Terms Beginning With 'c'

Commodity

  • November 10, 2020
  • Team Kalkine

We all have heard the stories of how people used to trade even before the currency was introduced in the human civilisation. Barter system was used to exchange one item as payment for another item. This is the basics of commodity trading, and today traders have a plethora of options to trade and invest in the commodities market.

Before going any further, let us discuss commodity and what sorts of goods come under commodity.

What is a commodity?

A commodity is basically a natural resource which can be used as raw material for creating goods that carry some monetary value. For example, iron ore is a commodity which is a basic raw material for the steel industry, which in turn is used by automobile, construction and other industries.

In the above example, iron ore is a commodity which can be exchanged for a predetermined value or with another commodity carrying equal value during the exchange period. When U.S.A imposed an embargo on Iranian crude oil and banned the payment in dollars for Iranian crude, India devised a mechanism to purchase the crude with an exchange of some sort of farm product as payment.

Interesting Read: Why is Gold a valuable metal? 

Basic Characteristics of Commodities

  • One unit of a commodity can be used or exchanged for another unit of the same commodity without any loss of value. For instance, 1 tonne of iron-ore can be exchanged for another 1 tonne of iron-ore without any significant loss in value.
  • The foremost characteristic of a commodity is that it is tradable. If a particular good is not tradable in the open market or at an exchange, it cannot be considered as a commodity. Gold can be traded easily around the world, but feasible Uranium cannot be listed on an exchange or traded legally by investors. Technically, Uranium is also a metal and used as a fuel for power generation but cannot be traded in the open market.
  • If the commodity is tradable, it should have liquidity. Liquidity ensures that high number of people are interested in buying and selling of a particular commodity at any given point in time. There is no cap on the amount of buying and selling.
  • Commodities should be deliverable also.

Some traditional examples of commodities are grains, gold, crude oil, natural gas and beef. Now a day’s currencies and indexes are also included in the commodity market. Some specialized commodity market also trades in bandwidths and duration of cell phone calls.

Trading in commodities involves complex strategies as it involves trading in derivative instruments. The equity market can also provide an opportunity to invest in the commodities market. If an investor buys equity shares of a crude oil-producing company, the investor is indirectly putting his/her money on the crude oil commodity.

Investment in Commodities Market

Physical Purchase

Physical purchase involves buying a commodity and taking delivery of the same. For instance, someone is interested in gold or silver commodity; the investor has to buy the commodity and has to take possession. The investor can hold the commodity till the appropriate price is not reached.

The method is not practical in normal trading for an individual investor. Suppose if someone is interested in crude oil, delivery of which needs specialised equipment and know how. So it is not practical to make the physical purchase of commodities in most of the cases.

Equity Markets

Equity market also provides an opportunity to invest in commodities indirectly. Investors can buy shares of companies that deal in commodities exploration or production. Investment in gold mining companies or oil exploration and production companies can provide returns as good as direct investment in commodities.

Companies like BHP Group or Rio Tinto are involved in the exploration and extraction of multiple valuable metals to coal to oil and natural gas.  Many companies are into the extraction of a single commodity only.

Investment in shares of such companies can be linked to investment in the commodities as the business of the company is intertwined with the business of the commodity. Non-renewable power companies listed on a stock exchange can get affected by the price movement of coal or natural gas.

Specialized Funds

There are mutual funds and ETFs, providing opportunities to the investors to invest with limited risk into the commodities market. Certain mutual funds deal only in commodities and have experts providing valuable insights which can be used by investors who want to get better returns in commodities.

Some hedge funds are also created to invest in commodities. Hedge funds are generally open for wealthy investors who can invest huge amounts and can retain their investments for a minimum of one year.

Futures Market

Futures markets allow traders to use commodities to hedge their investments from market fluctuations. Consider the case of a crude oil refinery, for example. The refiner can calculate and easily estimate the requirement of crude oil in by the refinery. Also, there are refinery products whose consumption are cyclic and are affected by seasons. Certain fuel oils natural gas is required in higher quantity during winters in European countries.

Since the supply and demand can be estimated easily based on past experience, the crude oil market is highly volatile and cannot be predicted with certainty. If the refiner wishes to fix the price of crude oil for its consumption, it can buy a futures contract in the markets.

This way, the refinery can hedge itself from the market volatility. The future contracts involve partial payment for the entire volume or quantity of the commodities. The delivery can be accepted at a price for which future contract was purchased after the expiry of the contract period.

