How to play a commodity spike

The Federal Reserve's pumping of another $600bn into the US economy could lead to a spike in the already red-hot commodities markets. Here's how to play it via spread betting.

So QE2 has finally been launched. The US Federal Reserve has just decided to pump an extra $600bn into the US economy in the hope of stimulating growth.

In an ideal world, the Fed hopes to buy assets from commercial banks in return for cash. The knock on effect is then supposed to be that those same banks will use that extra cash to help support businesses and individuals with new loans.

Trouble is, the best laid plans can go wrong, even when the planners work for the Fed.

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That's because the banks that receive all this cash the 'primary dealers' as they are known in the US, which include the likes of Goldman Sachs, Cantor Fitzgerald and Morgan Stanley have a choice. Sure, they can choose to lend fresh dollars to needy firms and individuals. But they may not. They might choose to speculate with it instead.

And one likely target is the already red-hot commodities markets. And it's not just speculative money that's headed that way. As the Fed creates more and more dollars electronically, many investors are getting nervous about the prospect of an outright dollar crash. Hard assets such as gold are very appealing as a hedge against just such a catastrophe.

For spread betters, QE2 therefore presents opportunities. Despite the best efforts of the Fed, quite a bit of new money is likely to leak into the commodities markets. Nervous investors will ensure more follows. And these days many spread betting firms offer the chance to place bets on the direction of a huge range of them.

A word of caution though for wannabe commodity punters make sure you get to grips with contract specifications and sizes in the commodities markets so you understand exactly how profits and losses may pan out as prices move. Also, since commodities are notoriously volatile short-term, make sure you use stop losses to limit the damage should a bet backfire.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.