If one asset class has caught the full force of money printing by central banks, it's commodities. Global recessions notwithstanding, some parts of the market have been on fire. Take silver. It's a useful industrial metal and it's a decent enough poor man's alternative to gold as a safe haven. But is that enough to explain a price rise from $13 an ounce before the credit crunch to above $40? Hot money has undoubtedly helped.
And silver is not alone. Across the board, commodities continue to surge corn hit a near-three-year high recently and pulled wheat with it. Meanwhile, a MoneyWeek favourite gold still trades near record highs of more than $1,400 an ounce. That's about five times the price at which Gordon Brown sold off half the UK's reserves just after he became chancellor under Tony Blair. As for oil jitters over civil unrest and outright war have helped keep the price up at around $120 per barrel (depending on which measure you use).
We are not suggesting that all commodities are a one-way bet. When quantitative easing (QE) ends, for example, a good deal of money may flow out again. However, for many spread betters, this is a market whether betting long or short that offers great variety and the chance to make money. And with spread bets you can take a view without ever having to worry about the hassles of owning a commodity. These include storage costs and insurance, not to mention the fact that some mainly the 'softs' can perish. So far so good. But watch out overconfidence can be costly.
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Here are the key quirks for anyone considering playing this market.
Volatility
Commodities markets can be less than opaque. Take the silver market it's tiny (even compared to gold, which isn't a huge market itself), so big moves from key players can have a dramatic impact on the price. If, for example, the likes of George Soros or Warren Buffett ever give a view on silver, watch out. Back in the 1970s two brothers even tried albeit unsuccessfully to corner the entire global market. So, although we like silver, as a novice be aware that you can get burned fast playing any commodity you don't understand.
Multiple factors affect the price
Commodities such as corn are directly affected by a vast range of supply and demand factors in a way that, say, Tesco shares are not. Many are difficult to predict and price in. For example, there's the weather a sudden flood or drought can cause short-term chaos. Then there's politics decisions about corn-based ethanol quotas taken in Washington affect the global market.
And while Tesco shares do not perish, corn does. So the location and security of large corn supplies is another key factor, as is the availability of substitutes. Then there's the harvesting issue. Most US corn is planted in April and May and then harvested in October and November. That means prices tend to most volatile in the intervening months. Again, not something a share investor would usually lose much sleep over.
So, while most investors would reckon at first glance that they understand the underlying product how complicated can corn and wheat be? judging where the price is headed is a whole different problem. In short, you need to do your homework to get good in this market. That's why many commodities investors are trend-followers they look for a rising, or falling, trend, and follow it. That way you don't have to be a corn expert, but you do need to be able to read price charts.
Contracts can be complex
Getting bet sizes right in the commodities market requires care. It's sometimes not as simple as betting on, say, the direction of the FTSE 100, where it's obvious how much you'll win or lose if the market rises or falls by a certain amount. So before placing a commodities bet make sure you understand how profits and losses are calculated. For example, corn is traded by the bushel, oil by the barrel, gold by the ounce and so on.
Also bear in mind that standard contracts may not expire at the end of the standard quarterly months of March, June, September and December. And because traders want to get out of having to make or take delivery of a commodity when a contract expires, the last trading date for a spread better may come sooner than you think. For example, a spread bet on July Robusta coffee would close at the end of June while a bet on December wheat closes mid-November. If this sounds fiddly that's because it is!
There may be more than one option
Oil is a good example. If you phone your broker and say you want to go 'long oil', you will be asked which type. For example, do you mean Brent Crude or West Texan Intermediate? They are different. And indeed the prices for the two have been so different recently that some traders place bets on the gap between the two either closing ('narrowing') or widening further. This is known as a 'spread' or 'pairs' trade.
None of this should put you off commodities as a spread better, but do make sure you understand the pitfalls before jumping in. At MoneyWeek we are fans of both gold and silver in particular. Both can be played through most major brokers.
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