What is Day Trading? Day trading is popular among a section of market participants. It is a type of speculation wherein trades are squared-off before the market close in the same day. An individual or a group is engaged in buying and selling of securities for a short period for profits, the trades could be active for seconds, minutes or hours.  One can engage in day trading of many securities in the market. Anyone who has sufficient capital to fund the purchase can engage in day trading. For a class of people, day trading is a full-time job.  Day traders are agnostic to the long-term implications of the security and motive is to benefit from the price changes on either side and make profit out of the asset price fluctuations within a day. They bet on price movements of the security and are not averse to take short positions to benefit from the fall in price.  Day trading is not only popular among individuals or retail traders but institutional traders as well, therefore the price movements are large sometimes depending on the magnitude of information flow and accessibility.  Everyone wants to make money faster, and many are inclined to speculate in markets, but it comes with considerable risk and potential loss of capital. People engaged in day trading also incur losses, and oftentimes outcomes are disheartening.  Day trading is a risky activity, similar to sports betting and gambling, and it could become addictive just like gambling and sports betting. Since the motive is to earn profits, the profits realised from day trading also tempt people to continue speculating.  People spend considerable time and efforts to make the most out of day trading. They have to continuously absorb and incorporate information flow, which has become increasingly accessible driven by new-age communications systems like Twitter, Facebook, forums etc. But not only information flows have been favourable, day traders are now equipped with best in class infrastructure to execute trades even on compact devices like mobile phones. The accessibility to markets is at a paramount level and gone are days of phone call trading and lack of information flows.  What are the essentials for Day Trading? Basic knowledge of markets With lack of basic knowledge of markets, day trading may yield unacceptable outcomes. It becomes imperative for people to know what’s on the stake. Prospective day traders should know about capital markets, and the securities traded in capital markets like bonds, equity and derivatives.  Buying shares and expecting a return from the price movements are on the to-do list for many. However, it is important to know about and risks and potential returns from speculating in capital markets.  After getting some basic knowledge about markets and securities, aspiring day traders should know how to analyse market prices of securities through fundamental analysis and technical analysis. Although day traders don’t practice fundamental analysis extensively, they spend considerable time to apply technical analysis, to formulate a entry and exit strategy.   Device and internet connection Trading is now possible on mobile applications as well as computer applications or websites. An aspiring day trader will likely begin with mobile phone given the accessibility, and laptops/computers are useful as scale grows larger and complex.  Internet connection is prerequisite to practising day trading, and it is favourable to have a fast internet connection to avoid glitches and potential problems. These perquisites are now available with large sections of societies.  Broker and trading platform A broker will facilitate a market for potential trades. The security brokerage industry has also seen a profound shift as technology has driven cost lower while competition is ramping up across jurisdictions. Large retail brokerages have moved towards zero commission trading in the U.S., and the same is seen being the trend across other geographies as well.  The entry of discount and online brokerages has perhaps given wings to the retail market participants as well as the retail market for security brokers. Robinhood has grown immensely popular in the United States, but there are many firms like Robinhood in other jurisdictions. Each country has some firms with business model on same lines as Robinhood.  Brokers now offer high-quality mobile applications and web services to clients, and trading security has never been so accessible. They also provide access to the global market along with a range of securities, including commodity derivatives, currency derivatives, CFDs, options, futures, bond futures etc.  Real-time market information flow   On public sources, market price information is at times not live due technical shortcomings, which will not work appropriately, especially for day traders. Brokers not only provide platform and market but several other services, including margin lending, real-time data, research.  Day traders closely track prices of securities and overall information flow to incorporate developments in bidding, and real-time data provides accurate prices throughout market hours.  Information flow largely relates to the news around the company, industry or economy. Day traders now have far better sources of information than the conventional sources, and sometimes these sources could be exclusive to a group.  What are the risks of day trading? Most of the aspiring day traders end up losing money, given the lack of experience and knowledge. They should rather only bet on capital that they are comfortable to loose, in short, they should avoid risk of ruin. Day trading is sort of pure-play speculation and application of knowledge, information flow, laced with good trading system is paramount. The only concern of day traders is movement in price, which contradicts from investments. Day traders try to time and ride the momentum in the price and exit the trade before momentum turns otherwise, which can happen frequently.  It consumes considerable time and induces stress on the individuals given the nature of security prices, which can move north and south abruptly throughout the day, hours, minutes and seconds. Day traders should have enough capital to trade in cash instead of margin.  Day trading on margin or borrowed money is extremely risky and has the potential to make a person insolvent, especially in cases of extreme risk-taking. The leverage associated with borrowed money magnifies profits as well as losses.  Aspiring day traders should equip themselves with adequate knowledge, competency and sound risk management process. Although fast money is dear to most, it is better to know what is at stake before jumping into markets with excitement.   

