Chapter 12 - Commodity Trading

While commodities are not, strictly speaking, marketable securities, certain of them enjoy broad and active trading markets and have proved attractive media for speculation. Speculation is the word for it! The commodity market is no place for timid investors. You might think it would be unhandy to trade in bushels of wheat, bags of coffee, or bales of cotton. It would be! But you don't actually trade in the commodities themselves; you trade in "contracts" for them. No trader ever has to go down to a warehouse with a wheelbarrow or a truck to make or receive delivery. It's all done with pieces of paper (contracts) which may be bought and sold on exchanges, after the manner of stocks and bonds. Most of this trading is done on "margin," and commonly the margin requirement is only 10%. With $1,000 of your own money you can buy or sell $10,000 worth of contracts. The daily price swings are slight compared with those of stocks, but because of the leverage created by the 1 for 9 margin ratio, fantastic and swift swings are possible exciting gains or dismal losses all within a matter of days. This activity and volume in commodity markets and the hope of swift "killings" have attracted tens of thousands of small traders to this market arena, which, traditionally, has been reserved for bold big operators, and plungers.

Commodity Markets

What are these markets like? What are the contracts? And how do you proceed if you are daring or sporting enough to risk your dollars on such capricious elements as rainfall in Kansas or drought in Argentina?

Commodity markets are, like stock exchanges, auction markets and most transactions involve buying or selling of contracts for future delivery of the actual commodity. A contract of purchase may be liquidated prior to its maturity by selling a contract covering the same amount and grade of the commodity. A sale contract may be liquidated (offset) by buying an equivalent contract.

To make this clearer, we are going to tabulate the major market commodities and the customary quantities and terms under which some of them trade. The principally traded commodities are as follows: cotton, wheat, corn, oats, rye, barley, potatoes, flaxseed, soybeans, soybean oil, soybean meal, hides, wool, eggs, lard, onions, rubber, coffee, sugar, copper, tin, zinc, lead, cottonseed oil, cottonseed meal and, less broadly or actively, platinum and pepper. So you have a lot to choose from. We won't bore you with a complete list but the following will give you an idea about standard units of trading price swings and commissions charged.

                                 Permitted                Each point in                 Per contract   maximum          fluctuation amounts                     round- trip
                                 Contract Quantity   to per contract              commissions
                                 daily trading limit     between:
                                 of fluctuation          
Cotton                       100 bales               2¢        $       5.00     $45 and $58
                                 (50,000 lbs.)
Wheat                       5,000 bushels         20¢      $       6.25    $15 to $18
Potatoes                    36,000 lbs.             60¢      $       3.60    $20
Oats                          5,000 bushels         12¢      $       6.25     $15 to $18
Cotton
seed oil                      60,000 lbs.             2¢        $       6.00     $30 to $36
Raw sugar                 50 long tons
                                 (112,000 lbs.)        5¢        $       11.20   $25 to $45
Rubber                      10 long tons
                                 (22,400 lbs.)          4¢        $       2.24     $40 to 42.50
Copper                     50,000 lbs.             4¢                 $5.00   $50 to $52

Now with this background, turn to the commodity page of the Wall Street Journal and you’ll see 40 or more market results from the preceding day listed. You'll notice the agricultural crops all specify the month (in the future) when the commodity is due for delivery. In actual practice, people not only buy and sell specific contracts but they may "straddle" or arbitrage by buying for delivery in one month and selling for delivery in another month. They may do this in the same market, say, New York, or buy in New York and sell in Chicago or New Orleans. They do this to take advantage of a temporary price disparity between two delivery dates or the trading range in two different markets. Milling and baking companies frequently use commodity markets to hedge their inventory cost.

From the foregoing you can see that trading in commodities requires a considerable technical knowledge of the individual markets and great dexterity and swiftness in judgment. Further, the following of political, economic, and agricultural trends is important. For example, a bumper crop in wheat augurs lower prices; changes in the various crop support programs of our government have an influence; and overproduction, underproduction or "dumping" on the export markets by other countries must be considered. And, of course, wars and rumors of wars can make or lose commodity fortunes overnight. Contracts in rubber, tin, and pepper had fantastic moves as a result of Japanese aggression in the Far East.

Speculative Advantages of Commodity Trading

The advantages, for speculators, in commodity trading lie in low margin requirements, rapid market action, and a broad diversity of commodities and contracts from which to make selection. Commissions are quite reasonable, and there are no interest charges on margin accounts (there are in stock margin transactions). To engage in this trading, do business with a brokerage house of quality that has a well-staffed commodity trading department. The knowledge and judgment of your broker may prove of great value in guiding your commodity into profitable channels. There are a few areas of investment or speculation in which ignorance can be so costly.

Resume

1. Trading is done in contracts for future delivery; not in actual commodities.

2. Price swings are often swift and dramatic.

3. Operation on a 10% margin creates a terrific leverage whereby you may gain swiftly or lose spectacularly.

4. Commodity trading should be done with brokerage firms specializing in the business.

5. Commodity trading is an unsuitable arena for the timid, for uninformed, and income-minded investors. It's only for speculators with sporting blood.

Are You Ready To Move Onto The Next Lesson? Click Here...