What are Agricultural Commodities?
Agricultural commodities are a vital part of our existence; almost everyone on the planet depends on agricultural commodities in one way or another. Agricultural commodities constitute staple crops and livestock produced or raised on farms and plantations.
Most agricultural commodities serve as a source of food, but numerous others serve as industrial components, such as cotton and lumber. In online trading, such commodities fall into the category of soft commodities, which include a variety of agricultural products, such as sugar, cocoa, wheat and coffee. In contrast, hard commodities are mined, and include, for example, crude oil, silver and gold.
Agricultural commodities can also be divided into 3 main categories:
- Food crops, such as corn and soybeans;
- Livestock, such as cattle and pork bellies;
- Industrial crops, such as wool and rubber.
The agricultural sector carries great significance in human living. Over 20% of people are directly employed by the sector (the percentage is even higher in developing countries) and as the population keeps on rising, agricultural commodities will continue seeing huge demand by people, nations, and companies globally.
Agricultural commodities are a basic need for human living, and they have been exchanged around the world since the beginning of civilisation.
They continue to be exchanged to date, with their prices fluctuating throughout seasons or all around the year. The changing prices offer many trading opportunities for traders to speculate upon their preferred commodities.
At Currency Hedger, we provide a secure and all-inclusive trading environment that enables you to trade your preferred agricultural commodity with access to a wide range of trading tools and features.
The Agricultural Commodities Market
The agricultural commodities market is the oldest financial market in the world, predating stocks and bonds trading. Ancient empires rose and fell depending on how they created, controlled, and facilitated commodity trading routes between different regions.
Today, commodity trading is largely structured and conducted via commodity trading exchanges such as the US CME (Chicago Mercantile Exchange) which formulates and enforces guidelines for trading standardised commodity contracts and associated derivatives.
The prices of agricultural commodities are affected by the forces of supply and demand, but there is a multitude of other factors to be considered such as weather patterns, agricultural technologies, and population growth.
This means that there are always great opportunities to diversify your portfolio with a wide selection of agricultural commodities available for trading throughout the year.
What Influences Agricultural Commodities Prices?
There are many factors that impact agricultural commodities prices. Like every market, demand and supply strongly influence the prevailing market prices of agricultural commodities.
When the demand is greater than supply, higher prices will prevail; whereas high supply will trigger lower prices in the market. Because agricultural commodities are a daily necessity for human beings, there are bound to be many disruptions on their demand and supply that can significantly impact their prices.
A major disruptor is weather patterns. Weather volatility has a big impact on the supply of agricultural commodities, with extreme shocks, such as heatwaves or prolonged rains, capable of having even more severe effects.
The impact on production is twofold: extreme weather can cripple production when it hits a commodity at a crucial phase of development, or it can lead to a high cost of production when various measures are taken to curb its impact.
Both cases will result in supply inconsistencies, which will consequently reflect in the eventual prices in the market. Some extreme weather events include droughts, floods, heatwaves, extreme cold, and other natural disasters.
The use of technology in the agricultural field is also a major factor that affects the supply side of agricultural products. Technological innovations have continually shaped the agricultural sector over time as humans seek to produce products for their use as well as industrial utility.
In crops, there is a bid to seek more efficient irrigation techniques as well as breed resistance to diseases or harsh weather. The same applies to livestock, where technology helps in the healthy breeding and feeding of animals.
For the most part, technology helps stabilise supply, and sometimes even enhances it. Higher supply can lead to lower market prices, but on the other hand, farmers can stabilise their returns or even boost earnings on higher production.
Furthermore, technology can also help in analysing relevant data sets, which can eventually lead to decreased production costs.
Tariffs and trade agreements also carry massive influence on the pricing of agricultural products.
In most jurisdictions around the world, governments apply tariffs to protect local producers of agricultural commodities. This is particularly more prevalent in developing nations where the agricultural sector is the biggest employer.
Other concerns, such as trade wars or mutual trade pacts, can also play a role in the fluctuations in the price of agricultural commodities.
Other varied factors impact the pricing of agricultural products. On the supply side, the prices of oil or other energy sources, as well as related inputs, can impact on eventual market prices.
On the demand side, household incomes as well as sociodemographic factors, such as urbanisation and changing consumption patterns, can also impact the prices of agricultural commodities. Agricultural goods are therefore traded with all of these macroeconomic issues in mind.
How Are Agricultural Products Traded?
The various factors that impact commodities and their prices ensure that the agricultural market is in perpetual volatility. This provides traders dealing in related derivatives with many opportunities.
Agricultural commodities are usually bought and sold in cash or in the futures market. In the cash market, settlement is done on the spot using prevailing market prices. Whereas in the futures market, settlement is done at a predetermined price and date in the future.
There are numerous commodity exchanges around the world, but the largest by far is the Chicago Mercantile Exchange. This is where the largest grain futures and other agricultural commodities futures are featured.
There are many reasons why one would use futures and options in the commodities markets. For example, a large buyer of corn, such as a company that produces breakfast cereal, may buy corn at a specific price for delivery in the future in order to lock-in the price. This is referred to as hedging.
Other market participants will use options as a way to protect themselves in the same way that a futures contract would. Options on agricultural commodities are often transacted directly between commercial market participants for risk management or hedging purposes.
There are also many speculators who seek to profit from changing prices without any need for the physical delivery of goods.
Prices in the futures market change over time in relation to expected spot prices. This creates many trading opportunities for speculators to trade any underlying futures contract.
The pricing discrepancy between the expected futures prices and expected spot prices is observed as either contango or backwardation.
In contango, expected futures prices are higher than expected spot prices. In agricultural commodities, contango usually manifests when there is a short-term surplus that is not expected to continue well into the future. For instance, if there is a surplus in pork bellies, farmers may cut back on production, but the decreased prices may drive demand upwards in the short term. The associated costs of financing, storage, or warehousing of excess stock may also drive prices higher.
In backwardation, expected futures prices are lower than expected spot prices. Backwardation usually manifests when there is a supply shortage in the short term. For instance, if the price of beef futures increases, consumers can shift to other alternatives such as pork. But going forward, producers will be motivated to supply more beef to take advantage of higher prices. The possible excess supply in beef will mean that futures prices will tend to be lower than expected spot prices.
In both contango and backwardation, futures prices will converge to meet the spot price at maturity. This means that in a contango state, futures prices of an underlying agricultural commodity will, by maturity, fall to converge with the expected spot price.
Similarly, in a backwardation state, futures prices of an underlying agricultural product will, by maturity, rise to converge with the expected spot price. This means that understanding contango and backwardation states in the market can help speculators pick out high probability trading opportunities during the lifetime of any futures contract.
At Today Markets, we offer commodity CFD trading, which means that you do not need to worry about the physical delivery of actual commodities – instead you will be trading their price changes. Based on this, commodity CFD trading with Today Markets removes the complexities of trading the actual goods and it enables traders to benefit, irrespective of the direction that the market is moving.
Agricultural Commodities Trading Exchanges
Agricultural commodities trading is classified as the world’s largest traded commodity class and traded on national and international commodity exchanges. All commodities, including soft commodities (coffee, sugar and cotton) are being traded on these exchanges:
Corn, Soybeans, Wheat – Chicago Board of Trade (CBOT)
Coffee, Cocoa, Sugar and Cotton – Intercontinental Exchange (ICE)