COMMODITIES
COMMODITY TRADING SYSTEMS
A GUIDE TO TRADING IN COMMODITIES
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COMMODITIES
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COMMODITIES
Commodities - Intro to Commodities - Part I
Why aren't paintings commodities? Because each one is unique. Commodities are uniform and one
individual or portion serves the same purpose as any other. An ounce of gold, a barrel of oil, a bushel of
wheat. In every case, one is pretty much like another. It makes little difference to most of those buying it
whether they receive this ounce of gold or that one.
Observe there are some differences. Because of shipping costs, differences in composition, and so forth,
some oil does sell for a different price than that from another source. Texas crude and North Sea oil are
close enough for many purposes, but they trade on different markets and have different prices.
Commodities can be traded on either spot markets, or in the form of futures.
Spot markets are those in which the commodity is traded immediately in exchange for cash or some
other good. You go to the local jewelry store and buy an ounce of gold. That's a spot trade. You give the
jeweler several hundred dollars in cash, he gives you an ounce of gold, usually in the form of a coin, 'on
the spot'.
Other traders exchange commodities on spot markets in much greater quantities - thousands or millions
of ounces of gold or barrels of oil. At some time the actual good is delivered. After all, at some point,
someone has to use the good or it's, so to speak, no good.
In the form of futures (or options), what is traded is not the good itself, but a contract to buy or sell the
commodity for a certain price by a stated date in the future. Hence the name.
Most commodities trading is done in the form of futures or options and it's that scenario that gives rise
to most of the huge potential for profit and loss. It also gives rise to all the interesting aspects of trading,
since it inherently involves predictions of the future and hence uncertainty and risk.
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COMMODITIES
Commodities trading has been around for centuries, but the modern markets arose in the late 18th
century when farming began to be modernized. Though the pace of trade and many of the detailed
mechanisms has changed, the basics are still the same.
Growing wheat, for example, took several months then from planting to harvest to delivery. It still takes
several months. A farmer might plant wheat in April and discover in June that the price someone is
willing to pay for delivery in August has dipped over the past month.
For example, suppose on May 1st wheat to be delivered September 1st is selling for $4.00 per bushel. By
June 1st, it has fallen to $3.80. The farmer may believe the price will continue to fall. He offers a contract
on his wheat to be delivered September 1st for $3.80 per bushel, locking in a price today at the current
market level. In exchange, he accepts a legal obligation to deliver the wheat on or before September 1st.
Fortunately for the farmer and others, some believe the price will in fact not fall but instead will rise by
September 1st to $4.20 per bushel.
That kind of prediction is typically based on a very complicated analysis of current conditions, such as
the total amount of acreage under plant, soil moisture levels, weather predictions for the coming
months, political events and dozens of other variables.
No one knows the future price with certainty, that's why it's called speculation.
Come September 1st the farmer delivers his wheat and is paid $3.80 per bushel. If the price turns out
then to be $4.20 per bushel, the speculator makes a healthy profit. If the price is, say $3.50 per bushel,
the speculator has lost money.
That's commodities trading in a nutshell, or rather in a basket.
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COMMODITIES
Commodities -- Intro to Commodities -- Part II
Let's examine a highly simplified commodities future contract trade.
Suppose a trader buys a contract to purchase oil trading on NYMEX (The New York Mercantile Exchange)
at $70 per barrel for WTI with an expiration date of August 6th. (Oil comes, obviously, from a variety of
major sources, including the North Sea near England, Alaska, Saudi Arabia, West Texas, etc. The
locations often lend their names to the different sub-types of commodity and generally have different
prices).
Note a number of things about this contract, called a future.
It names a specific commodity. It isn't a contract for North Sea Brent, it's for WTI (West Texas
Intermediate) Crude. Though oil as a whole is a commodity with similar properties, the actual material
recovered varies from place to place. There are as many types and names as there are for cigars.
Because of differences in cost of production, refining and shipping costs, inherent composition and
many other factors not least of which is expected demand, prices can and do vary.
It has a specified price: $70 per barrel. A portion of that money, called the margin, is to be paid today.
The required margin amount changes depending on a number of factors, such as how volatile prices
have been in the recent past. But somewhere around 5% is typical.
Each contract specifies a set amount, typically 1,000 U.S. barrels (42,000 gallons, equivalent to roughly
168,000 liters). At 5% of $70 per barrel, a contract for a 1,000 barrels requires a minimum investment of
$3.50 x 1,000 = $3,500.
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COMMODITIES
For an investment of $3,500 the speculator is controlling $70,000 worth of oil. That's known as leverage.
The contract has an expiration date and an associated obligation for delivery. On or before August 6th
the contract holder has to deliver 1,000 barrels of West Texas Intermediate Crude with specified
characteristics. Exchanges determine such things as minimum acceptable levels of sulfur content, for
example.
The vast majority of traders are never going to see a drop of that oil and don't have any real expectation
of delivering it. They don't have it to deliver. They are trading contracts for goods, not the goods
themselves. The final contract is ultimately handled by a specialist broker who ensures delivery of the
actual product to some 'consumer' like an oil refinery.
The important point for the average trader is simply that they have to do something by a given date.
That has interesting consequences, such as the change in price for the contract itself as the expiration
date nears.
Unlike an options contract, a futures contract carries not only the right to buy or sell something at a
given price by a specified date, but the obligation to do so.
If the spot price (the price of a barrel of oil at a given time, in a specific market) changes, the trading
price for the contract will change as well. How it changes, and by how much, we have to leave for later.
But suppose the price for WTI rises to $75 per barrel before expiration.
How much profit, in percentage terms has the trader made?
$75 - $70 = $5 per barrel. $5 per barrel x 1,000 barrels = $5,000. $5,000 - $3,500 = $1,500 (excluding
commissions). $1,500 / $3,500 x 100% = 42.86%.
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COMMODITIES
A very healthy return and, in today's oil market, not at all unrealistic. Of course, anyone considering
commodities trading should be fully alert to the possibility - even in today's market - that the price of oil
(or any other commodity) can and does fall as well as rise.
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COMMODITIES
Commodities - Commodity Types
Commodities are categorized for ease of price comparison, research and other conveniences in trading.
Investors interested in getting involved in one of the riskiest, and potentially most profitable, areas will
need to know the basics.
Energies
One of the most active areas recently, 'the energies' encompass a basketful of products used to provide
energy to heat and power homes and businesses. The most common are petroleum and its byproducts:
crude oil, heating oil, propane, natural gas, coal and a few others, mostly sub-types or derivatives.
Each commodity has its distinctive 'tick' (minimum price change, set by the exchanges) and standard
contract size. A standard contract size is the amount covered by a standard futures contract. In the case
of crude oil, for example, the amount is 1,000 barrels. By contrast, the amount for wheat is 5,000
bushels.
Grains
Wheat, oats, corn, rice and soybean are all agricultural products traded on various exchanges, not least
of which is the venerable Chicago Board of Trade (CBOT). Here again the exchanges also trade the
product, as well as futures and options contracts on these and several derivative products such as bean
oil.
Each product has a tick, unit and standard contract size. Some prices, like soybean meal, are listed in
dollars per ton where the standard contract size is 100 tons. Easy to see why most traders never see the
actual commodity.
