Understanding gold futures and other commodity derivatives
What are commodity derivatives?
Commodity derivatives are financial instruments or contracts that derive their market value based on the spot price of a given commodity. That underlying commodity may include common raw materials such as crude oil, soybean and palm oil. Commodity derivatives can be exchange traded – like futures contracts on palm oil – or traded in the over-the-counter market.
There are various commodity derivatives products on the market. To gain exposure on certain commodity derivatives, one option is going long or short on a futures contract. Going long means an investor anticipates a future price increase.
For example, if you go long on a gold futures contract at US$1,150 and the price increases to US$1,300, you will gain a profit of US$150. Multiply that amount by the amount of leverage – usually around 5 – and that will give you a total profit of US$750 before commission fees. You would then have to close out your original long position by going short. You could also profit from price declines by shorting a futures contract.
So, what are some of the most popular commodity derivatives among retail investors?
Gold is a commodity that needs little explanation. It is a form of precious metal and investors are able to profit from the movement of gold spot prices on a leveraged basis by buying or shorting gold futures contracts. Investing in gold through gold futures could be a good form of diversification as stock prices are known to have a low correlation with gold prices. Some of the futures products available include FGLD traded in Bursa Malaysia Derivatives Exchange.
Crude Oil Futures
Oil is one of the major energy sources in the world and widely used by many industries. Its market is huge and retail investors can get exposure to oil prices and potentially profit from oil futures contracts. The recent plunge in oil prices in 2015 and 2016 may bring about opportunities for investors looking to profit from the recovery of oil price. Some of the futures products available include the Crude Oil futures on NYMEX (New York Mercantile Exchange).
Crude Palm Oil (CPO) Futures
Malaysia and Indonesia are the 2 largest palm oil producers globally, accounting for nearly 85% of world’s crude palm oil output. Crude palm oil is widely used to produce household products such as soap and cooking oil and crude palm oil futures are one of the main commodity derivatives used by producers to manage price risks.
Experienced investors would typically look through fundamental data like export figures and inventory levels to forecast future price trends. Some other key factors which affect inventory levels include weather patterns. The most recent key event was El Nino when higher temperatures in the South East Asia region crimped palm oil output and sent palm prices soaring to historical highs.
Technical analysis is also used in conjunction to assess market sentiment. Investors can potentially profit from the price movements by buying or shorting futures contracts. The best available futures contract on crude palm oil would be FCPO traded on Bursa Malaysia Derivatives Exchange which boasts deep and highly liquid market for crude palm oil futures contracts.
Coffee beans are mainly grown and harvested in Brazil and Vietnam. Coffee is an indispensable beverage for most working adults and widely consumed by the world’s population. Similar to palm oil, investors can take advantage of futures contracts on coffee and gaining exposure to coffee bean prices. There are two major coffee bean grades: Arabica and Robusta. ICE (Intercontinental Exchange) offers Coffee C Futures which is a standard futures contract on Arabica coffee bean. The key to analyzing or forecasting coffee price trends includes in-depth analysis of export figures, supply and output forecasts.
Before you start trading commodity derivatives, take note of this
Commodity futures are leveraged financial instruments, so in order to trade futures contracts, you must first open a brokerage account with a licensed futures broker in Singapore that is governed by Monetary Authority of Singapore (MAS). The futures broker would require an account holder to demonstrate a working knowledge on derivative financial instruments before giving approval to proceed with the account opening. Account holders must also deposit a minimum of $10,000 in the margin deposit before the account can be activated and trading can commence. Do note that the margin deposit requirement differs from broker to broker.
Where can I go to start investing?
Some of the established players in the futures brokerage industry in Singapore include:
- Phillip Futures
- Saxo Capital Markets Futures
- KGI Futures
- OCBC Securities
As with many financial instruments, investing in commodity futures may lead to losses to investors. The best approach would be to allocate a small proportion of total investable funds into commodity futures. Money management skill is vital to being a successful commodity derivatives investor. Always be mindful to use stop losses to limit losses as price swings of commodity futures can be extremely volatile.