Commodities Flashcards
The commodity market can be accessed in which two ways?
1) Direct
2) Indirect
What two ways can the direct commodities market be accessed?
1) Cash Market
2) Futures / Forwards
Direct market can mean taking delivery of the goods.
What costs must be paid if delivery of a commodity is taken
1) Storage Costs
2) Insurance of Goods
What way can direct access of commodity avoid taking delviery of goods?
Forward and futures contracts exited before expiry.
What are the benefits of direct commodity investment?
1) Portfolio Diversification
2) Inflation Hedge
What is a hard commodity?
Give two examples
Natural resources that must be mined or extracted
1) Metals
2) Crude Oil
What are the two categories of metals?
1) Base (Tin, Copper, Lead)
2) Precious (Gold, Silver, Platinum)
What are the two primary crude oil benchmarks?
Where are they traded?
1) Brent Crude - Traded on Ice
2) West Texas Intermediate - Traded on NYMEX
Oil tends to be the largest component of most commodity indexes
What are softs, and what are the 3 main categories?
Softs are argicultural commodities with a variety of uses.
1) Foodstuffs (Wheat, Soya, Sugar, Orange Juice, Rice etc)
2) Livestock (cattle, pigs)
3) Textiles (Cotton, Wool)
Who is the direct cash market suited for?
Suited for wholesale industrial buyers and producers.
Why is the direct cash market unsuitable for retail investors?
1) Large contract size
2) Potential deterioration of softs
When is delivery made on the cash market?
Immediately.
Payment also taken immediately (including storage / insurance)
For metals it is possible to store these at an approved warehouse by the LME.
Give 4 key features of the futures market / contracts:
1) Standardised quantity
2) Specified asset
3) Fixed future date
4) Price Agreed today
If a farmer no longer wishes to deliver their goods, how can they get out of a futures contract?
Undertake an equal and opposite trade
This is common, few contracts run through to physical delivery
Investors can also gain commodity exposure through forwards. How do these differ from futures?
1) Trade OTC
2) Bespoke / Customiseable
3) More counterparty risk
How do commodity swaps work?
Party 1 pays fixed leg (fixed price of commodity - hedge against price rises)
Party 2 pays a floating leg (floating rate of commodity - hedge against price falls)
Party 1 is a buyer of the commodity
Party 2 is a seller of the commodity
What ways can an investor indirectly invest in commodities
1) Shares of a commodity producers
2) Non-retail OEIC / UCITS (QI scheme)
3) Investment Trust
4) ETF
5) ETC
How to ETFs and ETCs differ?
ETFs can track a basket of commodities, futures contracts or company shares.
ETCs track the price of a single commodity.
ETCs allow access to hard to invest in commodities
One benefit and one risk of ETF/ETC
1) Liquid/Simple
2) Follow price falls in bear market
What are the advantages of indirect investment in commodities?
1) Liquidity of ETFs and ETCs
2) Low correlation to equities and bonds
3) Some funds can pay dividends
What indices are used to track comodity performance?
1) S&P GSCI
2) Bloomberg COmmodity Index
Commodities hedge against inflation
But can be volatile and cyclical. What effects commodity price/performance?
Supply and Demand - Influenced by:
1) Weather
2) Economy
3) OPEC
When can commodity performance be correlated with equities?
During downturns - as production / demand falls
What do base metal prices show?
Serve as a bellweather for economic performance/demand
due to their use in industrial production
When do base metals perform well and when do they perform poorly?
1) Perform well during booms / expansion (production increases)
2) Opposite in contraction (production falls)
When do precious metals perform well?
When needed as a safe haven asset (e.g. fall in USD)
Why are soft commodity prices more volatile?
1) Harvest quality
2) Disease
3) Good/bad weather
4) politcal / local factors
Investors need to bear in mind the short cyclical factors at work in agricultural commodities
What does Oil price fluctuate inversely with?
USD
e.g WTI rose to 110 and fell to 30 as dollar weakened then rallied
Give 2 examples of how demand affected oil price
1) Covid - WTI went negative
2) Russia / Ukraine - price rose as supply fell
