Why Trade Commodities

The commodities market, rich in history and diversity, presents traders with a myriad of opportunities across various levels of volatility, liquidity, and risk. Here’s why commodities matter and how they can enhance your trading strategy.

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Benefits of commodity trading

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1. They balance your portfolio

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^Trading commodities offers a great way to diversify your portfolio due to their low correlation with traditional financial assets like stocks and currencies. This low correlation implies that when stock values decline, commodities may rise, helping to balance your overall risk across various markets.

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2. They protect you against inflation

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You might have heard the term “hedge against inflation” when referring to commodities. Think of it like a physical hedge, which acts as a barrier protecting a piece of land.

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Hedging in commodities is a way to protect your investments from the negative effects of price volatility. So, when commodities are the ‘hedge’, they protect you (the land) from the negative effects of inflation (outside influences). 

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Inflation is what happens when purchasing power weakens because of rising prices. One of the main causes of rising prices is an increased demand in goods and services. 

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When there’s a rising demand for goods, more raw materials (like metals or agricultural products) are needed to produce these goods, which leads to an increase in demand and the value of these materials. This is good news if you trade on them.

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3. They are a store of value

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Commodities also provide additional protection for your capital by acting as a store of value. 

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What is store of value?

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A store of value refers to an asset that usually retains its value over time, without being significantly affected by economic or natural disasters. Precious metals are considered a store of value, or safe haven investments, as they have generally retained their value over the years. 

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Why is gold a store of value?

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Take gold for example, which have been traded for thousands of years and are still considered valuable commodities today. The value of gold increases even in failing economies thanks to increasing demand as people rush to store their wealth in a safe asset. 

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Commodity and currency correlations

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Certain currencies offer indirect exposure to commodities, making it crucial to understand these relationships for potential trading opportunities. Here are three key currency pairs linked to commodities, along with strategies to integrate them into your trading approach:

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1. US dollar/Canadian dollar (USD/CAD)

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Canada, among the world’s top 5 oil producers and exporters, shares a strong trading relationship with the United States (US). Nearly all of its exports go to the US, so the country earns most of its USD earnings through selling oil. This is why oil prices hugely influence Canada’s economy and financial health. When the price of oil rises, the CAD typically rises too.

USD/CAD trading tip

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Compare the charts of oil and the CAD. Identify the support and resistance levels, trends, and patterns. If you see a sudden spike or dip in the oil charts that isn’t reflected in the CAD chart yet, this commodity currency will likely follow suit. Additionally, suppose your research and analysis lead you to speculate that oil prices will rise. In that case, you could observe the value of CAD rising as well.

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2. Australian dollar/US dollar (AUD/USD)

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Australia is one of the largest gold exporters, earning revenue through gold exports. As a result, the AUD has an 80% correlation with the gold prices. 

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China, a key contributor to global manufacturing, is Australia’s largest trading partner. China tends to prefer Australia’s natural resources over its competitors’ due to the quality and Australia’s proximity. This makes the Australian economy’s health heavily reliant on the prices of the commodities they export. 

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AUD/USD trading tip

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Along with keeping a close watch on the performance of gold, also stay abreast with news on China’s economic and political affairs. If China increases its demand for raw materials, Australian exports could also rise, resulting in a rise in the AUD.

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3. New Zealand dollar/US dollar (NZD/USD)

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New Zealand is the world’s biggest exporter of dairy products. It also exports meat and wool. The NZD’s value fluctuates according to the price of these commodities, which determines the revenue the country will receive. Australia and China import vast quantities of dairy products from New Zealand, so the NZD also depends on the economic performance of these countries and the demand that stems from them.  

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NZD/USD trading tip

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The NZD/USD and the AUD/USD are highly correlated since New Zealand is located close to Australia and the two countries export a lot of goods to and from each other. Compare the NZD/USD and AUD/USD price trends and use this information to base your speculation.

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Start forex and commodities trading today!

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Trading commodities provides numerous advantages, such as portfolio diversification, high liquidity, and the potential for substantial returns, along with exposure to global markets. By grasping the connections between commodities and specific currencies, you can capitalize on opportunities driven by global economic trends. Keep in mind that all trading carries risks, so ongoing education and adaptability are crucial for sustained success. Open your free practice trading account and dive into the commodities market today!