Six things to consider when trading soft commodities
1 COMMODITY CATEGORIES
Though most spread betters of commodities tend to focus on the energy sector and on hard commodities such as gold and silver, you can also take a position on softs. Typically listed are: cocoa, coffee, corn, lean hogs, live cattle, oats, soy, wheat and sugar. Commodities are then often split into various grades, for example arabica and robusta coffee.
2 SUBSIDISING YOUR PROFITS
Political factors can greatly influence soft commodity prices. Grain subsidies in US states – as a way to sweeten a huge voting bloc ahead of an election in an agricultural state – can drive one price down at the expense of a less politically favoured commodity, as the policy creates an excess of supply and deflates the price.
3 PREPARE FOR THE UNEXPECTED
When it comes to commodities, it can be very difficult to trade using a system. Fibonacci retracement and bearish engulfing candlesticks don’t put up much of a fight when a harvest is wiped out by a drought. Non-quantifiable natural occurrences can side swipe grain prices – unfortunately, consuming pestilence and deadly plague cannot be expressed by a Greek letter in a pricing formula.
4 DOLLAR EXPOSURE
With the exception of London cocoa and UK soya, soft commodities are priced in dollars (bear in mind that there is also a dollar denominated US soybean). When you take a position on soft commodity prices, you are actually making two bets – one on the fortunes of that commodity and another on the US dollar. No matter if you have Duke and Duke-type insider knowledge of the US Department of Agriculture report on the Californian orange harvest, if the US dollar jumps one way or another it could turn a gain into a loss.
5 CONSUMPTION PUSH
With the world population increasing, growing soft commodity demand is a one-way bet. And with increases in demand outstripping advances in farming technology, prices in the long term are going to continue to rise – though this doesn’t mean that they won’t fall and rise in the short term. And as countries become more affluent, their consumption of red meat and cereals tends to rise. China, with an exploding population, has increased its meat consumption from 20 kilos per person per year in 1985 to more than 50 kg per person per year today. With 8 kilos of grain needed to produce one kilo of beef, the spike in grain demand is going to drive prices ever higher.
6 EQUITY ALTERNATIVES
For those who want to take a position on soft commodities without the direct exposure to the sometimes wild fluctuations in price, you can instead take a position on soft commodity-linked equities such as sugar refiner Tate and Lyle, and Sygenta, the world’s largest producer of commercial seeds. Another option is to gain exposure via the food manufacturing giants. If London cocoa prices go through the roof, then you can take a bet that Nestlé will feel the squeeze.
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