The Everything Guide to Commodity Trading

All the tools, training, and techniques you need to succeed in commodity trading

David Borman

• Publisher: Everything
• Year: 2012
• ISBN:
  9781440536229
• Topic: Negocios y empresa
• Subtopic: Mercancías

Insider tips from investment pros! Over the past two decades, no investment has returned more profits than commodities, but these assets can also be perilous for the uninitiated. The Everything Guide to Commodity Trading demystifies this dynamic market, and gives you the levelheaded, clear guidance you need to make a killing in commodities!Inside, you'll learn how to conduct fundamental and technical analysis of commodities, build a portfolio, and anticipate movements in the commodities markets. The book also includes valuable info on:

• Cutting-edge energy and material commodities
• Investing safely in ETFs, index funds, futures, and options
• Maximizing profit in developing economies
• Key "set-ups" that signal when to buy and sell

With trading strategies crafted for various levels of budget and risk, and featuring a chapter on numismatics and collectibles, The Everything Guide to Commodity Trading gives you the advice you need to cash in on this red-hot market!

CHAPTER 1

Why Invest in Commodities Now?

In this first chapter, you will learn the reasons behind why commodities experience rapid price growth. You will also learn that if history repeats itself, you can take the price of everyday goods such as coffee, corn, oil, and gasoline and fairly assume a rise in these asset prices that can easily surpass those of stocks or bonds. You will learn the basics to the price of raw materials: supply and demand. This chapter sets the stage for the concepts that are presented throughout the rest of this book.

Unlimited Growth, Limited Resources

“Oil reaches $175 a barrel; gold tops $3,500 an ounce!” Are these tomorrow’s business headlines? Could it be true that you will be living in a time when you have to pay $12 for a gallon of gasoline and $7 for a small cup of regular coffee? Some say that if the economic growth of the world continues that these will soon be some of the average prices of the products you consume daily.

With the potential unlimited growth of the world’s economies and the ability for central bankers to create an unlimited supply of the world’s paper and electronic currencies, there still remains the fact that there is a limited (sometimes very limited) supply of the world’s natural resources. Some of these natural resources are consumables such as foodstuffs; some are used as inputs in further processed manufactured goods; and others are an age-old method of storing wealth in nondestructible forms. Either way, commodities are physical goods that are grown or mined and must be shipped and stored. This puts them in a special class of investments. This also puts you in a special time in history: a time of worldwide growth and worldwide money expansion. These combined factors add up to an ever-increasing demand and price increase of the class of investments called commodities. You can choose to ride the wave with the increasing scarcity of commodities and reap healthy rewards as you do so.

Wouldn’t it be nice to invest in such a way that you can capture some of the price increases in commodities? Wouldn’t you like to insulate part or all of your entire portfolio from the effects of the massive increases in money supply that have been pumped into the world’s economies? Wouldn’t you like to record capital gains when you sell off your holdings of gold and silver as they reach their ever increasing price levels?

If you answered yes to any of these questions, then this book is for you. By reading this book you will learn the whys of commodity investing, including why now is the time to include a portion of your overall investments in commodities such as energy, agriculture, and metals. You will also learn how commodities can be considered an alternative asset class, and how historically commodities have had returns uncorrelated to the stock markets.

You will find answers to the questions: Are commodities a good investment for you personally? If so, how do you go about building up a commodities portfolio? You will learn how to use ETFs, futures, managed futures, electronic spot trading, and even the physical commodity itself as investment tools.

Once you make the decision that commodities are for you, you will then learn how to use fundamental and technical analysis to know the best times to invest and build your positions, as well as how to read developing news for signs of the future prices of your commodity positions.

You will learn about crude oil, gold, silver, and copper trading. You will also learn about the food commodities including coffee, cocoa, and sugar. You will learn the ins and outs of getting into the market, including indirect methods such as mutual funds and commodity currencies. Lastly, you will learn the most basic method of shopping for and buying the metal commodities in their actual physical form such as gold coins, silver bars, and copper ingots and coins. Additional information will be given on how to determine the actual gold weight (AGW) and actual silver weight (ASW) of gold and silver jewelry and other items found at antique shops and second-hand stores.