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COMMODITIES
Softs
Coffee, cocoa, sugar, cotton and orange juice are all 'soft' commodities, many of which are traded on
the aptly named CSCE (Coffee, Sugar and Cocoa Exchange). Interestingly, since 80% of the oranges
grown in the U.S. are turned into frozen orange juice concentrate, it's the juice that is traded as a
commodity, not the fruit.
A relative newcomer on the New York Cotton Exchanges, FCOJ (Frozen Concentrated Orange Juice) has
been actively traded since the creation and widespread use of inexpensive refrigeration, post WWII.
Meats
Live cattle, pork bellies and lean hogs, and some derivatives are traded on various exchanges, including
the KCBT (Kansas City Board of Trade), the historical center of livestock trading in the U.S.
Pork bellies are particularly interesting, in that the bacon produced from them generally has no
substitute with a similar product. Also, their price is heavily dependent on the price of grain, since the
hogs are fed mostly corn and a few others. Prices tend to be less volatile than many other commodities.
Financials
Since most traders invest in commodities futures or options, not the good itself, financial products are
often listed on the same exchanges.
Along with purchasable U.S. Treasury Bonds futures traded on the CBOT and elsewhere, there are a few
indexes that track stocks and others. The S&P 500 Index futures contract is a popularly traded item, for
example.
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Keep in mind that when you see prices quoted, some sites will list abbreviations for the expiration
month of the futures contract. The list used is as follows, listed by quarter:
January F, February -G, March - H
April J, May K, June - M
July N, August Q, September - U
October V, November X, December Z
Hence, you might see an item listed as PBH07, which is a Pork Belly contract which expires in March of
2007.
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COMMODITIES
Commodities - Financial Indexes
Stocks and bonds aren't the sort of thing the novice investor typically thinks of as a commodity. Even
less do they view a statistical measurement of changes in their prices as similar to gold, wheat or oil. Yet,
because stocks and bonds (and the indexes that measure price changes) trade in the form of futures and
options contracts, they can be traded in the same way as other commodities.
While oil remains the most traded physical commodity, the financial futures market today is the largest
for all contracts traded. One of the most popular is the contract for the Standard and Poor's 500 Index,
the S&P 500.
As the, so to speak, gold standard of indexes the S&P gives traders a broad view of the stock market as a
whole. The companies contained in the S&P 500 represent 80% of the entire market capitalization - the
top 40 stocks in the S&P 500 represent 50% of its total.
That means traders can be confident that there will be no liquidity problems, as sometimes happens
with some other commodities.
It also means risk is easier to assess. The tools available to measure and predict the S&P 500 are more
reliable, since predicting stock prices is much easier than that of commodities. Easier, but definitely not
easy. Just as one example, the stocks in the S&P 500 have reliably offered the highest return over a 30
year period of any investment, around 12% depending on the range selected.
Stock prices can definitely be volatile, and large single-day price drops have happened several times. But
indexes typically, by design, move less far and less rapidly than other prices. The idea of using a broad
based index is precisely to smooth out the bumps of individual stocks, in order to assess the direction of
the market as a whole.
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Yet, along with reduced risk and better predictability, traders still enjoy the other advantages attendant
on using futures and options as trading vehicles. Margin percentages are in the 5-7% range, so high
leverage is still available, as it is with other commodities futures and options contracts.
Commodities trading is often very short-term oriented, with day trading the norm. Yet with index
trading, investors can take advantage of those sharp swings, yet still take a long-term horizon view, as
they would with ordinary stock investing.
For example, one common trading strategy is the 'rollover'. This technique allows traders to take a long
position on a futures contract, then - as expiration nears - transfer the position to another contract with
an expiration date farther out into the future.
This 'spread' strategy makes it possible to take advantage of price differentials and low commissions,
while controlling the liquidation date. It's executed when traders predict that prices will soon move in
the preferred direction, where 'soon' is just beyond the expiration date.
S&P Index futures are traded on the CME (Chicago Mercantile Exchange), and there's even an S&P 500
'E-mini' contract available, which carries a smaller commitment - one-fifth the standard contract. The
trade unit is $50 time the S&P 500 Index. The trade unit for the standard contract is $250 times the S&P
500. In addition, since it trades all electronically, with no open outcry or pit trading, trading hours are
almost around the clock.
For current prices and contract specifics, see the CME website at http://www.cme.com/.
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COMMODITIES
Commodities -- Fundamental Analysis
Fundamental analysis, in essence, comes down to studying the factors affecting supply and demand.
When supply is great relative to demand, prices tend to fall. When demand is large relative to supply,
the price of a commodity rises. But beyond those simple and obvious principles, there's a world of
complexity. What, after all, affects supply and what influences demand?
Some general factors affect all commodity prices. Taxes, inflationary pressures and money supply,
political events, weather, transportation costs and technological changes all play a part along with a
dozen other large-scale causes.
Beyond those general factors, the detailed answers depend heavily on which commodity a trader
researches.
'Softs' - sugar, cocoa, coffee and a few others - are agricultural products in demand all over the world by
millions. One of the reasons they make excellent commodities. As such, their demand is affected mostly
by price with some minor influence from cultural factors. Sugar demand is suppressed slightly, for
example, by newspaper horror stories about the alleged evils of consumption and obesity. Supply, on
the other hand, is influenced by weather, soil quality and moisture levels, transportation costs, insect
population changes, etc.
Energies, such as crude oil and natural gas, on the other hand show almost the opposite profile. Supply
grows very slowly, owing to technological and political factors, while demand has been rising for
decades with no end in sight. For example, China's economy is growing as is India's. In both cases, this
produces a heavy demand for energy to build new buildings, increase manufacturing plants, heat and
power homes and a hundred other uses.
Fortunately, no matter what commodity an investor considers, there is a host of data sources available.
Crop and weather reports from the USDA (U.S. Dept of Agriculture), available directly or through your
broker, are just one example of a major source of information about softs or grains.
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Mining levels, information about new sources of gold, silver, platinum and a dozen other factors
affecting supply are similarly easy to obtain, often through the exchanges themselves. (See
http://www.thebulliondesk.com/ or http://www.amm.com/ as just two examples.)
One could hardly avoid hearing news about oil, which is discussed endlessly on the front pages of
newspapers. Behind the scenes things get even more interesting. Offshore Engineer, for example, is just
one excellent source of information about offshore oil news. (See http://www.oilonline.com/oe/)
Coffee is the second most widely traded commodity, after oil. That tells you something about the world.
It's grown in a dozen countries and has been a popular product for over 200 years. Recently, however,
prices have been depressed owing to large supplies, even though demand remains strong.
Coffee trading is here to stay, though. For data see the International Coffee Organization website:
http://www.ico.org/ and in particular the statistics page at http://dev.ico.org/trade_statistics.asp. For
current prices see: http://dev.ico.org/prices/pr.htm
Fundamental analysis in commodities trading runs counter to one basic difference with the stock
market, however. Stock trading professionals trade every day, but the average investor tends to take a
slightly longer view. In commodities trading, almost all investors trade short term. Supplement any
fundamental analysis with technical analysis to get the best possible chance for profits.
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Commodities - Funds
Investors come in all flavors. Some are bold, whether they have the capital to lose or not. Some are
cautious and regard capital preservation, with the hope of some small return over a long period, as the
paramount value. Somewhere in between, but closer to the latter probably, is the territory for most
fund investors.
