Commodities are usually negatively correlated to stocks. This means if the stock market is falling, the prices of commodities will rise. This negative correlation makes commodities a hot-seller for investors looking for diversification.
Investors trade in commodities through futures. Futures are contracts where buyers and sellers agree to buy or sell a particular item at a future date at an agreed price irrespective of what the price will be at that time. For example, say you enter into a contractual agreement to buy 10 kgs of wheat after six months at a price of Rs.25/kg. This would be a futures contract. After six months, you will get the delivery of wheat at Rs.25/kg irrespective of the actual price of wheat at that time.
Commodities can be traded as futures for the simple reason people like to assume confidence in a future price. Futures, if each executed at completion, would physically deliver goods to the purchaser of a futures contract. From a business standpoint this makes a lot of sense because it gives you confidence and accuracy in projections of future expenses.
So, how do futures contracts benefit investors?
It is pretty simple. After entering an agreement, if the commodity’s price goes up, buyers profit as they book the commodity at a lower price. Alternatively, if the price of the commodity drops, sellers make a profit. They can sell the item at a fixed price without suffering the loss of a price drop.
Other reasons why trade commodities as futures include the following –
- They guarantee the rate of the commodity in future, irrespective of market movements
- Since the cost is fixed, it reduces speculation risk
- Sellers know the cost that they would get for their commodities in future. As such, they can plan their production accordingly
- Commodity futures create a price discovery mechanism run on market fundamentals, thereby removing the possibility of price manipulation
- The low margins in futures allow investors to invest in multiple contracts even with limited funds
- It enhances competitiveness in foreign trade as futures allow exporters to hedge the price risk.
- Investors can use hedging as a way to limit their investment risks from economic uncertainty. More specifically, future trade can be a useful financial instrument to hedge against the swings of commodity prices.
Commodities are, therefore, traded as futures to allow hedging opportunities, portfolio diversification and to be a profitable investment avenue for investors.
Being a savvy investor requires grabbing opportunities at the right time and of course to grab the one you should follow the latest market trends and revamp your financial knowledge, take the help of the best app for finance – The FlipItNews App, where you can get the latest stock market news within 50 words facts, the app also provides the stock market latest news in Hindi.
FlipItNews App is all set to revolutionise the way Indians perceive finance, business and capital market investment. FlipItNews aims to promote financial literacy among the Indian masses and investment through contextual information and engagement with smart investors.
FlipItNews launched “Circle”- a community of smart investors. A smart platform where any fin-tech company can build its community.
Feature Circle provides you with the opportunity to learn from market advisers, fin-tech companies, wealth advisors etc and engage yourself with other users through group discussion, polls and quizzes. Also, earn flipitcoin for every action.
Download the best finance app – the FlipItNews App now and join Circle to become a part of the biggest investment network.