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Commodity trading

Updated on May 19, 2011

Trading of commodities can be challenging. Commodities have typically high volatility. Since many commodities are traded in US dollar the price is often typically inversely related to the dollar for longer term contracts. A stronger dollar causes a lower commodity price and vice versa. A proxy for dollar strength is therefore the Eurodollar exchange rate. The Eurodollar is influenced by macroeconomic data such as industrial production, gross domestic product (GDP), etc but also depends on monetary policy and interest rate decisions. The easy money policy provided by the Federal Reserve has caused the dollar to weaken versus the euro. However, during the recent years there has been a strong correlation between the Eurodollar and risky assets including commodities. When the dollar weakened risky assets gained but when equities and other risky assets plunged dollar gained as it was perceived as a safe-haven due to its reserve currency status. Shorter term contracts should be influenced by the underlying fundamentals such as supply and demand. Both these may in turn be influenced by weather and temperature. Moreover there can also be a relationship between the longer end of the forward curve and the shorter end. For example if the longer dated part of the curve gains it may lift the shorter end and vice versa.

The market players in the commodity market include hedgers, speculators and arbitrageurs. Hedgers are producers or consumers who want to fix the price of their production or consumption today for delivery in the future. Speculators are trading companies who take speculative positions in a commodity. They may sell or buy a certain contract or trade a spread. Arbitrageurs try to eliminate pricing inefficiencies by taking various market positions with little risk. The interaction between these market players influences the pricing formation in the commodity markets.


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