What are ETFs? ETFs are similar to funds where pooled money of investors is managed by a fund manager, who runs the ETF. These funds invest in equity, debt, commodity or any other asset class, depending on its offering. Good read: Mastering the Basics of Investing in ETFs Price of the ETF is based on a value of net assets in the fund and is subject to change each trading day consistent with underlying changes in the value of net assets. Since ETFs are traded in markets just like shares, the quoted price of an ETF either reflects a discount to its NAV or a premium to its NAV. Investors have flocked to ETFs because of low-cost proposition and opportunity to take exposure in a specific pool of assets, which are professionally managed by an investment team with the investment manager. Some ETFs are also used as a proxy to define sentiment in an underlying sector, commodity or index since ETFs are actively traded in market hours, incorporating the latest information in prices. Fund management businesses have continued launching new and innovative ETFs, which have seen great demand over the past.    Read: Gold ETFs register massive capital influx; while PDI, GPP, ERM, AME, RED Under Investors’ Lens Large and popular ETFs have also defied liquidity problems because of large scale investor participation. But it remains a problem with lesser-known ETFs with small market participation. ETFs also pay distributions to the holders that are either derived through interest income, dividend income or capital gain. Active and Passive ETFs With ETFs markets growing strongly as ever, there remains a divide between active fund managers and passive fund managers. Passive investment strategies have grown immensely popular among market participants over time. This strategy is cost effective. Many seasoned investors such as Warren Buffett, John C Bogle- founder of the Vanguard Group have endorsed passive ETFs. Active ETFs do not track a benchmark, and performance is not tracked to any given index. These funds are based on countries, sectors, market capitalisation, asset classes, etc., and active investment management allows a manager to beat the returns delivered by broader markets or indices. If you look at the great investors like Warren Buffet, Philip Fisher or Peter Lynch, they have set themselves as a preamble for active investors, and their record of delivering sustainable returns over the long term continues to attract investors to active alleys of markets. Since Passive ETFs are designed to match returns of respective benchmarks, there is no scope of delivering outperformance no guarantee that fund will not underperform the benchmark. However, the expenses charged to investors are relatively lower compared to Active ETFs. Passive ETFs are cheaper than Active ETFs because the use of resources is limited in the former. Since they are designed to match the benchmark and its underlying securities, trading in Passive ETFs is mostly automated running on algorithms, and stock picking is not required, thereby no research. Read: ETFs: Investors Up the Ante and ETFs Run the Show for Long-Term Returns ETFs based on asset classes and style Sector ETFs: These are the most common type of ETFs in market. Sector ETFs track specific sectors like Information Technology, Consumer Staples, Consumer Discretionary, Metal & Mining. These are similar to index funds but are actively traded in stock exchanges. Equity ETFs: Equity ETFs may include equity-focused Sector ETFs. As the name suggests equity, these funds invest in stocks independently or are benchmarked to a specific index. Perhaps, Equity ETFs are the most common ETFs. Fixed Income ETFs: These funds invest in fixed income instruments and pay distributions out of the interest earned on bonds. Further Fixed Income ETFs can be separated as investment-grade ETFs, high-yield ETFs, Government bond ETFs. Commodity ETFs: Commodity ETFs invest in physical commodities like precious metal, agricultural goods, natural resource. These funds include products like Gold ETFs, Oil ETFs, Grain ETFs, Silver ETFs. Good read: Investing in Commodity ETFs Short ETFs: Also known as inverse ETFs, these funds are designed to benefit when the benchmark is falling. Short ETFs hold short positions in the benchmark index futures or constituents of the index to benefit from fall in value or prices. To know more about short selling read: Minting Money While the Asset Price Tanks; Enter the World of Short Selling Leveraged ETFs: Leveraged ETFs use derivatives to amplify the returns and risks of a fund. These are also called geared ETFs. Leveraged ETFs may also hold equity or bonds along with the derivatives to amplify the net asset value movement of funds. Do read: All You Need to Know About Exchange Traded Funds Why investors prefer ETFs? Passive investment vehicles continue to appear compelling to a large investor base, and there are numerous reasons driving the demand for passive investment vehicles. Low-cost and no minimum investment: ETFs have lower expenses compared to traditional mutual funds, and most of the funds have no minimum investment criteria. As a result, the market for ETFs has grown strong, due to its reach to investors with limited capital. Must read: Mutual Funds vs. ETFs: Which Are Better? Exposure to specific asset classes: Investors with large portfolio also use ETFs to enter to into specific asset classes like Gold ETF or Commodity ETF, but not limited to sector ETFs, theme-based active ETFs like technology, mobility, e-commerce etc. Portfolio diversification: ETFs provide investors with an opportunity to diversify a portfolio of concentrated stocks by including exposure to specific sectors, indices, and commodities. More importantly, the diversification is available at a low-cost investment, which further drives the need for ETFs in a portfolio. Accessibility: It is perhaps the most compelling value ETFs provide to investors. Since ETFs are available on stock exchanges like shares, investor participation remains strong, and some popular ETFs boast high liquidity levels. Read: Confused on How to Invest in ETFs? We Have Some Tips! Further read: 6 Reasons to look at ETFs    

