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Commodities are Cheap, Here's How to Trade the Sector

06/20/2019 5:00 pm EST

Focus: COMMODITIES

Carley Garner

Senior Strategist & Broker, DeCarley Trading

The commodity markets are dealing with obstacles from multiple angles, writes Carley Garner

The commodity markets are dealing with obstacles from multiple angles. For instance, a higher U.S. dollar has put downward pressure on energies, grains, softs, and even meats. As the U.S. dollar weakens, U.S. exports look more expensive to overseas buyers causing them to look elsewhere for their purchasing needs. Further, U.S. trade tensions and tariffs have disrupted the supply chain that facilitated grain and meat trades with China. Adding salt to the wound, the U.S. shale boom has resulted in supply gluts in both crude oil and natural gas. Domestic commodities are historically cheap while other assets such as stocks and Treasuries are historically expensive. 

 

Investors often flock to what is familiar to them, which is stocks and exchange traded funds (ETFs) to gain commodity exposure but that is often the least efficient method. There is nothing cleaner than speculating in the commodity markets using futures contracts. Not only do most futures trade around the clock, but they are also tied to the underlying asset enabling the price discovery to be pure. On the contrary, many commodity ETFs are simply pools of money fund administrators turn around and use to purchase futures contracts. This creates an inefficient derivative of a derivative diluting the correlation between the ETF and the underlying commodity price. With that said, there is a low margin and relatively low-risk futures contract available that tracks a basket of commodities; the Bloomberg Commodity Index (BCI). This product enables traders of all sizes to participate in the futures markets in a diversified manner without being forced to take the outsized risk most assume are required.

 

The BCI is currently valued near 78.00 and makes or loses $100 per point. Thus, a move to 79.00 creates a profit of $100 to a bullish trader but a move to 77.00 creates a loss in the same amount (see chart below). A weekly chart of the index depicts a market sitting on support near all-time lows. Should prices hold, the BCI could make its way back into the low-90.00s. The margin on this futures contract is $350; while trading it can feel like watching paint dry, once the market trends there can be an opportunity for traders. 

weekly commodity chart

 

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