Archive | March, 2013

How Commodity Trading Works?

23 Mar


Do you think gold prices will go up further?

Are you sure that crude oil prices are going to fall?

Have you heard that the soya crop this year is bad and will result in soya prices going up?

If you believe that these predictions have a good chance of coming true and are willing to bet some money on them, you could try your hand at playing the commodity futures market.

The commodity markets have changed a lot from the poky, little hole-in-the-wall trading offices in narrow streets next to crowded markets where traditional dhoti-clad merchants used to trade.

Brand new commodities exchanges—the main ones are NCDEX and MCX—have been set up and these are fully computerised.

More and more stock brokers are setting up commodity brokerages as well, and trading volumes in commodity futures is widely predicted to rival the volume of derivative transactions (futures and options) on the stock exchanges.

What’s more, you can also trade online.

 Why commodities trading?

Well, let’s suppose you want to buy gold because you believe that the price of gold will rise.

You could then buy gold ingots, store them, wait for them to go up in price, and then sell them at a profit.

But, you have to be sure that the gold you buy is pure, you have to find a place to store it, you have to provide the security, transport it to vault and other such hassles.

A far better way to invest in gold would be to buy gold futures from the commodities exchange.

How do you do that?

When you buy a Gold Futures contract, you undertake to do three things.

1. Buy the amount of gold specified in the contract.

2. Buy it at the price specified in the contract.

3. Buy it on the expiry of the contract. This could be after one month, two months, three months and so on. Of course, if you sell the Gold Futures contract before it expires, then you don’t have to worry about actually buying the gold.

Let’s say you buy the Gold Future contract at say Rs 7,200 per 10 gm.

Your hunch comes true and the gold prices rally to Rs 8,000 per 10 gm.

You can sell the Gold Futures any time before expiry of the contract.

Gold and other commodity futures prices are quoted on the commodity exchanges in exactly the same way in which stock prices or stock futures prices are quoted on a daily basis in the stock markets.

How it works

When you buy a Futures, you don’t have to pay the entire amount, just a fixed percentage of the cost. This is known as the margin.

Let’s say you are buying a Gold Futures contract. The minimum contract size for a gold future is 100 gms. 100 gms of gold may be worth Rs 72,000.

The margin for gold set by MCX is 3.5%. So you only end up paying Rs 2,520.

The low margin means that you can buy futures representing a large amount of gold by paying only a fraction of the price.

So you bought the Gold Futures contract when it was Rs 72,000 per 100 gms.

The next day, the price of gold rose to Rs 73,000 per 100 gms.
Rs 1,000 (Rs 73,000 – Rs 72,000) will be credited to your account.

The following day, the price dips to Rs 72,500.
Rs 500 will get debited from your account (Rs 73,000 – Rs 72,500).

What you need to know

Compared to stocks, trading in commodities is much cheaper, because margins are much lower than in stock futures.

Brokerage is low for commodity futures. It ranges from 0.05% to 0.12%.

Because of this, commodity futures are a speculator’s paradise.

If you are a hard-core trader who follows the technical charts and do not really care what you trade, and if you are nimble and savvy, then commodity futures could be another asset class that you would be interested in.

The advantages in this line is that there are no balance sheets, no complicated financial statements—-all you have to do is follow the supply and demand position of the commodities you trade in very closely.

Go onto the commodities trading exchange – NCDEX and MCX – to see which commodities are offered for trading, their contract size and other criteria. You will have to get hold of a commodities broker but that should not be a problem. There are lots of brokers that offer commodity trading these days.

But, it would be wise to avoid commodity trading if you are a rookie. A better move would be to initially trade in stock futures before opting for commodity futures.

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Commodities Should Rise on Low Prices & Dollar’s Decline

22 Mar

Will the government soon collapse under its debts? Will Inflation take off? What events might affect our investments in the near future? How should we react to these risks?

Rick Rule, Chairman and Founder of Sprott Global Resource Investments Ltd., says that most market participants unwittingly consign themselves to failure, because they fail to critically analyze their own investment decision processes.

Rick explains, “Most market decisions are made with an expectation in mind of something to come in the future, but things may turn out differently from what we expect. Too many investors fall victim to wishful thinking. Properly evaluating outcomes and their probabilities will help you become a better investor and improve your performance.”

“Speculating on the events that are certain or almost certain to occur is almost always more profitable than gambling on a long-shot, unlikely occurrence,” he says. “Make investments based on unlikely scenarios only when the potential risks and rewards are disproportionately in your own favor and you can afford the loss that you may incur.”

So what scenarios are Rick and his team preparing for? What are his investment expectations?  He outlined specific scenarios that he foresees.

The debasement of the US dollar, says Rick, is a near-certainty. “It appears very unlikely that our society can sustain its level of consumption with its current level of disinvestment. The U.S. federal debt exceeds 16 trillion dollars and off-balance sheet liabilities exceed 60 trillion dollars, while our annual on-balance sheet budget deficit exceeds 1.5 trillion dollars, half of which we borrow and the other half of which we counterfeit by printing. So the government is attempting to service 76 trillion dollars in debt with just 2.5 trillion in revenue, while spending 3.6 trillion annually.”

In order to avoid a default, says Rick, the Fed will likely continue to debase the currency so that the government can repay its debts at lower cost.

This leads Rick to conclude a second scenario.  Because Rick projects that currencies will progress on this path of devaluation, he continues to view real assets as one of few ways to play defensively.

Commodities Prices high, even in the face of a very soft economy:

“Look at the escalation in commodities prices, even in the face of a very soft economy. The pricing numerator is less important, when the denominator – the U.S. dollar – is falling.”

Rick reminded me that prices are cyclical in the natural resource market. “Resource and commodity markets are cyclical, capital intensive and volatile,” he explains. “These characteristics are often inconvenient and frequently unnerving, but outcomes are often broadly predictable, though not necessarily the timing.”

He continues: “In natural resources, markets tend to work, and periods of low prices give way to periods of high prices, and vice versa. Low prices — as, for instance, uranium and natural gas are experiencing now — stimulate demand and constrain supply. Demand goes up because the utility of the commodity to users increases, and conservation and substitution go down. Low prices encourage fabrication methods to adapt by substituting the cheaper energy sources to a greater extent. Rick says that natural gas is so low-priced now relative to other energy sources that supply will come under pressure: “At today’s prices, producers of natural gas in the U.S. and Canada are often neither earning their cost of capital nor covering their operating costs. These producers are therefore unlikely to spend billions of dollars developing new supplies, and may shutter their projects entirely.”

The turnaround may occur gradually, he explains: “This process takes time, because producers will continue to extract gas even at low prices in an attempt to recover the capital already invested in productive capacity, producing down to or below their costs of production.”

Once you outline your expectations, and then deduce the probability of their occurrence and the reward you would expect to receive, you can guide your investment decisions with much less emotion and with much more success.

Get accurate commodity trading tips by share tips expert.

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