (and potentially lose) real money.
3. Open And Monitor Your Trades.
Once you’re ready, open your short or long position, or search for the ticker symbol of the stock/fund you’re looking to invest in and select buy.
If you’re trading with the intent of making short-term profits, you should review your account to see how your positions are faring.
Unless you’ve set up orders like a stop-loss, which automatically sells when the value of the commodity/share hits a certain price, you’ll need to manually close positions to realise your profits or limit losses if the market moves in the wrong direction.
Ready To Trade The Commodity Markets?
Commodities trading in Australia can include the exchange of actual goods, speculating on commodity market price movements, or becoming a shareholder in companies whose success hinges on commodities.
Depending on your personal risk appetite and diversification approach, you might find a commodity-based strategy attractive.