Spread Betting on Commodities

Spread betting providers offer spread bets on a wide range of metals, oils and other commodities (oil and gold being the most popular). You can even spreadbet on the future price of soft commodites like coffee and soybeans in a very similar way that you can spreadbet on the future price of Crude Oil, Gold, the DOW..etc
Although the currency the commodities are traded in on the exchanges is fixed, when spread betting on commodities you trade in the currency that suits you - for instance you can bet Pounds per unit, Euros per unit or Dollars per unit.
Spread bets on commodities futures follow the same characteristics as future bets on indices with one notable difference - the months quoted do not normally follow the more traditional quarterly cycle, i.e. March, June, September and December, this is because spread betting providers make extensive use of hedging but do not want to take delivery of the underlying assets so the spread betting contracts are settled well in advance of the delivery date to allow the providers to unwind any hedging positions before the expiry date gets too close. This means, for instance that a spread bet on July Robusta Coffee at IG Index would actually close on the last business day of June.
Oil and gold trading, although most popular aren't the only commodity markets available - in fact currently spread betting providers make more than 40 other commodity markets available for their clients. The more popular markets tend to be the ones regularly in the news, so the energy markets like oil, natural gas and heating oil tend to be popular as these have a direct effect on the consumer. For example, cocoa has been in the news recently because of the prospect of a bad harvest in West Africa, driving the price to a 33 year high!
Amongst soft commodities, spread bets are offered on soyabeans, cocoa, coffee, sugar, cattle, hogs, pork bellies, orange juice, cotton, wheat, oats, corn, lumber and even potatoes. Commodity spread bets are also offered on silver, platinum, palladium, copper, aluminium, lead, nickel, zin, tin and natural gas. Some betting providers even offer spread betting contracts on the price of exchange-traded commodities or commodity baskets such as ETFS Grains, which are listed on the LSE or the ETFS Agricultural, which follows the Dow Jones Agricultural Index.
When spread betting on the future price of soft commodities the settlement date of your futures trade is normally in 1-3 months. Example for wheat the settlement months are listed as March, May, July, September and December. The Wheat September market closed on 20 August and the Wheat December market closes on 19 November.
Commodities have a tendency to remain quite static over time, and then just when you were getting bored at the whole static nature of them, there are sudden price swings. This is because there is a limited amount of any commodity to readily deliver in the short-term, and especially in agricultural production supply cannot be turned on or off like a tap. This means that lead times can extend to 12 months or more, and crops especially are always vulnerable to disease or bad weather.
A problem with holding futures is the risk of getting locked into 'limit down' and not being able to sell. There is a horror story by one of the traders in Market Wizards where he lost a fortune not being able to sell a position for several days. Limit Up or Limit Down is the maximum that the exchange will allow in the price movement on any one day. It's a rare situation where you find you can't buy or sell for one or more days whilst the price rockets up or down. It is usually about 6% a day but can vary. In the case of a future spreadbet where you are short of a commodity and the price goes limit up, whereby you cannot buy the commodity, you will not be able to close your position until the market is no longer limit up and therefore tradeable. Spread betting companies have to replicate what happens in the underlying and if the offer is not tradeable they can not open any buy positions for clients or close short positions. Recently, Corn and Wheat went Limit UP at the announcement of USA harvest reduction forecasts. The price went up 6% which meant buying had to stop. There is a good chance after a Limit Up day that it will be followed by a strong trend. There is plenty of information if you google 'futures limit up'. In the meantime Corn and Wheat look set to continue.
Betting on commodities is not for the uninformed as the markets are very technically driven; and most of the time the news follows the price - to be successful you need to follow trends and use the financial newspapers, magazines, newsletters and websites to keep up-to-date. Check out how the commodity you're interested in has trended over the years - price changes are often cyclical. The Commodity Research Bureau (CRB) of Chicago publishes the most detailed information on commodity prices. It covers the world's major markets, London and Chicago, and is quoted in US dollars. In general terms future market prices for commodities depend on:
- Future Demand: Undoubtedly the most important variable to keep in mind when predicting future commodity prices. Anticipate this correctly and you will predict whether the price for your chosen commodity will fall or rise, and how quickly or slowly. Demand can depend on factors such as season, taste, how fashionable or unfashionable a product becomes and new technologies which require larger supplies of certain commodities while making other commodities less sought after or even redundant.
- Booms and Recessions: The nations of the world usually go through boom and recession on a cyclical basis. The important thing to remember is that commodity prices usually lag the peaks and troughs of booms and recessions, unlike share prices which usually precede them.
- Natural Disasters and Wars: Natural Disasters and Wars may restrict the supply of commodities in specific regions of the world. Although relatively difficult to predict, a natural disaster occurring or mere rumour of a war can cause commodity prices to rise even if the supply of the commodity is not affected.
