- Christian Armbruester
Why trading commodities could be the best thing you ever do.
There is another world out there and it has been around a lot longer than Tesla. In fact, mankind has been trading commodities ever since we came out of the caves. One may need a pig, while another has plenty but really wants a chicken and a deal is done. Nowadays, barter has moved to the exchanges, and we can trade oil futures just as easily as wheat, orange juice or lean hog forwards. Where it gets complicated is the physical stuff, and this is why most people tend to stick to stocks and bonds.
Think of it this way. When we buy shares in a listed financial security, our certificates of ownership are exchanged and custodied at our bank at the click of a button. When we enter into a forward contract on commodities, the physical goods also have to change hands. Clearly, we cannot send 60 cows from our trading desks to a bank on Wall Street every time we do a transaction in a live cattle contract. Therefore, all trades are anted up at the end of the month, when the contracts expire. But guess what, someone somewhere still has to deliver on the ingredients for a good steak.
There is an old wives’ tale of a trader in the City that took physical delivery of several tons of copper, but in reality these things rarely happen and the process is closely monitored and streamlined nowadays. All the shipping costs, warehousing, insurance and trucking expenses of moving goods from one place to another is interpolated, implied and included in the price of the instrument we buy or sell. These can vary from one period to the next, and the markets either trade in what is called contango or backwardation depending on the price of different instruments.
Great, how does that help the investor? There is a lot going on, many moving parts, and massive inefficiencies from which we can make money. Lest we forget that most raw commodities come from lesser developed economies and trying to put a cost on taking copper concentrate out of a jungle in Bolivia comes with a certain volatility. There is also the weather, and it can affect anything from natural gas to the next coffee crop and if you thought cryptocurrencies are volatile, try trading lumber or iron ore.
In other words, you have to be patient. Someone’s pain is another’s gain, and what we want to do is get involved when things get really stupid. Oil traded negative in April 2020. Yes, you actually got paid for buying oil. That kind of thing isn’t supposed to happen, but it did and if we had done nothing else but pile into this trade, we would have made enough money to last us for decades. So have a look at the commodity section in your on-line brokerage account. Look at softs, energy, base metals, or even gold. When nothing makes sense, that is the time when you want to put on your position. What could possibly go wrong?