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Markets divider Commodities

Commodities

What are Commodities?

A commodity is a basic good used in commerce that is interchangeable with other goods of the same type. Fungibility is a key characteristic, meaning that each unit of a commodity is identical, regardless of who produced it. Commodities are not only vital for producing physical goods and food but also offer investors a way to diversify their portfolios and engage in speculation.

Precious Metals

Precious metals such as gold and silver are highly sought after, with platinum and palladium being less commonly traded but still significant. Copper, while not a precious metal, is grouped with this category due to its popularity. Precious metals are crucial for traders as they often act as a hedge against inflation, market uncertainty, and economic volatility. Gold, in particular, is considered a stable, reliable asset and is often seen as a safe haven during times of currency devaluation or high inflation.

Energies

Crude oil, the most well-known energy commodity, is traded in two main forms: West Texas Intermediate (WTI) and Brent crude, which serve as U.S. and global benchmarks, respectively. Other energy commodities include heating oil, gasoline, natural gas, and liquefied natural gas (LNG). Energy investors need to stay informed about global economic conditions, as changes in demand can have a significant impact on prices. OPEC's production decisions and technological advancements in alternative energy sources, such as electric vehicles, also influence energy prices.

Advantages of Commodity Investing

Investing in commodities offers several benefits:

  • Diversification - Commodity returns tend to differ from those of other asset classes, which can help reduce overall portfolio volatility.
  • Leverage - Commodity trading often allows the use of leverage, magnifying both potential gains and losses. Traders must manage leverage carefully to avoid undue risk.
  • Reduced Manipulation - Due to the global nature of commodity markets, they are less susceptible to price manipulation.
  • Hedge Against Inflation - While inflation can negatively affect stocks and cash holdings, commodities typically rise in value in response to inflationary pressures.

Trading Example

One approach to trading gold is using the gold-silver ratio to decide when to enter and exit trades. The gold-silver ratio measures how many ounces of silver are required to buy one ounce of gold. For instance, if gold is trading at $1,500 and silver is at $15, the gold-silver ratio is 100:1.

Historically, governments set this ratio. In the Roman Empire, the ratio was 12:1, and the U.S. government maintained a 15:1 ratio from the late 18th century until the early 20th century. This ratio can provide insights into when one metal is relatively over- or undervalued compared to the other.