Serious, regular investing is the province of individuals who have the resources and can dedicate the
time to turn trades over often. Most traders don't have the time, the expertise, nor the risk capital to be
in and out of the market so regularly. For such people, funds - in particular, mutual funds - are the
perfect solution.
But stocks, bonds and other purely financial instruments aren't the only items worth investing in. True
enough, over long periods, the stock market performs better, on average, than most other investments.
Somewhere in the range of 12% annual return, depending on the period chosen. But there are shorter
periods, extending for several years sometimes, where other investments outperform the substantially.
In recent years, that has been commodities. As a result, commodities funds have risen in popularity.
Since early 2000 commodities have risen substantially. Gold has increased over 25% and oil has nearly
doubled. During this same period commodity funds have seen double-digit returns.
Pimco, for example, has over $12 billion under management in their commodity fund and from mid-
2004 to mid-2005 garnered a return of 14.5%. Their next nearest competitor, Oppenheimer, with
around $1.77 billion under management earned 19.5% during the same period.
Normally stocks and commodities tend in opposite directions. That was true for the period from 1974-
2000, when the Dow Jones Industrial Average rose, while the DJ AIG Commodity index fell. But the last
few years has seen a reversal of that historical trend.
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No one can predict how long it will last. As financial advisers always say: 'past performance is no
predictor of future gains'. But during the last year the S&P 500 fell 0.5%, while the Dow Commodity
Index rose 6.5%. Over the longer period from May 2000, the AIG Commodity index rose 47% vs. a 15%
decline for Standard & Poor's 500-stock index, assuming reinvested dividends.
It could end anytime, but given the pressure on oil and other energy source prices - which affects the
price of everything else - it doesn't seem likely to happen soon. Experts seem to agree, since most
commodity funds are not selling short. Selling short would imply that speculators are betting on a
decline in prices.
However, one has to look under the covers a little bit. Commodity funds often have substantial
investments in items you might not normally consider a commodity - like U.S. Treasury securities. Pimco,
for example, has over 90% of its assets in T's.
But, technically, even financial instruments act like commodities in some markets, since they trade in
the form of futures contracts on some of the exchanges. Not only do the instruments themselves sell as
futures, but the indexes that tract the instruments do too.
So a commodity fund may have investments in commodities directly, or the futures contracts that cover
them, or even indexes that track them. The latter may be three steps removed from something you can
see and touch, but the profits are real.
Investing in them is one excellent way to diversify your portfolio and not depend solely on stocks or
bonds.
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COMMODITIES
Commodities - Trading Strategies - The Spread
A large number of common trading strategies are for the purpose not only of making a profit but, as a
hedge. Hedging is essentially an attempt to buy some form of insurance to minimize risks. Typically,
along with minimizing risks comes a cap on potential profits. Let's examine one of these strategies: the
spread.
Most commodities trades are in the form of buying or selling a futures contract, not trading the
commodity directly. The most basic strategies here are 'going long' or 'going short'.
Going long simply means buying a futures contract with the expectation that the price of the contract
will rise before its expiration date. Futures contracts are bought and sold much like stock or options -
only a small minority of specialists actually have anything to do with trading the actual commodity.
Going short is the flip side - selling a contract with the expectation that price will decline before
expiration. Going short is often seen by novices as puzzling and even paradoxical. How do you sell
something you don't own BEFORE you've bought it?
Puzzling in theory, simple in practice. The mechanics are hidden from traders, but in essence speculators
borrow the contract, then buy one to make up the shortfall later.
Suppose you sell a futures contract in May for September wheat for $6.00 per bushel. The contract will
be written for at least a minimum amount, typically 5,000 bushels. Now suppose the price does in fact
fall in August to $5.40 per bushel. You've made a profit of 60 cents on each bushel. That's $3,000,
excluding commission. Though profits and losses are settled for trading accounts daily, the books
ultimately get balanced by the broker buying a contract of the same type on your behalf. With your
money, of course.
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Trading strategies involve mixing the types and lengths of contracts. One of the simplest is some kind of
'spread'. There are several varieties, but take a simple example.
Assume it's May and the price for a July wheat contract is $5.90 per bushel and for a September contract
the price is $6.00 per bushel. Suppose you predict the price difference ('the spread') between the two
will change before July to greater than 10 cents. If you turn out to be right, you could profit by selling
the July (today) and buying the September (today). You short July and go long on September. How do
you profit?
Suppose that (in June, say) the July contract has risen to $6.00 per bushel and the September to $6.25
per bushel. You 'liquidate both positions' (settle both contracts). What are the results? You lost 10 cents
on the July contract (ouch, can't be right every time), but you gained 25 cents on September. You pocket
15 cents per bushel (minus a small commission on the 'turn around'.) Since each contract covers 5,000
bushels your net gain is $750.
Naturally, you would have made even more had you NOT shorted July in the first place. But it's
impossible to predict the future with certainty. That's why they call it speculation.
The motivation for 'betting against yourself' by shorting and going long at the same time is to hedge
your bets on which way the market will in fact go in the future. This spread strategy (along with dozens
of other variations) does cap the profit potential, but it helps minimize downside losses.
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Commodities -- Basic Risk Management - Hedging
Two different motives compel commodities traders: speculation and hedging. They're not mutually
exclusive - one can do both at the same time - but speculation is primarily profit oriented. Hedging is
more oriented toward protecting profits or minimizing a potential loss, it's a defensive strategy.
Hedging is essentially recognizing a hard fact: traders can't predict prices correctly 100% of the time. In
order to be on the right side of a trade, an investor needs not only to predict the direction of prices, but
also to have good (or lucky) timing.
It isn't enough to guess correctly that prices are moving up or down, a trader has to know when to get in
and when to get out. They can improve their odds on all those points by use of some simple hedging
strategies.
First, some elementary concepts.
Hedging is effective, in part, because prices in the cash (spot) markets and futures prices tend to move
together. A 'spot' or cash market is one in which the physical commodity is bought and sold, as
distinguished from the futures market where contracts are traded for future delivery of the good.
But they don't move exactly in lockstep. Any difference between the spot price and the current contract
price is called the basis. Basis = cash price futures price.
In any hedge investors have two basic alternatives: going short or going long. Many strategies involve a
mixture of the two, they're not mutually exclusive, either. 'Going long' means buying in order to sell
later at a higher price. Going short involves selling before buying with the expectation of a future price
decline.
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Side note on going short: How do you sell something you haven't first bought, and therefore don't own?
In effect, by borrowing the commodity or contract from the broker, selling it, then buying the equivalent
later on to 'balance the books'.
In going long a hedger benefits from a weakening basis, as the cash price falls relative to the equivalent
futures contract. Shorting is advantageous when the basis is increasing, i.e. when the cash price rises
relative to the futures contract price. Observe that a basis can rise or fall in opposition to price levels. It's
the difference that matters.
A short example will help clarify the ideas.
Suppose a heating oil seller wants to hedge 50 percent of the anticipated April production of 3 million
gallons.
The seller goes short by selling April heating oil futures contracts at $1.98/gal on March 1. By the last
week of March, both cash and futures prices have fallen. On April 1, when the seller delivers heating oil
to the local terminal, the price is $1.85/gal. The seller simultaneously hedges, by purchasing April
ethanol futures at $1.90.
