We often hear about various stocks of companies bought and sold on the stock market, mutual fund schemes to invest in, investors dwelling into the future, and options contracts being created based on the stock’s share price. However, the market options are vast and extend beyond shares, mutual funds, and stock derivatives. Investors also trade in futures contracts whose underlying are tangible products such as cocoa, sugar, coffee, gold, oil, etc. Commodities form a vast market that investors trade in.
The commodity market is where natural products are bought, sold, or traded. It is divided into two types: hard commodities and soft commodities. Hard commodities include resources such as metal, oil, and rubber that need to be mined or extracted, while soft commodities include agriculture and livestock.
Let’s dive deep into this article to understand what soft commodities are, which are the most traded, where and how they are traded, and what makes the soft commodities market so big.
Soft commodity futures are an essential part of the futures market. A soft commodity is a futures contract where an underlying commodity is a group of agricultural products grown or livestock. Sugar, cocoa, soybean, rice, cotton, etc., are a part of products that form this group of agricultural products, while meat, live cattle, egg, feeder cattle, etc., form a part of livestock. Since such natural products have been available to humankind since the beginning, soft commodity contracts also happen to be one of the oldest traded futures in the world. Some traders often call soft commodities food and fibre commodities or tropical commodities.
Soft Commodity trading
Soft Commodities are traded in various ways on many exchanges. As the underlying in a soft commodity future is an actual grown product whose production can largely depend on environmental factors of a country, it can be more volatile.
For example, data presented in harvesting reports by the country’s agriculture and weather organisation can lead to a fluctuation in the prices of food grains and seeds, which can directly impact the contract prices according to delivery dates. Sometimes a bumper harvest can also lead to a fall in the crop price due to the surplus of the particular commodity in the market, affecting its future commodity contracts.
Soft commodity futures allow the producer to lock in the future price to avoid major volatility due to weather conditions, pathogens, or natural risks associated with farming or livestock. They make sure that the farmers or producers receive a proper fixed sales price when it’s selling time or time for harvest. It helps to limit the risk if there is a drop in price that particular season. These commodities also benefit speculators who tend to study future price movements of these commodities to invest accordingly to make profits.
Let’s look at an example to understand soft commodity trading
If a farmer understands and expects that there will be fluctuations in the price of the harvest during the crop harvesting season, he can choose to protect himself from that risk by entering into a futures contract and hedging his position in the market.
If he expected the prices to fall during crop harvesting, he could enter into a futures contract for a stated higher price according to the price decline he expects. On the set date, if the prices fall as he had anticipated, he will book profits in the future market due to the earlier set price, and he will be saved from suffering losses. If the prices do not decline but rather rise in the future market, he will suffer a loss. However, he can compensate for the loss by selling his harvest in the actual market at a higher price and regulating his losses.
Sugar Cocoa Coffee FCOJ Commodities Contracts
Soft commodity futures can be invested in through commodity funds in the form of commodity mutual funds or commodity exchange-traded funds (ETFs). It is essential to understand the commodity profile and how day trading in commodities is conducted before entering into contracts.
Since there is no exact classification of what comes under soft commodities, many alternatives have appeared within agricultural products and livestock. However, various exchanges consider certain fixed soft commodities that trade on their exchange. For example, only coffee, sugar, cotton, and cocoa futures are listed on the CME group, while the ICE futures U.S. also considers orange juice with more grains and other agricultural products on their exchange.
Coffee, cocoa, sugar, cotton, and orange juice are a few popular soft commodity contracts. Coffee involves creating long-term price cycles due to the five year duration required to cultivate it. Weather changes in Brazil impact coffee futures worldwide as Brazil is the largest producer of coffee in the world. The FCOJ Futures, ie. The frozen concentrated orange juice futures play an essential role in the soft futures commodity markets as they are widely consumed and have regular price movement.
At a global level, the world prices of soft commodities depend on the market’s emotions, climate changes, speculations, and demand and supply. This makes it important to enter into a commodity future contract after thoroughly understanding the underlying commodity and analyzing it’s historical trends. The good part is that it allows companies and producers to make better plans about their commodities and gives them the option to manage the risk associated with their produce. Hence there are many players in the commodity market with huge volumes constantly traded.
In fact, in 2021, soft commodity prices are reaching multi-year highs in their prices due to low production on a global scale. This occurred due to slow exports, cold frost, and supply shortages due to other bad weather. However, the prices are expected to collapse once the conditions are better as the market uncertainty is relatively high in this market.