Trading Commodities

Commodity trading may prove very profitable if you can recognize and follow the long-term commodity cycles. 

1. Trading Oil Price Volatility

Historically, the price of oil moves in a wide price range from 30 to 150 U.S. dollars per barrel. The capital leverage taking place on derivative markets gives a good explanation for excessive short-term fluctuations in the oil price.

Two International Oil Types

There are two main types of oil:

1) Brent

Brent oil is a combination of 15 different types of oil. Brent is priced with a market premium of about $4-5 per barrel in comparison to Opec Basket's price (Opec Basket is mentioned later).

2) West Texas Intermediate (WTI)

WTI oil is characterized by high quality and, therefore, is mainly used for gasoline production. Historically, WTI is priced with a market premium of about $1-2 per barrel in comparison with Brent and $5-7 per barrel in comparison to the Open Basket.

How the Price of Oil is determined

There are three main ways to determine the price of oil: (a) NYMEX, (b) Opec price, and (c) Imported Refiner Acquisition Cost.

1. NYMEX Futures Price

2. The Opec Price (OPEC Basket)

3. US Imported Refiner Acquisition Cost (IRAC)

Methods to speculate on Oil Price fluctuations

1. Derivatives (Futures and Options contracts)
2. CFDs and CFDs on Futures (explained below)
3. Buying shares of Oil Companies
4. Buying an Oil Mutual Fund
5. Buying an Oil-Stock ETFs (Exchange Traded Funds)

► Basic Information About Oil Trading

Read more: Introduction to Commodity Trading

TRADING OIL

Historically, the price of Crude Oil moves in a wide price range from 30 to 150 U.S. dollars per barrel. The leverage of capital taking place on derivative markets gives a good explanation of excessive short-term fluctuations of the oil price.

Two International Oil Types

It is estimated that worldwide there are more than 160 different types of oil which differ qualitatively and therefore, they are priced differently. 

Internationally, two major types of oil are traded:

(1) Brent

Brent oil is a combination of 15 different types of oil. Brent is considered a high-quality oil and is used for gasoline production. Historically Brent is priced with a market premium of about $ 4 to $ 5 per barrel in comparison to Opec Basket price (Opec Basket is mentioned later).

(2) West Texas Intermediate (WTI)

WTI oil is characterized by high quality. therefore is mainly used for gasoline production. Historically, WTI is priced with a market premium of about $ 1 to $ 2 per barrel in comparison with Brent and $ 5 to $ 7 per barrel in comparison to the Open Basket.

How the Price of Oil is determined

There are three main ways to determine the price of oil: a) NYMEX price b) Opec Basket price c) US Imported Refiner Acquisition Cost.

1. NYMEX Futures Price

The NYMEX crude oil futures started trading in 1983. The NYMEX oil price is the most important and widely used method of reporting the price of oil worldwide. NYMEX Futures Price represents the value of a barrel of oil that will be purchased in the future. NYMEX futures as derivatives let investors bet in both directions (↑long and ↓short).

Read more: Information About Crude Oil Trading

A Historical View of the Price of Gold

The total amount of available gold in the world today is about 156,000 tons. Each year only 2,500 tons are mined from which the 2,000 tons are absorbed by the jewelry industry and the rest 500 tons are used as investment gold. As gold production is controlled and concentrated in a few countries -increased demand is often not satisfied by supply. Historically, gold was used as the world’s currency, and during periods of financial turmoil gold is considered by many investors as a “Safe Heaven”. During these periods the price of gold is making excessive upward movements without intermediate corrections. Investors’ psychology plays a huge role in gold price movements. Market psychology beats the laws of demand and supply. In 2009 (in the middle of the financial crisis) market demand for gold fell 32% while gold prices significantly increased.

J.P. Morgan said in 1912: "Gold is money, everything else is credit"

Precious Metals versus Industrial Metals

There are two main categories of metals, industrial metals, and precious metals. A key difference between these two categories is that precious metals do not react with oxygen while industrial metals do react with oxygen.

• The three major precious metals include gold, silver, and platinum
• The four major industrial metals include copper, aluminum, zinc, and lead

The price of industrial metals reflects the overall state of the world’s economy. The stronger the economy the higher the investment for building new houses and offices. The higher the expenditure for housing and infrastructure the higher the demand and prices of industrial metals.

Traders of industrial metals may use a simple technique to evaluate the real supply and demand for a particular industrial metal. The two major metal exchanges (COMEX/CME and LSE) offer information about warehouse supplies.

Therefore by examining the available stock:

(i) If the stock levels are higher then the demand is lower or the production is higher

(ii) If the stock levels are lower then the demand is higher or the production is lower

But as concerns precious metals this is not always the deal. Precious metals tend to trade within longer market cycles that usually last a decade. The precious metals are used as investment assets (35%) and as raw materials for jewelry (45%). The price of precious metals tends to peak during a financial or political crisis, wars, etc. Gold is seen by investors as a ‘safe-haven’ during an economic crisis.

Read more: Historical Price of Gold