Introduction

In the economic market, commodities are essentially the raw materials that are used to make refined goods. Traders come together to buy and sell commodities such as metals, agricultural goods, petroleum on the commodity exchanges. The aim is to generate profit through the trade of such commodities, and commodity trading is steadily gaining recognition for the certain features and benefits it carries. One of the biggest plus points of commodity trading is that it acts as a hedge against inflation. Read on to know more about how to trade in the commodity market, and how to trade commodities during inflation.

What is commodity trading?

Commodity trading is simply the act of buying and selling commodities in the market. While it may entail physical trades too, it generally takes place in the form of futures contracts. Futures contracts are agreements that assure that a certain commodity will be bought or sold for a particular price at a predetermined date. Traders who work with futures contracts then attempt to bet on the commodity’s price movements. If the price seems to indicate an upward movement, traders purchase futures, and if they seem to indicate downward movement, they sell futures. This is also known as going long or going short, respectively. Futures contracts are often used by major consumers as a tool to hedge against price movements. Such trading takes place on exchanges such as the National Commodity and Derivatives Exchange.

How to trade commodities?

Traders have a few different methods to choose from when it comes to commodity trading:

Commodities Futures: Buying and selling contracts on exchanges on the basis of the commodity’s future price. A brokerage account is required for this.

Physical trading:Some may be physical purchases such as silver and gold in the form of jewellery, coins, bars. This is only a good approach for commodities that are very high in value.

Commodity Stocks: You can also invest in stocks offered by companies that operate in commodities; for example, stocks of an oil refinery or agricultural business. This can be less risky than directly betting on commodity prices.

Mutual funds, Commodity ETFs and ETNs:Commodity exchange-traded funds (ETFs),  exchange-traded notes (ETNs) and commodity-based mutual funds are also commodity sector investment options.

Managed futures, Commodity Pools: These are basically private funds that focus on commodity investment but they are not public and traders have to be approved in order to invest. The potential returns, as well as management costs, may be higher.

How does commodity trading act as a hedge against inflation?

Commodity prices tend to go up when inflation is on the rise, thereby protecting investors and traders from the direct impact of inflation. Generally, inflation in the market is not considered good news, but commodities tend to benefit from it. With an increase in demand for goods or services, their prices rise, as do the prices of the commodities that are utilized to provide those goods and services. This leads to futures markets seeing continuous auctions, and they essentially become clearinghouses for the supply and demand updates.

How to trade commodities during inflation?

Due to the aforementioned reasons, commodities have been a reliable investment during inflation. In times of inflation, prices of commodities such as agricultural goods, metals, energy, all tend to rise as the related goods and services see a price increase. Investing or trading in a variety of commodities is better than relying on one single asset, as it gives you a better chance of benefiting from inflationary periods. As a trader dealing in futures, it is necessary to identify the type of inflation. In the case of monetary inflation, certain indicators and markets need to be observed closely in order to handle certain turns in the way inflation progresses.

Inflation can be broken down as a decrease in purchasing power as a result of a rise in the average price of a particular good or set of goods. The three main types are:

Cost-push inflation:

Production or input costs are carried over to finished consumer goods costs.

Demand-pull inflation:

The demand for goods and services is greater than the supply of those goods and services.

Built-in inflation:

Wages are increased due to an increase in the cost of living.

As long as the supply of a certain commodity that is high in demand remains scarce, its price will stay high or keep increasing as the supply dwindles further. Supply chain inflation can be quite unpredictable, but also may not cause long-lasting impacts.

However, monetary inflation that is longer term, can lead to long-lasting crushing effects on the economy. Here is where commodities can protect traders; precious metals like silver or gold are two traditional commodities that are used as hedges against inflation. This is because a metal like gold is still a monetary metal – it is essentially money. Meanwhile, not only is silver also a precious metal, it is also an integral component of modern technology for solar and renewable energy.

Conclusion:

Commodities can help with portfolio diversification and provide investors and traders protection against events like inflation. Commodity trading can bring in potentially high rewards, but it also involves high risk. It is crucial to have a solid understanding of how the commodity market dynamics or supply and demand, as well as inflation, operate. Research, as always, is an absolute must, along with caution and patience. With time and experience, you can build a portfolio with wisely chosen asset classes that can get you the returns you desire.