Commodities

Question 1

The commodity market can be accessed in which two ways?

Answer 1

1) Direct
2) Indirect

Question 2

What two ways can the direct commodities market be accessed?

Answer 2

1) Cash Market
2) Futures / Forwards

Direct market can mean taking delivery of the goods.

Question 3

What costs must be paid if delivery of a commodity is taken

Answer 3

1) Storage Costs
2) Insurance of Goods

Question 4

What way can direct access of commodity avoid taking delviery of goods?

Answer 4

Forward and futures contracts exited before expiry.

Question 5

What are the benefits of direct commodity investment?

Answer 5

1) Portfolio Diversification
2) Inflation Hedge

Question 6

What is a hard commodity?

Give two examples

Answer 6

Natural resources that must be mined or extracted

1) Metals
2) Crude Oil

Question 7

What are the two categories of metals?

Answer 7

1) Base (Tin, Copper, Lead)
2) Precious (Gold, Silver, Platinum)

Question 8

What are the two primary crude oil benchmarks?

Where are they traded?

Answer 8

1) Brent Crude - Traded on Ice
2) West Texas Intermediate - Traded on NYMEX

Oil tends to be the largest component of most commodity indexes

Question 9

What are softs, and what are the 3 main categories?

Answer 9

Softs are argicultural commodities with a variety of uses.

1) Foodstuffs (Wheat, Soya, Sugar, Orange Juice, Rice etc)
2) Livestock (cattle, pigs)
3) Textiles (Cotton, Wool)

Question 10

Who is the direct cash market suited for?

Answer 10

Suited for wholesale industrial buyers and producers.

Question 11

Why is the direct cash market unsuitable for retail investors?

Answer 11

1) Large contract size
2) Potential deterioration of softs

Question 12

When is delivery made on the cash market?

Answer 12

Immediately.

Payment also taken immediately (including storage / insurance)

For metals it is possible to store these at an approved warehouse by the LME.

Question 13

Give 4 key features of the futures market / contracts:

Answer 13

1) Standardised quantity
2) Specified asset
3) Fixed future date
4) Price Agreed today

Question 14

If a farmer no longer wishes to deliver their goods, how can they get out of a futures contract?

Answer 14

Undertake an equal and opposite trade

This is common, few contracts run through to physical delivery

Question 15

Investors can also gain commodity exposure through forwards. How do these differ from futures?

Answer 15

1) Trade OTC
2) Bespoke / Customiseable
3) More counterparty risk

Question 16

How do commodity swaps work?

Answer 16

Party 1 pays fixed leg (fixed price of commodity - hedge against price rises)
Party 2 pays a floating leg (floating rate of commodity - hedge against price falls)

Party 1 is a buyer of the commodity
Party 2 is a seller of the commodity

Question 17

What ways can an investor indirectly invest in commodities

Answer 17

1) Shares of a commodity producers
2) Non-retail OEIC / UCITS (QI scheme)
3) Investment Trust
4) ETF
5) ETC

Question 18

How to ETFs and ETCs differ?

Answer 18

ETFs can track a basket of commodities, futures contracts or company shares.

ETCs track the price of a single commodity.

ETCs allow access to hard to invest in commodities

Question 19

One benefit and one risk of ETF/ETC

Answer 19

1) Liquid/Simple
2) Follow price falls in bear market

Question 20

What are the advantages of indirect investment in commodities?

Answer 20

1) Liquidity of ETFs and ETCs
2) Low correlation to equities and bonds
3) Some funds can pay dividends

Question 21

What indices are used to track comodity performance?

Answer 21

1) S&P GSCI
2) Bloomberg COmmodity Index

Question 22

Commodities hedge against inflation

But can be volatile and cyclical. What effects commodity price/performance?

Answer 22

Supply and Demand - Influenced by:
1) Weather
2) Economy
3) OPEC

Question 23

When can commodity performance be correlated with equities?

Answer 23

During downturns - as production / demand falls

Question 24

What do base metal prices show?

Answer 24

Serve as a bellweather for economic performance/demand

due to their use in industrial production

Question 25

When do base metals perform well and when do they perform poorly?

Answer 25

1) Perform well during booms / expansion (production increases) 2) Opposite in contraction (production falls)

Question 26

When do precious metals perform well?

Answer 26

When needed as a safe haven asset (e.g. fall in USD)

Question 27

Why are soft commodity prices more volatile?

Answer 27

1) Harvest quality 2) Disease 3) Good/bad weather 4) politcal / local factors ## Footnote Investors need to bear in mind the short cyclical factors at work in agricultural commodities

Question 28

What does Oil price fluctuate inversely with?

Answer 28

USD e.g WTI rose to 110 and fell to 30 as dollar weakened then rallied

Question 29

Give 2 examples of how demand affected oil price

Answer 29

1) Covid - WTI went negative 2) Russia / Ukraine - price rose as supply fell