(The standard heating oil contract covers 42,000 gallons. The speculator would have to purchase 35.71
contracts. But partial contracts aren't traded. Figures are approximate for ease of demonstration.)
Date Spot Market Futures Market Basis
Mar 1 $1.88 per gal. Sell April at $1.98 per gal. -$0.10
Apr 1 $1.85 per gal. Buy April at $1.90 per gal. -$0.05
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Hedge Result:
Gain on the futures trades: $0.08 per gal. (Sell April at $1.98, Buy April at $1.90. $1.98 - $1.90 = $.08
or 8 cents)
Net sales price: $1.93 per gal. ($1.85 + $0.08)
Total Result Price April Income
50 percent hedged at: $1.93/gal $2,895,000
($1.93/gal. x 1.50 M gal.)
50 percent unhedged: $1.85/gal $2,775,000
($1.85/gal. x 1.50 M gal.)
Average April sales price:$1.89/gal $5,670,000
What would have been the result without hedging? The seller would have received $5,550,000. ($1.85 x
3.0 million gallons) Hedging between the spot and futures market resulted in a net increase of April
heating oil income of $120,000. Hedging can help protect traders from losses, but it can also be
profitable.
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Commodities -- Basic Risk Management - Order Types
It's common knowledge that in trading commodities, like any other kind of speculating, there are no
guarantees. You can make money, or lose money - a lot, and quickly. What's less commonly known by
the average trader are the many methods professionals use to reduce the risk of loss and limit the
amount.
The most basic knowledge needed is that of the different kinds of orders that can be executed: Market,
Limit, Stop and their variations.
Market
Market orders are the simplest, the one with which everyone is familiar. An order is placed and the
broker attempts to fill it at whatever is the going price. Even with such loose requirements, there's no
guarantee the trade will get executed quickly.
When liquidity is very low, some orders may wait a considerable time, even to the next day. The
commodities and futures markets, though, are huge and active. Market orders generally are filled within
minutes, if not seconds.
There are several variations on market orders, including MOC (Market On Close), MOO (Market On
Opening), MIT (Market If Touched) and others.
Much as the names suggest, market on opening is an order to execute at the best possible price during
opening, and similarly for a market on close order, at closing.
Market If Touched orders are similar to limit orders (see below). In this case, though, orders are filled if
the price is reached and continue to be filled even when the price moves away from the limit.
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Limit
The next simplest type, limit orders are a request to buy or sell at a designated price. Typically, buy
orders are placed below the current market price and sell orders above.
Depending on the designated price, and general market conditions, the order may not get filled. Even if
the market reaches the limit price, there are thousands of trades executing every second. Yours may or
may not get executed.
Stop
Stop orders, short for 'stop loss' are used to limit potential losses on a long or short position. A buy stop
order is typically requested for an above market price, sell stop orders below market. Once the stop
order price is reached, it becomes a market order and is executed accordingly.
There are a few variations: stop limit, stop close and others.
Stop limit orders list two prices. One price is listed just as an ordinary stop order, the second in the form
of a limit price. Once the stop is reached, the limit requirement is effectively cancelled.
Stop close orders are used only near the close of trading. The order is attempted to be executed only if
the market reaches the stop price at this time. Since commodity markets are typically volatile, this can
protect traders from intraday fluctuations.
OCO (One Cancels The Other)
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This is actually a combination of two orders in one. The order requests that floor traders attempt to fill it
until one side or the other is executed.
Fill Or Kill
In this scenario, the floor broker will bid or offer up to three times at a specified price. If no suitable
trade is available the order is cancelled.
In every case, brokers are obligated to obtain the best possible price for their clients, but can never
guarantee a trade at any given price. The market is so active and liquid, though, that the overwhelming
majority of orders are executed at or very near the designated time or price.
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Commodities -- Commodities In Your Portfolio
For over thirty years - roughly 1974-2004 - the S&P 500 trended upward, with the CRB (Commodity
Research Bureau) trending down. The CRB is analogous to the Dow Jones Index - a mathematical
combination of commodities prices that indicates their movement. It's composed of weighted averages
of prices of oil, coffee, gold, wheat, etc. Yet many savvy investors continue to trade in commodities, and
many of those do very well. Why is that?
One reason is that indices don't tell the whole story. General trends don't show the detailed, day-to-day
price movements that many traders take advantage of to make profits. After all, at the end of the day
what matters is the difference you bought and sold for, not the absolute prices.
Another reason is the historical role commodities have played in trading strategies. Since commodities
and stock prices tend to move in opposite directions, commodities form part of many intelligent hedging
strategies.
Possibly part of the explanation lies in the contrarian stance of many investors. One school of thought
argues, plausibly and with historical data support, that you can't make money by following the crowd. In
order to profit you have to do what the other guy isn't. That's true within an investment type, and also
across different investments.
It's also true that any well-diversified portfolio will have some of just about everything: stocks, bonds,
cash and - in some cases - commodities. As part of an overall hedging strategy, and to diversify both risk
and income, it's wise to have a bit of everything. As bonds move down, for example, commodities move
up. Inflation tends to work on them in opposite directions.
Lastly, it's simply an empirically observable fact that many commodities have been moving up for many
years. Oil is probably the most notable example, with precious metals being the typical alleged loser.
'Loser' really is a misnomer, though. The price of gold did peak almost 30 years ago, but after dropping
sharply it has remained steady over most of that period, and has trended sharply up the last few years,
rising over 40% since 2003.
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COMMODITIES
Some would argue that the price rise for gold will continue for some time to come. Given the latest
views of the Federal Reserve on inflation, that may well be true. As with any investment, no one can be
sure. If they could, it wouldn't be called speculation.
This much is a good bet, however. The world will continue to consume wheat, oil, gold, coffee and other
common commodities. Another truism is that some of those can't be replenished and the more you
extract the harder it is to get what remains.
That's certainly true of gold, though with national governments holding the largest stores and with the
trend toward liquidating them, it will be under continued price pressure for some time to come. Canada,
for example, eliminated all its horded gold over the period 1980-2003.
Oil, too, is likely to be harder to recover. Recovery of North Sea oil peaked several years ago and has
been declining ever since. Until and unless radically new technology comes into play, or environmental
policies change, the rate of supply isn't likely to increase substantially. Meantime demand is continuing
to rise, particularly from China.
All those factors tend to bode well for including commodities as part of your portfolio, at least in the
form of ETFs (Exchange Traded Funds). Other mutual funds that focus on commodities are available, as
well. And there's an additional advantage to those investments. Some tend to move in the same
direction as stocks, not opposite to them.
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COMMODITIES
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COMMODITIES
Commodities - Commodity Exchanges
There are more than a dozen major commodity exchanges around the world, reflecting the global
nature of speculation today.
The Chicago Board of Trade (CBOT, http://www.cbot.com) for example trades a wide variety of
commodity types. On the exchange, traders will find everything from corn, soybeans, wheat and oats to
several metals contracts: 100 oz Gold, 5,000 oz silver and newer 'mini' contracts for both. Mini's are
contracts in which the amount covered by a standard contract are smaller than the traditional amount,
allowing for a lower initial investment and smaller price increments or 'ticks'.