Growth in Emerging Markets

One of the reasons behind commodity price increases is the rapid growth rate of the world’s emerging markets. Markets in developing countries such as Brazil, China, and India are growing at rates of 6 percent, 7 percent, and even 10 percent or more per year, year after year. This growth rate means added demand of finished goods that the Western world would consider normal; that is, there is a huge demand for finished products such as cars, scooters, and higher-quality homes. These finished goods require raw material inputs such as iron, steel, copper, and lumber. This equates to an added demand not only of raw materials but also of the energy commodities that go into the fuels to get the raw materials to the manufacturers.

Adding to the overall commodities demand is the fact that, in addition to the growth in many of these other countries, there also comes a higher level of inflation in the home country. This brings an increasing demand for commodities that can serve as currency alternatives, which act as protection from paper money that might be worth less in the future, or as savings accounts for the increasingly richer population. This means an added number of people are buying precious metal commodities such as gold, silver, platinum, and palladium. This increased demand is felt worldwide, especially during times of the year when the local customs are to buy for wedding and holiday gifts.

The Chinese New Year in mainland China or the marriage season in India can lift the prices of gold and silver as much as 20–30 percent in a few months. Historically, these higher price levels of gold and silver remain until they fall back a few percentage points in the slow months of August and September. The prices of gold and silver get pushed up farther again starting in October and ending in April of the following year.

The price increase of precious metals commodities such as gold and silver can act as an upward commodity demand/price spiral. The increasing price of gold and silver brings added wealth to the holders of the metals, which in turn spurns demand for more cars, scooters, and houses. If the increasing price of gold brings enough wealth, there is an increased demand for other goods, including finer clothing (affecting raw wool and cotton prices), better and more food products (which affects the price of food commodities such as wheat, corn, and cattle), and heavier usage of fuels in larger and more expensive cars.

Do not make the mistake of underestimating the potential demand and consumption of the world’s developing nations such as Brazil, China, and India. There is so much demand for these countries to grow and modernize that it will take years of development for them to slow down and reach the growth levels that are seen in the United States and Western Europe. This growth demand will be adding to the raw materials demand for years to come. The net effect of all of this current and potential demand is one means for you to get in on an opportunity and gain high returns with commodities investing.

Supply and Demand and Commodities Investing

The basic question of any form of investing is, Where does the price base come from? In other words, who or what is establishing the price of the item that is to be invested in? If the item were to be bought for an investment, then you would need to know what has the potential to move the price up, and therefore give you the opportunity to sell the item in the future at a higher price (thereby making profits on the investment).

With this in mind, it helps to get a grip on what moves the price of the commodities. Basically, the prices of commodities are directly related to supply. Somewhat. To put it simply, the more of a good that is in the market in relation to the amount of demand there is of that good, the less the price of the good in the marketplace. Turning that around, if there is a higher demand for a good than there are supplies of that good, then there will naturally be higher prices paid for it.

Starting with Commodity Price Intervention

As far back as the 1950s there was a great quantity of commodities such as coal, steel, copper, tin, oil, and natural gas. Because of this, prices were low. In addition to this glut of supply, some commodities had their prices regulated by the government. There have been times in the past (and possibly in the future) that the U.S. Congress has regulated the price of food commodities and of some energy commodities. In the 1950s the price of natural gas was managed by the U.S. government and regulated to keep its price low.

How did regulations act to suppress the natural gas industry?

This government intervention prevented the oil producers of Texas, Oklahoma, and other western states from developing the equipment to get the natural gas they produced to the market. The prices were so low that there was very little development of the natural gas industry during these years. In fact, there was very little effort to keep an adequate storehouse supply of natural gas and other energy commodities.

As you will learn later, the glut of natural gas and other energy commodities slowly found itself widdling away until there wasn’t a surplus. In fact, the combination of the underdeveloped natural gas storage capacity and the style of U.S. cars to have bigger and less fuel-efficient engines led to a kind of energy crunch in the early to mid 1960s.

The Beginning of the Commodity Demand Cycle

This energy crunch led to the beginning of the modern commodities investment/demand/supply cycle. Commodities investors continued to enjoy good profits during the period from 1966 to the early 1980s. Gold, corn, oil—it seemed as though all the commodities were in high demand, and investors got rich. There was inadequate supply for the demand of the day.

