What are cash commodities?
What are cash prices?
Cash prices on commodity CFDs are created by stripping out the carrying costs that are built into complex futures prices. By doing this the cash price becomes smoother and more continuous, avoiding the price disparities (price jumps) seen when a futures contract expires and is replaced by the next contract.
The carrying costs are then applied to the position as a financing adjustment at the close of business each day, providing total transparency on the cost of holding the position.
The logic is based on the same link between a cash price on an index CFD (such as the UK100) and the FTSE Future. With an index CFD, the relationship between the two prices is linked by the rate of interest and any dividends individual companies pay out (hold the index CFD and you receive dividends, hold the future and you do not).
Whenever a futures contract becomes the new front month, the difference between the CMC Markets cash price and that future’s price will be at its widest. On the last day of trading of the futures contract the price is roughly equivalent to the CMC Markets cash price (at expiry the futures contract is no longer a contract for settlement/delivery in the future, but 'now').
You can approximately work back to the futures price from the CMC Markets cash price, using this formula:
Daily Move of the Future ≈ Daily Move of the CMC Markets Cash + Daily Carrying Costs
What drives volatility in the commodities market?
Traditionally, commodities have shown very little correlation with popular financial products, such as shares and bonds, and have historically performed with considerable volatility.
Supply and demand are the main drivers that affect the prices of commodities. The doubling of the world’s population in the past half century to almost 7 billion people has largely driven demand. There are more mouths to feed, infrastructure to build, and cars to fuel. The emergence of resource-hungry economies like China and India, with a combined population in excess of 3 billion people, accounts for much of these fluctuations in commodity prices.
Production
There are many factors that impact the movement of the commodities prices, including weather conditions, acres planted, production strikes, crop diseases, technological developments and international trade unions. Commodities are capital-intensive products to produce, have considerable lead times and, in many cases, are politically controlled, through subsidies, taxes or trade restrictions. All of these factors are important and have considerable influence on the cost of production, export potential and, therefore, prices.
Inventories and infrastructure constraints
Commodity price movements are also closely tied to inventory and storage capacity. Inventories serve as a bridge between physical supply of a commodity and the current global market demand. Inventories in themselves are heavily constrained by storage capabilities. Metals and agricultural products do not run into storage capacity constraints as quickly as oil or gas. An inability to manage either of these through supply and demand shocks (drought and production strikes, for example) can force prices to react quickly and aggressively.
There are large, expensive infrastructure constraints when it comes to the storage of commodities. In fact, if there was an infinite ability to store excess supply, there would be very little fluctuation in the price of many commodities over the short term. The easier a commodity is to store, the less volatile the price is likely to be. Agricultural commodities can have the additional constraint of being perishable, which adds a further time constraint to how long they can be stored. When a commodity has low inventories, then consumers are more likely to pay a premium for the scarcer commodity.
Demand and cyclical movements
There have been considerable cyclical movements in commodities prices over the last few years. Emerging market demand has attempted to grow during a period of developing market constraints, pushing many commodity prices higher, and bringing supply in line with demand. In essence, the market is now paying for recent lack of investment in underlying production, distribution and storage. When you factor in depleting supplies, environmental pressures, political constraints and continuing uncertainty in the equity markets, it is easy to see why commodities are now a very real and interesting alternative to traditional investment products.
The costs of holding a commodity
If you were to take physical delivery of a commodity like oil or gold, you would incur the cost of holding that asset in the form of storage fees, insurance, opportunity costs and seasonal factors. Traditional futures contracts build these costs into the price, making it hard to distinguish between the actual price of the commodity and the cost of carrying the position until expiry.
Interest cost
If you buy a commodity in the future you only have to pay for those goods at that point in time. If you buy now, at the cash price, you have to pay for that commodity now. The cash price will be cheaper, therefore, to reflect the missed interest of buying now (opportunity cost).
Example: Risk-free interest
One simple way to think of this is like keeping money in the bank. If you kept the money in the bank until the future payment date, you will have received interest. So, by paying for the commodity now, you forgo this interest. This opportunity cost is traditionally reflected in the futures price.
Storage costs
Commodities such as corn, wheat, gold and oil need to be stored. The associated costs will be different for each commodity.
Example: Storage cost for crude oil
The US consumes approximately 22 million barrels of crude oil per day while only producing 5 million barrels per day. This considerable shortfall requires them to maintain a stockpile. With total storage capacity limited to 350 million barrels, the storage cost is currently between US$0.15 to US$0.30 per barrel per month, while transportation costs are approximately US$0.20 per km per barrel. These storage costs would be built into the futures price.
Seasonal factors
The supply of a commodity may be greater at different times of the year, depending on where it is produced. Supply may also be severely disrupted by things like weather, politics, natural disasters or human error. Demand changes seasonally. Good examples of this are heating oil and natural gas, which peak during winter and slow during the warmer summer months.
Example: Seasonality in the US Heating Oil market (demand)