- Exchange Rates: Most commodities are bought and sold worldwide in US dollars. If you are betting in any other currency a change in the exchange rate can affect the price independently of any other factor. All other things being equal if the Dollar goes down in value against the Euro, commodity prices (quoted in Dollars) will go up and vice versa. This also means that interest rate changes will also have a knock-on effect - when in 2008 the United States was lowering interest rates causing the Dollar to weaken, this pushed up the price of the commodities that were priced in USD.
If the world's population continues at its current rate of growth it is predicted to rise from 7 billion to 8 billion by 2030 and more than 9 billion by 2050. This by its very nature is continuing to put pressure on world food production supplies. The demand for commodities is also being boosted by the emergence of economic giants such as China and India. For instance demand for goods is growing at approximately 3.5% a year but the supply of land is rising by just 1%. Crop demand is being driven by a rising global population, biofuel demand and changes in diet. Currently an average person in Brazil, Russia, India and China still consumes less than a third as much meat as someone in the United States. This gap is likely to narrow in future with pork imports in China being up by an estimated 130% year on-year. Also, as consumers in emerging economies eat more meat and dairy, livestock also takes up more land than grain - arable land that by the very limitations of world land mass is a finite resource. Industrial commodities demand also remain strong with India following China's lead with infrastructure investments.
Soft commodities like rice, grain, corn and soybeans have risen steeply in price in the last year or so due to rapidly growing demand - especially from China and India. The problem is so serious that leading rice exporters, including India, Vietnam, China and Cambodia, have imposed bans on foreign exports in recent months.
The most actively traded contract is Brent crude which trades on London's International Petroleum Exchange and acts as the benchmark price for around two-thirds of the world's internationally traded crude oil. The weather can also have an impact on the oil price, at least in the short-term. For instance persistent cold weather across Europe or the US can boost demand and push prices higher.
Lower liquidity can make certain soft commodities particularly more expensive to trade than other markets like forex or index trading. For instance, the spread on euro-dollar could be two pips with a spread bet, however on agricultural commodities the spread could be $3 (say 612.40 to buy 609.40 to sell). This means that you would need the market to move a full $3 in your predicted direction before you are just breaking even. Novices would do best to steer clear from these markets.
Prices for industrial commodities tend to be less volatile than for softer commodities (less prone to sudden wild moves) but there can still be significant short-term moves, for instance if a war or an industrial dispute breaks out.
Commodity prices are also widely affected by the price of oil as a high oil price will result in increased transport and energy costs. Another factor to keep in mind are political policies that may force or encourage farms to grow certain types of crop.
Make sure you understand the markets you're dealing in and don't go buying Brent crude in April just because summer's coming and demand for heating oil is likely to fall - as this is usually already factored in the price. Also, unlike the FTSE or Dow which you can translate in spread betting points, in commodities a point or a tick may not be a 1 point - for instance corn trades by the bushel, natural gas in 5 decimal places and so forth. Keep also in mind that there are two opening times for some of the soft commodities. The CBOT market opens electronically at 2:14 and at 2:40 for pit traders.
Beware the effects of interest rates and exchange rates when trading commodities - for instance when in 2008 Uncle Sam lowered interest rates in the USA this naturally caused the Dollar to weaken. Because most soft commodities are traded in US Dollars this had a knock on effect on commodity prices which were driven up. Soft futures prices are also affected by the exchange rates. All other things being equal, if the Dollar goes down against the Euro, the commodities price (in Dollars) will go up and vice versa. This is not always guaranteed but it is an important correlation to take into account.
I have recently had a re-read of Taming the Lion by Richard Farleigh (the Aussie former hedge fund manager & ex Dragons Den). He says that commodities fall as rates fall and rise as rates rise. Presumably if rates are held low then commodities will bounce along the floor. That ties in with why in recessions all commodites fall into the recession and rise coming out of recession. The exception from my own research is gold. Gold falls into the recession but rises before the bottom and continues into a bubble with the usual ups and downs. The reasons for the bubble mania are fairly obvious - fear of capital depreciation, something rising when all around are falling and finally the world and his wife jump in just before the peak as we come out of recession.
Try to anticipate the unexpected. After the 9/11 attacks, for example, all traders were left thinking: 'What else can happen that can affect the markets like this?' There is no easy answer. However, you must try to be aware of what can happen in the market and how it would affect your bottom line. Minerals sourced in developing and unstable countries in Africa, Asia and the Middle East are prone to disruptions including strikes, wars and political coups. All of these can represent a great opportunity to those traders prepared to keep a close eye on current affairs in order to try and anticipate the next shortage and then get in at the bottom of the market, ready for the swift ride to the top before disembarking double quick.
Spread betting firms hedge extensively in the underlying futures markets in order to cover their exposure on the bets they take, but obviously do not want to take delivery of platinum or oil, for instance. For this reason, bets on futures that have physical delivery are always settled well in advance of the delivery date. This means that a bet on, say, December Silver might expire in November rather than in December.

>> Seasonality and how it Affects Commodities

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