Commodity trading fundamentals
The history of commodity trading is very old. Commodity trading was prevalent much before trading of financial products started. The development of agriculture resulted in the formation of the commodity market.
To contain the price volatility of the commodity market, the concept of ‘forward contract’ evolved. In a forward contract, the buyer and the seller finalize the price of the asset at a future date. Through the contract, both parties neutralize the price fluctuation till the date of expiry of the contract. The settlement between the buyer and the seller takes place on the expiry date of the contract.
A forward contract is a private contract between two parties. An obvious drawback of such a contract is counterparty risk. As it is a private contract, it can’t be accessed by retail investors through online trading.
The scope of commodity trading was broadened by the concept of ‘futures contract.’ In a futures contract, the counterparty risk is guaranteed by the clearinghouses of the exchanges. Unlike a forward contract, a futures contract is settled daily. These contracts are available to retail investors for online trading. The commodity option is another advance tool of online trading.
Traded Commodities
Various agricultural, energy, metal, and agricultural commodities are widely traded in commodity exchanges. Oil is the highest traded commodity in the world. Gold and silver are also two popular commodities by trading volume.
Gold Trading
Gold is categorized as a precious metal. It has been a popular trading commodity. Gold was used as money in the past. Due to its unique characteristics, gold is also traded like other securities by way of gold exchange-traded products such as exchange-traded funds and exchange-traded notes. The volatility of the gold price is largely due to sentiment and not due to demand and supply variations.
2020 was an unprecedented year. There was Covid-19 scare, despair, and also hopes of recovery. In April 2020, oil prices fell to a record low. This was due to demand contraction caused by lockdowns. Throughout the year, gold consumption demand was low. Gold supply also fell sharply. However, demand started to pick up as the year progressed. Bar and coin investment grew by over 3% from the 2019 level. The total global gold investment was higher by 40% over the 2019 figure. Gold-backed exchange-traded funds recorded high inflows in 2020. Investor preference for gold led to price rise. Price rise accelerated gold investments further. The factors that positively impacted gold investment in 2020 were the risky business environment, low-interest rate, and price rise in the later part of the year.
In the Indian commodity exchange MCX, gold futures rose by 43% in 2020. In the volatile year, gold futures were considered safe by Indian investors. In INR terms, gold prices appreciated by 20% in 2020. But in March 2020, gold prices hit seven months low.
Analysts are optimistic about the performance of gold in 2021 but not expecting the same performance as in 2020. In November 2020, there was a correction in gold prices. This was due to profit-taking and vaccine hopes. If in 2021, vaccination progresses fast and the situation turns normal, investors may switch to riskier assets. This will adversely impact the gold price. The factors that will positively impact the gold price are inflation, lower interest rates, and depreciation of USD. Gold online trading may be a good investment option for 2021.
Silver Trading
Silver is another precious metal commodity. Silver is used in making jewelry. It also has industrial and scientific applications. Similar to gold, silver is a good investment option when there are political unrest and inflation. Under such circumstances, investing in other assets becomes riskier. Silver production and supply position is declining in recent years. This is another positive factor for silver trading. A rise in industrial activities also raises the silver price.
Like gold, silver did a stellar performance in 2020. Covid-19 created economic condition made silver a safe investment option. Later in the year, increasing industrial activities also raised silver demand.
In India, the silver price went up by almost 50% during 2020. India is an importer of silver. The industrial application of silver is going up in India. Silver is likely to remain a very attractive investment proposition in India.
Silver is likely to perform well in 2021 and beyond. The new US administration is set to encourage green technologies. Silver has significant applications in green energy products. This is likely to increase silver demand. Likely depreciation of USD will help silver price to move up.
Analysts find that Gold and silver make similar moves in the commodity market. However, silver is linked to the industrial market. Industrial activity in China directly impacts silver. No such link exists for gold.
You may refer to iFOREX to know more about gold and silver trading.