Commodities have always seemed to be one of the safest investments; people think that their prices can only rise. What’s happened over the last few months has disproved this belief.
What is happening in the commodities market? What should we expect in the near future? How should traders behave if they don’t want to lose the capital that they’ve invested in these markets? Let’s answer these questions together.
Commodities are goods which for a number of reasons can be easily traded. First of all, they are homogeneous products; the fashion industry might differ from country to country, but it doesn’t matter whether the cotton used in production comes from China or Uzbekistan. They can also be used as inputs for production, not only in retail; so salt, sugar, gas, oil, meat, metals (precious or not) and many other goods are considered commodities.
Commodities are often traded on the futures market and their price changes are really low because supply and demand is usually stable.
This is true for commodities in general. But commodity prices can vary depending on the product and, interestingly, it is the king and queen of commodities, precious metals and oil, that are most risky on the market. They run the show: even if their prices are usually stable, what about the crude oil barrel price breakdown that happened this year?
Are the Seven Sisters arguing?
The businessman Alberto Clò stated that the current oil trend is due to typical oversupply, the result of overproduction over the last decade. Another factor is the demand decrement in industrialized countries- even China, the driver of developing countries, is suffering a recession in its economy.
But these factors are not enough to explain how fast prices have fallen. Overproduction did not happen for no reason- it was likely due to policy decisions taken by the Saudi Government and, later, Iran. The decision caused a price decrease between 2014 and 2015, and when Iran followed the Saudi lead last summer, it affected even the Russian economy.
What is happening? Basically, we think that this is a strategy similar to the ‘commitment device’: I’m ready to suffer in order to hurt you! The United States tries to be self-sufficient in energy, although their technologies are more expensive- and so the decision to overproduce was taken in order to erode American ‘shale gas’ and ‘tight oil’ company’s profits.
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In fact the Bank of America considers the OPEC trust ‘dissolved’, and J.P. Morgan forecasts a loss of 90 billion dollars per year in the Saudi economy, all due to its decision. It seems that the only countries that are enjoying the current situation are those that don’t produce oil, like the European countries.
Why did it happen?
Is it possible that the ‘Seven Sisters’ don’t want to work in a trust anymore and prefer to be in competition, even if it is limited? Oil is the base of production, all over the world, and we know that a decrease in its price produces positive effects; at least in the short term it breathes life into the economy.
Of course, we know that the decision was provoked by the arm-wrestling between OPEC countries and the world superpowers (to avoid their energy interdependency): I’m sure that Riyad isn’t letting me pay less for my petrol because they love me! It does so in order to maintain its global position, and this energy provision is the only way.
What can the importer countries do? They can passively accept the situation (till the oil finishes!) or they can keep playing this game of balancing the powers. For example they can develop and use renewable energies, which are for sure sustainable in the long term, cleaner and more shareable.
How can a trader move in such a scenario?
Consider that oil is the hard-core commodity of the economy and modern industrial production. It is also subject to many decisions made by policy makers. This importance creates one of the commodities market’s peculiarities- information asymmetry.
When a trader cannot access some information that is important for his investment, which occurs when a market is affected by policy makers, big investment companies, rating agencies and so on, the trader cannot just trust the macroeconomic news to invest his savings. He’d do better to study the specific market (taking into account for example the COT report issued every week by the Commodity Futures Trading Commission). He should analyze the trend and its technical figures with supports and resistances.
Above all he must carefully undertake a strategy of risk management. If you want to invest in oil, the first objective nowadays is to protect your capital, because the development of alternative energies and price volatility make oil an asset full of risks and difficult to manage for a private trader in the long term.