The CBOT also offers an array of non-physical 'commodities' futures contracts. Government bonds
futures contracts are traded: 30-year bonds, 10-year notes, 5-year swaps, and more. A swap is the
combination of a cash trade and a forward - similar to futures. They're used primarily for hedging. The
CBOT also trades a number of indexes, such as the Dow AIG Index (a commodity index), and the Big Dow
(an index on stocks).
Also housed in Chicago, the CME (Chicago Mercantile Exchange, http://www.cme.com) trades
commodities as it has for over a hundred years. Reflecting its long history, the exchange trades live and
feeder cattle, hogs, pork bellies and others. Lumber, milk, butter and even fertilizer are traded here.
But the CME has other, more esoteric products. The exchange offers an E-mini S&P 500 contract to
trade the Standard & Poor's 500 Index on stocks. If the NASDAQ is more your style, they offer the E-mini
NASDAQ 100 that trades a futures contract on that popular index.
Even Eurodollar futures are traded here. But the most unlikely contract has to be the Weather derivative
- a futures contract that speculates on weather around the globe during different seasons.
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COMMODITIES
NYMEX is the acronym for the New York Mercantile Exchange. (http://www.nymex.com/index.aspx)
Among the oldest in the U.S., they offer commodity and futures trading on a wide variety of petroleum
and metals products, each with a distinct exchange abbreviation. Brent and mini-crude (CL, WS), Natural
Gas (NG), Gasoline (HU), Heating Oil (HO, BH), and others.
Gold (GC), Silver (SI), Copper (HG) and Aluminum (AL) are offered, too. Note that the commodity
abbreviations do not match the common chemical element abbreviations. Futures contracts are listed
second and have their own abbreviation.
Another major exchange housed in New York is the NYBOT (New York Board of Trade). New York's
original futures exchange, it offers contracts on cocoa, coffee, sugar, FCOJ (frozen concentrate of orange
juice), cotton and other agricultural products. It also trades non-physical items, such as currency pairs,
the U.S. Dollar Index, the famed NYSE Composite and more. The NYBOT offers live price info and will
even feed a Blackberry device.
But the U.S. has no monopoly on commodity and futures exchanges. One of the world's most active is in
London: Liffe (http://www.liffe.com). Formerly known as the London Fox (London Futures and Options
Exchange), it's now merged with euronext. The exchange trades cocoa, sugar, coffee, wheat, barley,
potatoes and other agricultural products.
Not far away is the historic London Metal Exchange (http://www.lme.co.uk), one of the grandfathers of
precious metals trading. Copper, lead, aluminum, and several others are traded here. The exchange
even trades plastics.
Japan, too, has a major exchange, the Central Japan Commodity Exchange (C-COM, http://www.c-
com.or.jp), based in Nagoya, Japan. Formed in 1996 from the merger of three other major exchanges,
commodities range from eggs to gasoline and kerosene to ferrous scrap.
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COMMODITIES
Commodities - Leverage
Most commodities trades are executed in the form of futures contracts. A specified percentage of the
asset price is paid and a buyer accepts the obligation to deliver (or take delivery of) a set quantity of the
good at a future date. Hence the name.
Why do futures offer any advantage over trading the commodity directly? They're riskier, since they
expire within a certain amount of time, and their values are more complicated to assess. The asset price
is difficult to predict, and the price of a futures contract in the future is even more so. Contracts are
bought and sold in a way similar to stocks or options.
As derivatives they have no inherent worth. A derivative is a financial instrument that 'derives' its value
from some underlying asset. What do commodities futures traders know that some investors have yet
to learn? One thing they know is the value of leverage.
Imagine a teeter-totter in a children's playground. A small child can lift an adult into the air, provided the
pivot point under the horizontal plank is placed in the right spot. That force 'multiplier effect' has an
analogy in financial markets.
For somewhere in the neighborhood of 5% of the price of the commodity, an investor can control - even
though he doesn't own - 100% of a quantity of the good. That's leverage. The 5% figure is known as 'the
margin'. The specific number varies depending on recent price volatility, legal regulations and several
other factors.
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COMMODITIES
Suppose gold is trading at $580 per Troy ounce on the CBOT (Chicago Board of Trade). 5% of $580
equals $29. Therefore a trader purchasing a futures contract for, say, 100 troy ounces, can control
$58,000 worth of gold for only $2,900. The broker, in effect, loans the trader the rest of the money. Not
a bad deal considering that commissions are in the range of $15-$40 for a 'full turn', i.e. a pair of trades
to buy and sell.
Now imagine the price rises to $585 before the expiration date of the contract. The net profit is: $585 -
$580 = $5 per ounce. $5 per ounce x 100 ounces = $500. The percentage of profit is: $500/$2900 x 100%
= 17.2%. Considering the modest amount invested, a very decent return. And such price swings for gold
happen almost daily. It goes without saying that the price can just as easily, and even more quickly, fall.
Futures have other advantages over the spot market. Suppose you actually had enough capital to
purchase 100 troy ounces of gold. You now have transportation, storage and security problems.
If the commodity in question were, say, oil your problems intensify. Even if you could afford to
purchase, transport and store 1,000 barrels of oil (the standard minimum contract amount, equal to
42,000 gallons), very few dealers are going to take it off your hands. They only do business with
professionals who deal in very large quantities.
So unless you bought it to use rather than trade, you are going to find it difficult to sell again. If you
could sell it, you again have a transportation problem and expense.
Small wonder that almost no traders ever see the actual commodity. Nevertheless, don't forget that,
unlike options, futures contracts carry the obligation to deliver (or take delivery of) a good by a certain
date. Rarely are the contracts for longer than a year.
In practice, of course, the contract is sold on or before expiration at either a profit or loss (or
breakeven). The actual goods are ultimately transferred to an end consumer (jewelers, refineries, bread
making companies, etc) by a specialty broker.
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COMMODITIES
Take advantage of futures and the leverage they provide.
Commodities - Margins
Suppose you've been reading the newspaper lately and seen the substantial rise in inflation over the last
two years. You bet, along with many others, that this trend is likely to continue for the next two years.
You decide to hedge your portfolio, and possibly pick up some profits, by investing in gold.
Unfortunately, you don't have $58,000 to purchase 100 Troy ounces of gold at the current market price
of $580. Instead you do what most speculators do, you buy a gold futures contract. Now instead of
having to come up with $58,000 you only have to invest an initial amount of $2,900, 5% of the total.
That 5% is known as the (initial) margin. The exact percentages are set by the exchanges and brokerage
firms on a daily basis, per individual commodities futures contracts. Exchanges monitor prices, volatility
and many other factors to determine acceptable levels of risk and then set the margins accordingly.
Minimums are set by the exchange, but brokerages will sometimes have slightly higher requirements.
Now suppose the price of gold rises by $5 before the expiration of the contract. Excellent. You've made
$5 per ounce x 100 ounces = $500 (excluding commissions, around $20). If you had purchased the gold
outright you would have made the exact same amount of profit. But look at the difference between
outright purchase and a futures contract in percentage terms.
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COMMODITIES
$500/$58000 x 100% = 0.86%, slightly less than 1%. On the other hand, $500/$2900 x 100% = 17.2%.
