Before we go into any real knowledge on commodity trading, we feel it would be best to cover the basics of it first. It’s important to note that, as with any financial trading, commodity trading is an investment that can lose as well as make money. It’s important to have a good grounding in the subject so that you can make the best decisions for your wealth.
What are commodities?
Classic Economic theory normally breaks economic activity (whether private or public) down into three sectors:
- Primary Sector: Taking or producing raw materials to be used in other industries/products/services. I.E. Mining Gold, breeding horses, growing Cocoa. These are commodities for the sake of economic trading.
- Secondary Sector: Generally the same as manufacturing, takes the materials created from the Primary Sector – commodities – and uses them to produce finished goods. These goods are used for other businesses, for export, or for sale to domestic consumers. I.E. Building a ship from metal, or a desk from wood. This is further categorized into Light Industry and Heavy Industry, though we won’t break down into those here.
- Tertiary Sector: Generally called the Service Sector. This regards the supply of services to businesses and consumers in an economy. I.E. Bartending, Nannying, Banking. This normally uses products from the Secondary Sector to support its trading.
All three of these sectors support and require each other. If one of them were to start failing, the other two would begin to suffer as a result. e.g. if consumers were to suddenly stop eating beef, this means that not only would the butchering industry take a hit – affecting the Tertiary Sector, but also cow husbandry would be much less called-for, causing farmers to lose money and specific beef farmers to be left without a livelyhood – affecting the primary sector.
Modern economic theorists however, have begun to include the use of two other sectors:
- Quartenary Sector: “The knowledge industry”. This is based entirely on knowledge and skills – human-based resources. i.e. Government, Culture, Consultancy, R&D, Education, ICT etc.
- Quinary Sector: “The Executive Industry”. This is the sector of economy where top-level decisions are made by government, executives in companies, industry, media, non-profit and other industries – leadership of the Quartenary sector – that will affect the economy as a whole.
What is commodity trading?
Commodity trading is trading on the financial markets of primary economic sector products – meaning raw materials. These are split into two groups:
- Hard commodity trading – Materials that are mined or retrieved from the earth (further categorized into Energy commodities – oil, gas, etc. and Metal commodities – Gold, Platinum, Copper etc).
- Soft commodity trading – Materials gained from agriculture (further categorized into Livestock – Live Cattle, Pork Bellies, etc. and Agricultural – Cotton, Wheat, Coffee etc.)
Commodity trading is most likely the earliest form of economic trading. Some have pointed to Sumer in 4000-4500 BC, where people would promise a future time and date for goats to be delivered in exchange for the money up-front. While others have pointed to China in 6000 BC where rice futures were traded. As well as actual commodity trading happening across the Silk Road during the time. This meant trades could take weeks/months to complete and often ended up with spoiled or robbed goods, however, merchants had trust in the system due to the guarantees provided by governments.
The most common and oldest form of trading in the commodities market is future-trading, where a buyer will agree to buy a commodity at a pre-arranged price, at a certain time in the future.
I.E. In 6000 B.C., a trader will have agreed up-front with a producer to buy 10 metres of Silk. Both parties knew this would take considerable time to produce, arrange and deliver, sometimes up to months. Therefore, in order to enact the transaction, the best possible solution for both buyer and seller, would be to agree to pay X amount of coinage for the silk at a date in 6 months time.
This however, throws up a whole range of complications – and for the savvy traders, opportunities – into what should be a simple transaction. It’s where things get very interesting for traders!
These are what we will cover in the next blog post!