Agricultural commodities: trading opportunities from global volatility.

Pandemic or no pandemic, the world will always need to be fed. Agricultural or ‘soft’ commodities – those that can be picked or farmed or harvested – are a popular trading product because so many elements can influence the price: in the short-term it may be weather, or other supply shocks; in the longer-term it may be changing consumption patterns, such as the move to a plant-based diet.

What are agricultural commodities?

Agricultural commodities markets are well-developed and sophisticated with a wide variety of derivative contracts based on wheat, corn, soy beans, cocoa and coffee among others. The iconic film ‘Trading Places’ gave a useful lesson into the nuances of trading frozen concentrated orange juice, for example. All these commodities are subject to different influences, everything from sunshine and rain to locusts and caterpillars.

There are two main players in most soft commodities markets. The first group are large businesses dependent on agricultural commodities that need to hedge future costs. These businesses may be clothing manufacturers dependent on the cotton harvest or food producers dependent on raw materials such as grain. These markets also attract speculators and traders, who seek to profit from rising and falling prices.

What influences the price?

There are long and short-term influences on pricing in these markets. In the short-term, the price of an individual commodity may be influenced by supply disruption, usually caused by unusual weather patterns. For example, last year’s drought in Australia, one of the world’s top 10 exporters of wheat, saw its harvest fall to the lowest level since 2008. This contributed to concerns over global supply and saw prices move higher.

Agricultural commodities prices can also be influenced by the anticipation of problems in supply. For example, in the recent Covid-19 outbreak, wheat prices rose in expectation of disruption in global supply as the virus inhibited the movement of goods from country to country. The problems, however, didn't materialise and the price has now fallen back. Aspiring traders will need to judge the mood of the market as well as the reality.

There are also longer-term influences on the price of commodities. Climate change and population growth, for example, are shifting the long-term demand/supply balance for many commodities. The University of Minnesota’s Institute on the Environment estimates that climate change is reducing global rice yields by 0.3% and wheat yields by 0.9% on average each year. At the same time, demand for cereals, which are used for both human and animal food is projected to reach around 3 billion tonnes by 2050, up from just over 2 billion today.

Picking a commodity to trade

For traders starting out in commodities, it can be worth focusing on one individual commodity and understanding its dynamics before branching out. Almost all crops have seasonal dynamics and will be focused on different regions of the world and their weather patterns. Earlier this year, swarms of locusts wreaked havoc on cotton, wheat, onion, chilli and tomato crops in Pakistan, for example.

Far-sighted traders will have been watching these trends in this vulnerable part of the world. It is useful to understand the elements likely to be influential on the price of an individual commodity.

This applies to the demand side as well as the supply side. Someone looking at grain prices needs to focus on areas such as the Midwest in the USA or Latin America, where a significant amount of it is grown, but also to the Middle East and North Africa, which are significant consumers. If they are experiencing problems, this may prompt lower demand. The World Bank can be useful place to start in understanding the dynamics of commodity markets.

Risk management

Agricultural commodities can be volatile and pricing can be disrupted by sudden and unexpected events – such as natural disasters. As such, it is perhaps even more important to hedge risk effectively. That may mean putting stop-loss orders in place or other automatic trading facilities.

On the Fineco platform investors can trade agricultural commodities through futures and options markets or through contracts for difference (CFDs). Our service is designed to be low cost, allowing you to trade flexibly and to keep more of any profits you make.