What are the Factors of Production? Production of anything requires inputs to produce an output, and the inputs used in the production are known as factors of production. Alternatively, these are resources used in the production of goods and services.  Factors of production are also critical to economic growth given the economic growth requires expansion in output/national income or total production. Factors are a class of productive elements, which individually are known as units.  Units are interchangeable and homogenous, moreover, they are perfect substitutes for each other. Factors, which constitute a group of units, are not a perfect substitute for each other. Modern economists prefer using ‘inputs’ instead of conventional factors of production: land, labour, capital and entrepreneurship.  Classification of Factors of production Land Land includes all the natural resources available such as water and air. It constitutes a natural resource that yields income and is exchangeable for a consideration. In the absence of land, water and sun, a farmer cannot produce crops.  Every commodity traded in the world can be traced back to land directly or indirectly. Such as gold is extracted from mines, crude oil is explored and extracted from oil fields, grains are produced in agricultural land. Moreover, the land is arguably the ultimate origination of commodities.  Meanwhile, the quantity and quality of land are vital to yield an acceptable utility for the user. But the availability of land does not guarantee economic growth because the ability to use resource determines the optimal use of the resource.  Land can be further classified as renewable and non-renewable. Renewable resources can be used again and again in the production like an agricultural land used year after year for the cultivation of food, grains etc.  Non-renewable land is not usable again and again and is exhausted as the consumption increases. A gold mine may not yield additional income for a business when ore reserves are exhausted. And a new discovery would provide additional resource.    Land, as a blessing of nature, is fixed in supply. Whether the demand increases or decreases, the supply of land will remain the same. As a result, it is not dependent on the price, therefore supply of land is perfectly inelastic.  Labour Labour does include not only physical but also mental abilities that are done by humans for a monetary benefit. The contribution of labour depends on the size and quality of labour.  For instance, Japan has been successful in the production of small and compact cars, while the US producers were efficient in slightly heavy cars.  Higher productivity of labour will likely deliver favourable benefits. As a human factor, labour cannot be exchanged for value, unlike land and capital. Labour is used with land and capital and cannot be separated. Labour is available in return of wages and is not a saleable commodity. While one cannot store labour for future use, the supply of labour is dependent on the need for production. Labour supply is elastic, and it takes time to develop overall supply. Division of labour emphasises on the speciality of labour in a particular work. Every labour group in an organisation is further classified into various divisions, depending on the quality, skills, knowledge and demand.  Capital  Capital is a critical factor of production and largely means wealth, which includes stock of raw material, machinery, tools, building etc. It is also the money available for productive and investment purposes.  Capital also extends to physical assets such as machinery, raw material that are directly used in the production. Securities such as shares and bonds are not classified because they are not used in production, thus not the factor of production.  It is largely classified into fixed capital and working capital. Fixed capital is used in the production continuously and incur wear and tear. Fixed capital does not mean it is immovable, but the essence of fixed is the cost incurred, which largely remains fixed over the period of production.  The cost incurred in working capital is, however, recovered when the product is sold. Such as the cost of raw material, along with other inputs, is a component of the total cost of the good. Capital also includes human capital.  Human capital is also a vital unit of production and means the education, skills, and health of people. It is essential for the improvement in productivity. It is now understood that investments in human capital provide favourable growth.   Entrepreneurship Entrepreneurship is vital to confluence the factors of production and manages risk & uncertainty associated with the production. Now it is understood that production is a function of land, labour, capital, and entrepreneurship.  Entrepreneurship is more concerned with the incorporation of production, rather business affairs, which are managed by other people working on wages. Therefore, an entrepreneur takes the risk and uncertainty associated with production.  An entrepreneur is responsible for initiating a business enterprise and is engaged in assembling the factors of production, including land, labour, capital and entrepreneurship. Innovation and development are also associated with entrepreneurship.  Entrepreneurs undertake crucial decision of capital allocation, which may include setting up new factors, purchasing machinery, upgrading skills of human capital, innovating units of production etc.  Elon Musk is an entrepreneur aspiring to reach mars, produce e-vehicles, launch space travel. He is effectively managing and bringing about the factor of production to achieve results.  

