The commodities market is any market in which goods are traded so that investors can move away from stocks and balance their portfolios during periods of stock volatility. Traders use the commodity market to profit from the fluctuation of commodities prices. Natural gas, oil, gold, silver, soybeans and other products are good examples.
There are many advantages of trading in commodities. Let us understand those in detail with examples.
Protection against inflation
As the demand for goods and services rises, it increases the price of the goods and services as the cost of the raw materials, i.e., commodity, increases. In such an inflationary environment, interest rates rise, which increases the cost of borrowing and subsequently reduces the company's net income. A decline in the company's income also affects the profits shared with the shareholders.
During inflation, the prices of stocks fall because investors are afraid that the purchasing power of their money will decrease. On the other hand, the price of a commodity rises during inflation because there is an increase in demand and supply. Everyone wants to buy some more before it becomes more expensive. In short, the demand for commodities during inflation is high, and so are their prices. Investors who want to protect their capital and investments go towards buying commodity futures rather than stocks or commodities because they know they will get their initial capital back when they sell them later on, unlike stock markets where they would lose 50% of their money.
Hedge against risky geopolitical events
To eliminate any supply chain problems, businesses need to partner with contract manufacturing and processing firms in geopolitical events such as conflicts, riots and wars. This way, their operations can continue without facing any problem with the acquisition or transportation of raw materials to develop finished goods. However, there are still certain risks that come with an unstable consensus mechanism and a volatile network. But suppose entrepreneurs figure out sustainable ways to deal with these challenges from the onset by implementing secure platforms powered by blockchain technology and smart contracts. In that case, they could generate stable revenues while enjoying a decentralized technological environment.
Diversification
Commodities have a negative or low correlation with stocks. Commodities are usually raw materials required to make the finished goods.
Rising commodity prices result in a decline in profits, which is bad news for shareholders and results in a lowering of the earnings per share. This ultimately leads to greater inflation levels as the present value of future cash flows decreases because future money would be able to purchase fewer goods and services than it could today. The price of stocks reflects this reduction in value - a core reason they drop in price.
Stocks and commodities have an inverse relationship. Commodities cost more when inflation occurs, and stocks cost more when inflation does not occur or is declining. For example, if oil prices rise, the price of cars also rises, resulting in fewer car sales. This decrease in the demand for autos results in falling car prices and, thereby, stock prices (of automakers). The same happens with precious metals: rising metal prices result in fewer building construction projects, decreasing the price of real estate. Adding commodities to a portfolio allows investors to diversify against overvaluation risks inherent in the stock market.
Unlike stocks, commodities are not attached to the value of a company. They can be volatile since they change daily based on supply and demand factors, like weather or actions by the U.S Treasury that affect their price volatility. And like when you overeat chili, you end up feeling sick; extreme volatility in your portfolio can give some portfolio managers an upset stomach. So what should they do? The answer is simple: get diversified!
For more information on day trading futures and commodity trading courses, reach out to COMMODITIES UNIVERSITY!
Source URL : https://www.commoditiesuniversity.com/