That difference is the effect of something known as leverage. You invested only 5% of the total purchase
price, but you still get 100% (ignoring commission) of the profits, not 5% of the profits.
But with the possibilty of reward comes the risk of loss. If the price had decreased $5 and never rose
again before the contract expired, the result would have been a $500 loss instead. In order to protect
themselves against the possibility that you won't be able to cover the amount at expiration, brokers may
issue something known as a 'margin call'.
All potential profits and losses are calculated and settled on a daily basis. If the price drops below the
minimum set by the broker (based on the exchange minimum), brokers will require their clients to
deposit additional funds to bring the account back up to the level of the initial amount.
Here's the kicker. They may or may not give you adequate notice and time to actually do that.
Depending on the level of price volatility, the amount involved, and your relationship with them, brokers
can (and sometimes do) liquidate your position without waiting for you.
Under normal circumstances, most brokers will give you notice and reasonable time to meet this
'maintenance margin', the amount required to bring your account up to the required level. But it's the
trader's responsibility to monitor his or her positions and know the guidelines.
Beyond bringing the account up to the previous level, it's possible you may have to come up with an
even larger amount. Exchanges and/or brokers can and do raise (or lower) the minimums depending on
current market conditions.
Futures trading, particularly in the fast-paced, high risk world of commodities, isn't for everyone. A high
tolerance for risk and the ability to input additional funds is necessary, along with the ability to
withstand the losses.
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Commodities - Reading Prices
Welcome to the confusing world of commodities.
Most trades are carried out by buying and selling futures contracts, rather than trading directly in the
commodity. And most futures contracts trade more or less like stocks or bonds, with the key exception
that they have an expiration date. Nevertheless, some of the mechanics of trading can still be confusing
to the novice. One of these is the most basic item of information: price quotes.
Gold
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COMMODITIES
Because of advertising, its accessibility, and the historical allure of gold, this commodity will be one that
most novice commodity traders take an early interest in. Price quotes are fairly straightforward, with
just a few wrinkles.
Gold price movements have a minimum set by the exchanges. Gold futures, for example, traded on
COMEX (Commodity Exchange of New York) have a 10 cent minimum 'tick' (price movement) as it's
called. Since each futures contract covers a 100 troy ounces, that makes the minimum price movement
for a contract $10. That's a significantly larger movement than the average stock investor may be used
to, where prices typically move by ten to twenty-five cents per share.
Quotes will often be shown without the dollar sign, and sometimes the decimal point is also left out. So,
a price of $580.65 per troy ounce of gold may be shown as: 58065. Normally, it will be displayed as
580.65.
Natural Gas
Traded on NYMEX (the New York Mercantile Exchange), here the minimum price change is 1 cent. Prices
are quoted in dollars per million metric British Thermal Units (mm BTU). A BTU is a measure of energy
produced by burning natural gas.
The standard futures contract size is 1,000 mm BTU. So, a price movement from, say, $35.50 to $36
would represent an increase of $.50 x 1,000 = $500.
Live Cattle
Live cattle futures are traded on the CME (Chicago Mercantile Exchange), one of the oldest and largest
in the U.S. Prices are quoted in cents per hundred weight, with a standard contract covering 40,000
hundred weight.
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COMMODITIES
The tick (minimum price movement) is 0.025 cents, and a movement from 71.125 to 72.125 would be
calculated as follows:
71.125 is read as 71.125 cents per hundred weight. So, a common price change would look like:
$0.72125 - $0.71125 = $.0100
$0100 x 40,000 = $400.
Coffee
Coffee is one of several commodities known as a 'soft', a category used to distinguish it from metals,
energy, grains, etc. Traded on the appropriately named Coffee, Sugar and Cocoa Exchange (CSCE), the
price is quoted in cents per pound. The standard contract size covers 37,500 pounds.
Since, the minimum change (the tick) is 0.05 cent, a contract price changes by: $0.0005 x 37,500 =
$18.75. A price listed as 115.45 is equivalent to 115.45 cents per pound, or $1.1545 per pound.
Corn
Corn is one of several grains traded, and possibly the one with the longest history. Corn has been
harvested for thousands of years, and formed one of the earliest 'forward' contracts.
Prices are quoted in cents per bushel, with a minimum price change of 1/4 cent. The standard contract
covers 5,000 bushels. A price quoted as 290 would be equivalent to $2.90 per bushel.
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COMMODITIES
Hence a contract price change from 290 to 291 would equal:
$2.91-$2.90 = $0.01
$0.01 x 5,000 = $50.
Take a moment to absorb that. A one cent movement in the price of the commodity affects a single
contract owned by fifty bucks. Quite different from stocks or bonds.
Commodity prices move fast and they often move far in a single day. That makes commodity trading one
of the most volatile, and hence risky, markets traders can engage in. Be ready for a real adrenaline
pumping experience when you get involved.
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COMMODITIES
Commodities - Technical Analysis - Expectancy
Fundamental analysis in commodities trading looks at economic factors such as weather predictions and
crop yields, new mines opened, new oil extraction technology, etc. In short, factors affecting the causes
of supply and demand.
Technical analysis, by contrast, is based on the idea that trends can be detected by charting
mathematical manipulations of a few basic variables: price, volume and a few others. Most macro-
economic factors are given much less weight. Actual market activity in the recent past is what is
considered most important to predict future prices.
Both camps recognize that any predictions can only be made with a limited degree of certainty. Only
probable outcomes can be calculated. This gives technical analysis the edge with at least one variable:
expectancy.
Expectancy is a powerful trading tool and one that isn't used often enough by novice traders. Yet,
expectancy is simple to understand and calculate.
Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss)
Suppose an investor has (by whatever means) enjoyed profitable trades only 30% of the time for the last
year, and the average trade profit was 10%. Losses were on average 3% of the amount invested,
$10,000. Therefore:
Average profit = 0.10 x $10,000 = $1,000
Average loss = 0.03 x $10,000 = $300
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COMMODITIES
So,
E = (0.30 x $1,000) (0.70 x $300) = $300 - $210 = $90.
Observe that even though the percentage of losing trades (70%) swamped winners, the trader still sees
a net profit of $90 for the year. Not huge, but still not a loss.
Of course, the numbers could be anything, in principle. The point of using expectancy is to help keep
your eye on the ultimate goal: coming out ahead over the long term.
Psychologically, novice traders tend to focus on the number of times trades were profitable vs those
that resulted in losses. Expectancy helps you focus on the important item: net profits over time.
Stock traders are constantly debating whether it's better to trade longer term vs shorter term. Non-
professional day traders are often looked down on. But the situation in commodities is just the reverse.
Short term positions, even for relatively inexperienced traders, generally lead to better results.
It's difficult for most non-professional traders to accept losses. They tend to stay in the market too long,
hoping for a turn around to eek out a profit, or at least minimize the loss. In many cases, with stocks,
that will work out. Commodities are different.
Remember, the longer you stay tied to a position, the longer you have your capital tied up - capital that
could be making you a profit that will more than compensate for past losses. Accept the fact that you
can not predict correctly 100% of the time.
Also, since most commodities trades are carried out by buying and selling futures or options contracts,
you have only a limited time - usually no longer than a year, often much less - to make a decision. The
closer the contract gets to its expiration date, the more likely you are to lose, on average.