Then a curious thing happened. As with any business, the drillers, miners, and farmers found it more profitable to engage in their commodities-related businesses. If gold was $120 an ounce and it was profitable to open up a gold mine, how much more profitable would a mining endeavor be if the price of gold were $650 or even $850 an ounce (as it was in 1980)? The same concept was true for oil drillers and people in agribusiness. How much more profitable would a Texas panhandle oil well be if oil was $30 or $40 a barrel as opposed to $12 per barrel in the mid 1970s? What about a basic foodstuff as sugar or corn? Same thing: more profit.

The higher and higher prices from 1966 to 1980 were caused by higher and higher demand. The higher prices also led more people to develop businesses that would extract, mine, drill, or farm for more of the higher profit commodities items. The added mines, wells, and farms added to the supply of the in-demand commodities, and at the same time, technology improved to make more efficient cars, better furnaces for homes, and higher yielding crop seeds. The total effect was a double whammy: more producers and less demand. The net result was falling prices of the commodities in the early 1980s. Gold went from $850 an ounce down to $300 an ounce in a matter of two years. Sugar went to 1/20th of the price it had been ten years earlier. The fuel commodities took a plunge in prices also. In the supply/demand war, the supply side had won. Traders and investors pulled their money out of the commodities markets and prices went down even further.

Commodities Investing Today

The supply glut of the 1980s led investors to look elsewhere to put their money. The late 1990s saw many investors getting into the technology stocks of the day. The returns were so good on tech-heavy indexes that millions of investors poured money into ETFs like QQQ, or the NASDAQ-100 Trust. During these years commodities were flat, some would say even depressed. Kids could go to college hundreds of miles away and still come home every weekend if they wanted, as regular gas was 89 cents a gallon. Someone walking into a high-end jewelry store could buy a one-ounce American Gold Eagle coin for $320 and an American Silver Eagle coin for $5. Supply was high, demand was low, and prices were rock bottom.

Why, you might ask? Everyone was into tech, and they were in it in a big way. Not only was the main street investor putting all of her hard-earned money into high-flying “dot com” stocks, the U.S. dollar was very strong. As an example, Europe’s common currency, the euro, was introduced in 1999. It was originally priced to cost $1.17 U.S. dollars for one euro. Things got ugly for the euro soon after its introduction. Since the world’s investors wanted to get in on the stock market boom of the time, they were converting massive amounts of euros (and other currencies such as the British pound, also called the pound sterling) into U.S. dollars. This in turn drove the value of the dollar against the euro to higher and higher levels.

In 2001 a traveler visiting Paris could expect to pay 90 cents per euro (compared to the $1.17 per euro a few years ago). It seemed as though the whole of Europe was on sale!

This strong U.S. dollar value affected the price of gold in an inverse manner. Since gold is priced in dollars (as well as in euros and British pounds), the price of an ounce of gold fell every time the U.S. dollar got stronger. As the dollar got stronger, more people wanted to hold it as a store of wealth. As the prices of gold and silver fell, fewer and fewer people wanted to hold those metals in their portfolios as a store of wealth. Gold and silver were definitely out of favor.

Soon thereafter, the technology stock boom went bust, and there was a recession. To combat the recession and restore confidence, the U.S. Federal Reserve System—the Fed—lowered interest rates again and again, until the economy was going full steam ahead once more. This time, the developing countries of the world (such as China, India, and Brazil) were on investors’ minds as well. These economies were going strong, and their boom brought an increased demand in commodities.

This increased demand for commodities was due to the rapid growth in the production volumes of Chinese and Indian factories. In addition to the increased demand of raw materials for their factories, the workers in the factories desired to put their paychecks into things other than just savings accounts. These workers wanted and bought things that increased their standard of living, such as cars, homes, and other goods that took raw materials to make and build.

Some of the money that was paid to workers of high-production factories was put into precious metals such as gold and silver. In China, the people’s desire for gold had to wait until the government of China gave the go-ahead for gold ownership. Added pressure on the gold market was intense, and the price of gold climbed higher and higher.

The boom of commodities was on: Oil was up to $147 per barrel on July 3, 2008; people were talking about gold going to $1,000, and then $1,250, then $1,500 per ounce as it breached each new level. Other commodities followed suit. The high growth of the world’s economies had taken hold, and investors and traders took notice.

Money Supply, Central Banks, Decision Making

Another factor that has led to the rapid rise in the prices of commodities has been the increase in the world’s money supply. Money supply is a term that is use...