If you’re an investor, you’ve almost certainly heard of both commodities and commodities futures. These closely related trading assets offer great options for people looking to diversify outside of traditional stocks and bonds. Some people also prefer trading in commodities. That’s because instead of having to know the inside and out of individual companies, commodities traders can focus on larger trends. In some ways, this makes them a bit easier to trade.
So what are commodity futures? When you’re trying to figure out what a financial term means, it often helps to break the term down. This doesn’t work all the time, but it does work most of the time. And when it comes to commodities futures, it’s a very helpful method.
What is a commodity?
A commodity is something that can be bought and sold in bulk, and in which individual units of the same grade are essentially interchangeable. Even if this term sounds confusing, it’ll make sense, so bear with us. Commodities are something we are all familiar with, but they can be a bit tricky to describe and recognize.
Oil is an example of a commodity. One barrel of Brent crude oil is the same as another barrel of Brent crude, at least as far as traders are concerned. Rice of the same quality and type are also interchangeable. So too are bushels of wheat and corn. Gold is another example of a commodity. One ounce of pure gold is worth pretty much the same as another ounce of gold (there are some slight variations in grade and other things when it comes to gold).
So what then is a future?
Now let’s look at the term “futures.” These very specific contracts may not be familiar to you unless you are familiar with the investing field and futures specifically. A future is a type of contract. It bounds buyers and sellers to a very specific set of actions that must be carried out. As you have probably guessed, the “future” has something to do with these contracts.
Basically, a buyer and seller will get together and agree upon the price for a commodity, but the actual exchange of the commodity will not happen until some point in the future. The money, however, will be exchanged right away. So a food processor could buy corn from a farmer with a delivery date set for six months from now. The processor would give the farmer money in the present.
Current prices do not set future prices. Speculation becomes involved with both the buyer and seller trying to determine what the commodity will be worth in the future. This speculation is one of the key reasons futures make an attractive investment. Where there is speculation there is an opportunity to make money, and also to lose money.
Understanding and researching commodities futures
Bloomberg Commodities Futures
There are a lot of resources out there that you can use to look up information based on commodities. For example, Bloomberg commodities futures is a great place to start. Bloomberg’s website offers a lot of powerful tools, charts, and data regarding futures. Make sure you check it out! If the site seems difficult to use at first, don’t sweat it, keep practicing and eventually things will start to make more sense.
Commodities Futures Trading Commission
You can also head to the website of the commodities futures trading commission. This commission is very important for commodities trading, providing oversight for commodity trading markets. Any decision or action taken by the organization will, of course, have a big impact on the commodity futures market.
Commodities Futures Modernization Act
The commodities futures modernization act is also important to understand. This bill, which was signed into law by then President Bill Clinton back in 2000, helped modernize the futures industry, and also provide regulation for over-the-counter derivatives, of which futures based on commodities are a subset.
Some of the over-the-counter derivatives that were considered under the bill, such as credit default swaps, have been linked to the financial crisis of 2007-2009. You shouldn’t confuse these OTC instruments as future commodities, however. While these different instruments are somewhat related (think of them as distant cousins), they are not one and the same. Futures commodities are not necessarily high risk, especially when it comes to systemic forces. All futures are speculative, of course, but it’s highly unlikely that commodity future contracts will be destabilizing global markets any time soon.
When it comes to investing in futures, commodities are certainly worth a look. Just keep your eyes on major trends and, of course, the future! As with all investments, before jumping in you should do some research. You’re off too a great start having read this article, but work remains to be done. Make sure you check out our other articles on futures, and do some more homework before jumping in.