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COMMODITIES
Commodities trading isn't for everyone. It's high risk, fast paced and prices are volatile. But proper
research and use of the wide variety of tools available will help those interested to come out a winner in
the long run. Expectancy is one tool you shouldn't overlook.
Commodities - Trading Coffee
It's great to be able to trade a commodity where you wouldn't mind actually taking delivery.
Coffee prices have been rising for the last two years, after a substantial dip. Producers haven't
completely recovered, but for the first time in several years optimism is on the rise.
Prices fell from around 129 to 113 cents per pound over the first six months of 2006, but the good thing
about commodities trading is it's just as easy to make profits in a declining market as in a rising one.
Stocks, by contrast, make shorting a much more risky and difficult prospect. Investors tend to make
more money on a rising stock market than a falling one.
Currently, Brazil remains the world's largest producer, so as the saying goes 'as goes Brazil, so goes the
world' where coffee is concerned.
2006 Million Bags % of World
Brazil 36.1 32%
Vietnam 12.3 11%
Colombia 11.6 10%
World 112.7 100%
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COMMODITIES
But in recent years Vietnam has become a major producer, and in the two years since the U.S. rejoined
the ICO (International Coffee Organization) many interesting things have been happening.
World production, as estimated by the USDA (U.S. Dept of Agriculture), is expected to be around 123.6
million (60kg) bags, with an expected use of 122.4 million bags for 2006-2007.
The USDA is estimating the Brazilian coffee crop at 44.8 million bags, up 24%. The Brazilian government
is putting the estimate at 40.6 million bags. The International Coffee Organization, ICO, figures are
roughly the same at 120 million bags total, with Brazil at 40.6.
For complete statistics on coffee, including production amounts by type and country, historical and
current prices, etc see the International Coffee Organization website at
http://dev.ico.org/trade_statistics.asp
Coffee futures contracts are traded on the NYBOT (New York Board of Trade), currently around 98 cents
per pound in July 2006. The price has recently trended downward along with many other commodities.
But supplies remain relatively tight, with stocks being drawn down in both exporting and importing
countries.
With total ending coffee stocks at 21.75 million bags, the stocks-to-use (SU) ratio is the lowest in two
decades at 18%. That means upward price pressure, or at least good price support.
Balance that against the fact that most commodities prices, metals and energies in particular,
experienced sharp rises from 2000 to the present, while coffee fell or remained static. So, like any other
commodity, coffee is a crap shoot. But, several large traders, such as Paragon Trading in New York, are
expecting a supply crunch during 2007 that won't ease for at least two years.
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COMMODITIES
The standard contract size on the NYBOT is 37,500 lbs (approximately 250 bags). At that size, maybe you
won't want to take delivery after all, but a futures contract can be obtained for somewhere around
$2,000. With world consumption steady and supplies tight coffee still makes for a viable investment.
Commodities - Trading Oil
For decades, commodity trading in petroleum products was a club for only the big guns. At 42 gallons
per barrel, and a minimum contract size of 1,000 barrels, the prospect of delivering oil was only for
professionals. But several changes have occurred in the last few years to alter the scene.
Oil prices remained stable for decades until the explosion of the mid-70s. Political and technological
changes resulted in shortages, uncertainty and rising prices. Since then prices have risen to over $70 per
barrel and are expected to rise from mid-2006 to mid-2007 and then decline slightly for the following
two years.
No one can predict oil prices with certainty, but there are several large scale factors that make
reasonable projection possible.
Demand is rising, and is likely to continue for at least the next few years and probably longer. India and
China are both experiencing substantial technological and cultural changes. India in particular is
embracing more elements of a free-market economy than it ever has and the trend shows no signs of
being reversed, or reversible.
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COMMODITIES
Western technology and business methods are bringing India into the 21st century very rapidly. Along
with that comes an increase in demand for energy, primarily oil-based, in order to build new homes,
office buildings, manufacturing plants and more. Large segments of what was once a largely rural
economy are seeing the effects. That leads to even more demand.
Demand isn't enough, of course. An individual can want anything. But India's ability to buy those goods
is increasing. With an inexpensive, highly educated work force India is becoming the central focus for
outsourcing for Information Technology, electronics manufacturing, communications and more. Those
21st century businesses are expected to continue to expand for at least the next decade. Just as one
indication, broadband adoption is growing rapidly in India.
China now has the largest mobile phone use in the world, and the second largest Internet population.
Demand for energy is increasing there and is expected to continue for the next decade at least. Though
ostensibly ruled by the Communist Party, social forces are eroding its effectiveness. No one can know
whether repression will ease or increase, but the flow of information is difficult to block even for a
dictatorship.
As social changes continue, business is increasing in China. Energy demand is up. New buildings,
manufacturing plants and infrastructure is constantly being built. All those require energy, primarily oil-
based.
At the same time demand is rising, supply rates have becoming static or declined. Temporary refinery
loss, such as that due to hurricanes, can be recovered in a few months to a year. But North Sea oil
production peaked in 2000 and has been tapering off slowly. Until or unless political changes occur that
release the large known reserves in Alaska, substantial new sources are unlikely to come into play. No
new sources are expected to come online anywhere in the world.
Technology is leaning more toward developing other forms of energy, though they are not expected to
be on the market for more than ten years. Fuel-cell powered cars, which would account for only 7% of
gasoline use anyway, won't be in everyone's driveway for some years to come.
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COMMODITIES
Political pressures to forbid nuclear power, at least in the U.S., are not expected to change. The waste
disposal problem is still a political football with no solution in sight.
Finally, new forms of oil trading mechanisms are evolving to allow the average investor to participate in
this once-exclusive club.
E-mini futures on the Chicago Mercantile Exchange, for example, allow for trading contracts half the
traditional size, 500 barrels. Futures and options on NYMEX (New York Mercantile Exchange), though
still at the 1,000 barrel size require less than 5% investment, putting them within reach of all.
Commodities pools and funds (such as those from Pimco and Oppenheimer), which allow investing
fractional amounts, are becoming more popular.
The risk/reward balance was never more favorable for the average investor to investigate oil commodity
trading.
Commodities -- Trading Silver
Silver is unique among commodities. Like gold and a few others, private investors can feasibly take
actual delivery. But unlike gold, the price is within reach. Physical storage is not out of the question and
security can be as simple as bank's safe deposit box.
The possibility of taking delivery on a commodity expands trading strategies since it allows for additional
hedging, using a combination of spot and futures contract trades. It also allows for pure spot trading
with local merchants. 'Spot trading' means buying and selling the actual commodity, as distinguished
from trading futures contracts in which actual delivery, for most traders, is rare.
Another advantage of silver is its relatively low per ounce price. Silver has traded in the range of $5-$15
per ounce for decades. Like lower-priced stocks, those prices make silver more accessible to the average
investor in quantities large enough to make substantial profits.
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COMMODITIES
That price range doesn't sound good to someone used to trading stocks and seeing them rise to ever
greater heights over the years. But factoring in inflation, those stock prices don't always look so good.
Silver, like gold, is one way to measure real prices.
Traded on COMEX (The Commodity Exchange of New York) and elsewhere, the standard contract size
for silver futures is 5,000 troy ounces. A 'troy' ounce is 1.1 times the common avoirdupois ounce used in
cooking and packaging. COMEX is a division of the New York Mercantile Exchange.