Bear market is a scenario when the prices of securities are only moving in a downtrend for a prolonged period. Pessimism and fear across the board grips the market which leads to continuous selling pressure from the market participants, leading to downtrend. Apart from stock market, Bearish trends can also be present in other markets such as currency, commodity or bond market.   What Do We Mean by Stock Market? The stock market or financial markets in general, which includes stocks, bonds, commodities etc,  is a virtual marketplace for buyers and sellers willing to make a deal. Every party has his/her own analysis/view or opinion about the underlying security regarding its worth with respect to what it may be worth in the future.   What Drives Stock Price Movement? As the constant buying and selling of securities take place, the prices also fluctuate with respect to each of these transactions. This price fluctuation happens in either of the two directions, up or down based on the demand and supply equation.   In other words, where the price move would depend on whether the demand is higher than supply or is it the other way. If the demand for the security outstrips the supply, i.e. more no. of buyers is willing to buy than the no. of sellers who are willing to sell at that point of time, then the price tends to move up.   Similarly, if the no. of sellers is outnumbering the no. of buyers for the security at the same time, then the price tends to move down. All the price movement works on the universal law of demand and supply.   So, what is a Bear Market? As the prices are ever-changing, often they are not random and tend to move in a particular direction. Sometimes, due to excessive pessimism and fear among the market participants, the supply of securities gets overwhelmingly high, which leads to a fall in the prices for a prolonged period. This continuous fall in the price for a long time, often a few months/ years is referred to as a Bear market.    The secular bear market, which is a part of the stock market cycle, is often witnessed after a period of distribution which succeeds a strong bull market.   Although there is no estimate as to how long a bear market could continue, history tells us that often it lasts for a lesser time than a bull market but can be more erratic and fast during its fall.   What are the Triggers for a bear market? The major bear market which generally comes once in a decade can last up to a few years, although for   individual stocks it may last up to a few months respective bear market because individual stock’s fundamentals may change relatively more quickly than the broader economy.   This extended period of constant supply is not random and need a few reasons to sustain. These reasons are the major fundamental changes taking place behind the scenes. A few of these could be;   Weak corporate earnings Excessive inflation Downgrades by rating agencies Slowing GDP growth Incompetent top management (for Individual stocks)   How is a Bear market different from a normal correction? It is to be noted that the bear markets fall is completely different from the fall witnessed during an up-trending market. The market never moves in a straight line but rather in a wave-like pattern. This simply means even while moving up; it takes corrections or dips in the opposite direction and small rallies on the upside while trending down.   Therefore, a broader direction of the trend needs to be considered while identifying the bull or a bear market.     How to Quantitatively measure a bear market? Sometimes it gets difficult to measure as to when a bear market has started or ended as the price is always moving and fluctuating. But there are some quantitative measures available that can do the job in an objective way.     One of the measures which are generally used for the broader market is to look at the retracement level. A retracement is a move which is opposite to the bigger trend. As discussed above, markets take correction while moving up and shows rallies while going down. These dips in an uptrend and rallies in a downtrend are the retracement move.   A 20% retracement from a significant high point, preferably after the bull market is considered as the start of a bear market. Similarly, after the lowest point in a bear market, if the market retraces up by 20%, the bear market is considered to be over.   Another measure is to use a long-term moving average, like a 200-day. This method is very popular among individual stocks. A 200-day moving average is plotted on the stock’s price chart, and its interpretation is quite simple. If the stock is trading above the long-term moving average, then it is considered to be in a bull market and below the moving average is a bear market zone.     Which Strategies to be used in a bear market? When the market or a stock keeps on falling for a prolonged period, then a few strategies could come in handy to survive bear market or even mark decent profits like;   Selling the rallies As stated earlier, even in a downtrend, the market moves in a wave and shows some small rallies on the upside which ultimately get fizzle out, and the downtrend continues. These rallies are an ideal point for the short-selling as one can get a better price.   Selling after the break of support. Going short just after the support level gets breached is another approach to make money in a bear market. Although selling the support would yield a lower price for selling but if the market is in a true bear run, then expect a lot of support levels to be taken out throughout the downtrend.   Look for base formation to enter long There is something for the long-term investors also. For an investor, a lower price is always a better price, and a bear market offers tons of opportunities to buy stocks dirt cheap. But the question is when to enter. One way is to look for a consolidation phase after a severe fall, also known as the accumulation zone. It is the area where a lot of buyers come in to buy stocks at a low price, hence halts the prices to fall further. These consolidation zones are a good place to accumulate stocks, instead of trying to catch a falling knife.   

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