Introduction to Commodities

Posted on 02/09/2007, 05:39
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A commodity is any physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts. The term is sometimes used more generally to include any product which trades on a commodity exchange; this would also include foreign currencies and financial instruments and indexes. The price of the commodity is subject to supply and demand factors. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be. A speculator can pay the farmer or anyone else producing commodities because the speculator wants to make a profit. This is called trading in futures.

A commodity is any physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts . The term is sometimes used more generally to include any product which trades on a commodity exchange; this would also include foreign currencies and financial instruments and indexes. The price of the commodity is subject to supply and demand factors. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be. A speculator can pay the farmer or anyone else producing commodities because the speculator wants to make a profit. This is called trading in futures.

The following is a list of commodities available for futures trading:

Agricultural: grains, oils, livestock, wood, textiles, food products Metallurgical: metals, petroleum, chemicals Interest Bearing Assets: T-bills, bonds, notes Stock Indices Currencies

Most of these contracts are used by corporations to hedge positions taken elsewhere. Some futures contracts, notably those for stock indices, are settled in cash because they are not deliverable goods. The contracts also vary in terms of the transaction date and the quality level of goods to be bought and sold. New futures contracts are created continuously, but many are not liquid enough to trade regularly and are used only as hedges.

Other Ways to Trade Commodities

Investors can receive advice in the futures market from Commodity Trading Advisors. These advisors make specific recommendations about buying and selling futures contracts after considering the circumstances of the investor.

Managed futures accounts result from giving power of attorney to trade futures to an account manager. Even though the investor is no longer making trades, he is responsible for margin calls, and gains and losses appear as credits or debits respectively in the managed account.

Commodities pools are analogous to mutual funds in that many investors pool their assets to gain the power to make trades that they could not make individually. Additional benefits include bypassing margin requirements and limiting risk to the amount invested in the pool.

In all of these circumstances, investors must receive risk disclosure documents. The document should be read carefully to determine if futures trading is a viable investment option for the investor. Commodity pools also distribute disclosure documents that address the details, management and risks of the pool arrangement.

Investing with the help of an advisor, manager or pool may have its advantages, but it certainly does not eliminate risk or guarantee any degree of success, and we do not recommend commodities or future trading, with or without expert assistance, for any investors who aren't very experienced.

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