The Finatical

Week of November 23rd, 2021 - Commodities Tips, Inflation and Fed Tapering

Finatic

Aditya Bagga

, and

Sidh Aneja

Nov 23, 2021

FinaticTips - Learn about Commodities

Commodity trading is the exchange of different assets, typically futures contracts, that are based on the price of an underlying physical commodity. With the buying or selling of these futures contracts, investors make bets on the expected future value of a given commodity. If they think the price of a commodity will go up, they buy certain futures—or go long—and if they think price the commodity will fall, they sell off other futures—or go short. For investors, commodities can be an important way to diversify their portfolios beyond traditional securities. Because the prices of commodities tend to move in opposition to stocks, some investors also rely on commodities during periods of market volatility.

Some commodities exchanges have merged or gone out of business in recent years. The majority of exchanges carry a few different commodities, although some specialize in a single group. In the U.S., there is the Chicago Mercantile Exchange (CME), the New York Mercantile Exchange (NYMEX), the Intercontinental Exchange (ICE) in Atlanta, Georgia, and the Kansas City Board of Trade. In Europe, there is the London Metal Exchange (LME).

Common Types of Commodities:

Metal
Energy
Agriculture

Understand the Commodities Market

While investing in commodities might seem similar to investing in traditional investment options such as bonds and shares, however, the commodities market is quite different from other investments in your portfolio. Usually, all commodities move in cyclical trends which are determined by the interplay of demand and supply and economic and geopolitical factors. As you begin to understand the cyclical nature and pattern of the commodities market, you will begin to sharpen your instincts and gain more returns.

Here’s what we know about the cyclical process:

There is an increase in demand
Capital expenditure is increased to increase the production to meet the growing demand
This pushes the prices up due to high capital expenditure, and also due to demand outweighing the supply.
However, higher prices start dampening and eroding the demand
The supply slowly exceeds the demand leading to a fall in commodity prices to increase the demand.
Capital expenditure is reduced to accommodate the reduction in prices, which reduces the supply and subsequently bringing about a supply and demand equilibrium
And then the process starts all over again

Using Futures for Commodity Investing

A futures contract is a legal agreement to buy or sell a particular commodity asset at a predetermined price at a specified time in the future. The buyer of a futures contract is taking on the obligation to buy and receive the underlying commodity when the futures contract expires.

The seller of the futures contract is taking on the obligation to provide and deliver the underlying commodity at the contract's expiration date. Futures contracts are available for every category of commodity. Typically, there are two types of investors that participate in the futures markets for commodities: commercial or institutional users of the commodities and speculative investors.

Using futures is one way through which you can invest in commodities. This approach usually follows the old “Greater the risk, greater the award” approach as future contracts are considered slightly riskier than other forms of investment because of the leverage involved. As futures involve transactions at a predetermined price, it is best to focus on a commodity that has a relatively stable price throughout the year and then you can increase your chances of earning better returns. It is best to focus on commodities with the least amount of volatility. There are many advantages of futures contracts as one method of participating in the commodities market. Analysis can be easier because it's a pure play on the underlying commodity. There's also the potential for huge profits, and if you are able to open a minimum-deposit account, you can control full-size contracts (that otherwise may be difficult to afford). Finally, it is easy to take long or short positions on futures contracts.

Selecting the Appropriate Exchange

Like any other form of investment, commodity trading also involves some risk. However, that risk can be lowered significantly just by choosing the right commodity exchange. You must select an exchange where there is ample liquidity, so commodity futures can be freely bought or sold, without the constant worry of finding a buyer or a seller. Credit risk can be eliminated as the clearing house of the exchange acts as a counterparty to both the parties involved in the trade. Also, the risk is reduced further as all the leading exchanges require the positions in commodity futures to be marked to market on a daily basis. Hence, any counterparty risk is eliminated on selecting an appropriate exchange.

You can choose your right fit by checking the track record of the exchange and then selecting wisely.

FinaticTrends - Financial Trends

1 - Inflation: Transitory or Permanent?

The US inflation statistics for the month of October have many economists questioning the Federal Reserve’s long-held view that this inflation is “transitory”. Despite the new shift of public opinion, there is evidence that suggests that the federal Reserve might still be right. stronger-than-expected October retail sales and industrial production figures this week have indicated that the broader economic recovery may well be on track, even as inflation drives prices skyward. November’s jobs report indicated that the labor market was now gathering steam, with nonfarm payrolls increasing by 531,000 in October and driving the unemployment rate down to 4.6%. Considering this, it can be said that there is no reason to panic as of now. It might be safe to say that although inflation is likely to accelerate further in the coming months, it will revert to a more normal level by 2023. However, those who think transitory means that inflation will be back to normal in a few months will be sorely disappointed.

2 - Federal Reserve Tapers

The Federal Reserve announced that it will commence the long-awaited tapering of asset purchases. Markets barely budged in response, which is testimony to the communication skills of Fed leaders. They prepared markets for what was coming, explained it clearly, and the result was a modest decline in inflation expectations and strong performance of equity prices that are now at historic highs. The Fed will reduce asset purchases by US$15 billion each month until no new purchases are made. It indicated it could slow or speed up the pace of tapering depending on data. Fed Chair Powell said, “It is time to taper, we think, because the economy has made substantial progress towards our goals.” However, the other major policy too, interest rates, will not be changed quickly. Powell said, “We don't think it's time yet to raise interest rates. The time for lifting rates will depend on the economy. I think we can be patient.” Most people now expect a rate increase in 2022.

Financial Guidance

"Financial peace isn't the acquisition of stuff. It's learning to live on less than you make, so you can give money back and have money to invest. You can't win until you do this." - Dave Ramsey

By being modest in your spending, you can ensure you will have enough for retirement and can give back to the community as well.