The tick (minimum price fluctuation) is $0.005 per troy ounce. With a minimum of 5,000 troy ounces,
that makes a tick worth $25. That's a substantial change to those used to stock prices which move
around 10 to 25 cents per share, but multiplying by 100 shares brings it in the same range. In any case,
it's a normal amount in commodities trading.
A standard price quote may appear as:
Contract Date Last Change Open High
Jun '06 (SIM06) 1014.8 -3.7 1013.8 1014.8
Low Date/Time
1012.8 12:29
The contract date specifies the expiration month and year of the contract. The specific date is set by the
exchange. The characters in parentheses are a standard abbreviation for a futures contract. SI is silver,
M is the short form used for June and 06 specifies the year, 2006. The others represent familiar price
quote columns.
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COMMODITIES
The prices are specified in cents per troy ounce, hence 1014.8 would be equivalent to $10.148 per
ounce. One contract at $10 per ounce, for 5,000 ounces is therefore an investment of $50,000. For the
average investor, that's a substantial chunk and one of the reasons futures and options - which allow
investing around 5% of that - are so popular.
One caveat: silver prices - like those of any commodity - are volatile. In May 2006, the silver price
peaked at over $15 per ounce. It promptly retraced to around $10 per ounce. But, as with any other
form of trading, what counts is not the absolute price or even solely the trend. Profits are measured by
the difference between buying and selling prices and that means timing is essential.
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COMMODITIES
Commodities - Trading Soybean
Soybeans aren't sexy... except to a commodities trader. Yet this grain is among the lowest risk, most
potentially profitable trades around.
Soybeans were first cultivated in China thousands of years ago, and they continue to be grown there.
First arriving in America in the 1800s - they were used to stabilize clipper ships - their use as a food
additive has only grown as technology has advanced. When the crops in China were heavily damaged in
WWII, the U.S. became one of the largest suppliers.
Thirty-one states in the U.S. now grow soybeans, with Iowa producing over 400 million bushels and
Illinois over 500 million.
But the U.S. and Asia now have another major competitor: Brazil. Though suffering from reduced supply
the last two years, owing to a long drought, crop yields are recovering and are expected to reach record
levels in 2007. Soybeans now rival coffee (along with sugar) as one of Brazil's major exports. In the
2004/5 year, Brazil exported over 20 thousand metric tons of soybeans, two-thirds the U.S. total.
At the same time, demand remains strong. American livestock - cattle, chickens and pigs - alone
consume over 25 million tons of soybean meal per year. But it's also used in the preparation of dozens
of human food products.
That demand is expected to rise, owing to a number of factors that are not likely to be reversed in the
foreseeable future.
Population levels throughout most of the world continue to rise. The U.S. population is almost 300
million and still rising. The world population is over 6.5 billion and though the rate of increase is slowing,
the level is expected to continue to increase for several decades at least.
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COMMODITIES
Soybeans represent a low-cost food additive that is used the world over that can feed that growing
population.
Research and development on agricultural yields is continuing to advance. About 1.4 billion hectares
were used for cultivation worldwide in 1961. By 1998, less than 40 years later, 1.5 billion hectares were
used to grow twice the amount of grain. That's a substantial productivity gain and the advances are just
beginning.
Within the last few decades genetics research has improved and scientists now regularly offer
implementable genetic techniques to resist disease. By 2005, genetically modified crop production of
herbicide-tolerant crops expanded to 87% of soybean production. That figures was only 63% just two
years earlier.
Soybean rust continues to be a problem, but there is good reason to believe this can be eliminated in
the coming years.
And food isn't the only thing soybeans are used for. Most biodiesel fuel in the U.S. is produced from
soybeans, where in Europe canola is used. Corn is used to make ethanol. With rising gasoline prices,
pressure continues to encourage converting some vehicles (such as farm equipment) to diesel.
Soybean futures contracts are traded on the CBOT (Chicago Board of Exchange) with the standard
contract covering 5,000 bushels. The tick (minimum price fluctuation) is 1/4 cent per bushel, with a
maximum price swing per day of 50 cents per bushel above or below the previous day's settlement
price.
Investors interested in trading commodities should look into soybeans. Sometimes the plain girl next
door is as sexy as any gold-covered Hollywood starlet.
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COMMODITIES
Commodities - Trading Uranium
For those who like their trading radioactive, uranium offers a wild ride. Prices exploded a couple of years
ago, then dropped back just as quickly to the $29 level, the boom up to $45. And you thought oil prices
were volatile. Nevertheless, prices have been on a steady rise the last two years, and it's no surprise.
Uranium has a number of natural advantages over oil or other energy sources. The fuel produced from
uranium lasts for decades and can be recycled for decades more (in the form of plutonium). That, after
all, creates one of the pervasive problems in dealing with it - it hangs around so long that disposing of it
is a political hot potato.
Nuclear power has by far the best safety record of any large-scale energy generation technology. Oil and
chemical refineries can and have exploded, due to incompetence and accident. Controls on the use of
nuclear fuel are much more strict, and strictly adhered to, than with conventional fuels.
Though long considered almost evil, or at least generally dangerous, by many in the U.S., nuclear power
safely generates 16% of the world's electricity. Both Japan and France have relied heavily on nuclear
power for decades, and neither country regrets the decision to use it as a major source of power. France
generates 78% of its electricity from nuclear power and has never experienced a serious incident.
More power plants are being built around the world, particularly in Asia. China will soon award an $8
billion contract to build four new plants, on the way to constructing 27 by 2020. India plants to build 17
by 2012, tripling existing capacity. Russia has reduced exports in order to retain fuel for the 25 new
plants planned there by 2020.
Most of those plants have not yet secured a long-term supply, suggesting they will have to pay market
prices as they near completion.
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COMMODITIES
Even the U.S. may soon see a change in the political winds, where there is a coming together taking
place between long-time political foes. Many environmentalists are beginning to see that nuclear power
offers one of the best alternatives to continued fossil fuel use, as concerns over global warming heat up.
And with the rising price of oil, those political forces may just be reaching a tipping point in favor of
nuclear.
At the same time demand is rising supplies remain tight. Commercial stockpiles fell 50% from 1985 to
2003, and mining remains expensive and difficult.
Cameco, an Australian mining company, is one of the world's largest uranium suppliers. It plans to
expand production 18% in Canada's MacArthur River mine, currently the world's largest.
Even so, supplies are unlikely to expand enough to meet the growing demand to a point that would
suppress the price. Several analysts are expecting supplies to remain tight over the next 10 years. As a
result, prices are rising to levels not seen since their peaks in the 1970s and are expected to remain high
for quite a while.
Annual demand is roughly 170 million pounds, while annual supply is around 75 million pounds a year.
The deficit is made up from supplies stockpiled from the 1970s, the dismantling of Russian nuclear
warheads, and other sources. But that supply is dwindling.
Fuel costs are a relatively small cost for power plants, but vital to their operation. They can not afford to
run out, since there is no substitute.
All those facts bode well for metals traders who might have an interest in uranium. Note that uranium
doesn't trade on the open market, like other metals. Contracts are made privately. But investors
interested can buy mining stocks, futures contracts, options, etc just as with any other investment. See
your broker for details.
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COMMODITIES
THANKS FOR READING
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