How Does Physical Commodity Trading Work?

Physical commodities are seen as one of the underrated and underappreciated assets for traders. The reason for this is because it competes with stocks, mutual funds, and even cryptocurrencies. Still, they are great to have for your trading portfolio.

They provide you with an excellent opportunity to profit off of the market’s performance of certain commodities. In this guide, we will answer the question of “how does physical commodity trading work”? We’ll go into the basics and discuss who plays a critical role in the market and trading process. Let’s dive right in and discuss the following.

What are the basics of physical commodity trading?

Physical commodity trading features the exchange of actual goods. This is different from trading stocks or bonds, which are considered financial instruments. As such, physical commodities are tangible assets including metals, agricultural products, natural gas, crude oil, and even energy resources.

You can trade these on an online marketing platform that is available in your geographical location. Physical commodities, like anything else traded on the market, can also be influenced by various factors including geopolitical situations, events with the supply chain, and others. Thus, it’s always a good idea to keep an ear on things when it comes to information being reported by the media - especially when it can possibly affect certain commodity markets.

Who are the key players in physical commodity trading?

There are several different groups of people that play a role in the physical commodity market. Let’s cut to the chase and feature each of them:

Producers and suppliers

Without these two groups, there would be no commodity on the market to begin with. These are the people who extract and cultivate the materials that will be bought and sold on the market. Producers can sell directly to their consumers or take a more efficient distribution route partnering with traders and other intermediaries.

Traders and merchants

Traders are intermediaries or middle men between the producers and users. They purchase the commodity in large numbers. In turn, they will sell them to either the user or other traders.

Merchants may own the goods themselves. However, they are also responsible for the other aspects of market processes including transportation logistics, storage, and distribution. Thus, merchants may charge higher prices to cover the costs that arise.

End-users or consumers

These can be individuals or businesses to industries. The purpose of purchasing these commodities can be for consumption, investment, or production. It will depend on the intent of each end user.

Banks and financial institutions

On a regular basis, financial institutions can play a role in providing financing and risk management services to their clients. This includes trading strategies such as hedging or even offering loans with the funds being used for trading purposes. Such services offered may depend on the financial institution themselves.

The trading process: How it all works

Now, we’re going to dive into the trading process itself. Without wasting time, let’s explain every part of it:

Contract negotiation

This is the starting point of the trading process. Negotiations between producers and traders will be made here. The primary result is agreeing to the contract terms: including quantity, quality, price, and the delivery date of the commodity being negotiated.

Logistics and transportation

Once the contract is a done deal, the logistics phase will begin. This features the logistical aspects including transportation and storage. Processing of the commodities may also play a role here.

Storage and warehousing

Physical commodities may need to be stored prior to reaching their final destination. Meaning it will need to be stored in warehouses or similar facilities.

Quality control

Quality is everything when it comes to physical commodities. The better the quality, the more it can command a higher value and price. It can also affect the end-user experience, which can be positive or negative.

The end user feedback could also influence the supply and demand of the commodity, leading to future market movements in the positive or negative. The market itself may also voice their sentiment about a certain commodity, giving you an indication of how it could perform over the next few months and beyond.

Payment and settlement

Upon delivery, payment and settlement is reached. The payment is then transferred to the seller via the buyer. This can be in the form of financial instruments including letters of credit, cash, and others. 

What can impact the physical commodity market?

As we’ve mentioned earlier, there are instances where the physical commodity market could be affected by certain events. Many of them are outside of our own control. Here’s a look at the following:

• Geopolitical events: Such situations like military conflicts could affect the commodities market. For example, the Middle East is a region known for its crude oil production. Due to regular violent conflicts, the market itself is typically on shaky ground.
• Supply chain situations: If something adverse within the supply chain occurs, it can disrupt the remainder of the process. As this happens, financial implications may arise as a result. In order to cover potential costs, the price may increase.
• Economic development: Physical commodities can be a key element to economic development in regions across the globe. It has the ability to create jobs and other economic opportunities. If an area is rich in a commodity, it can signal strong economic development for the long term. Even so, certain events that may disrupt the market may still occur.

Work with PermuTrade when it comes to physical commodity trading

If you are planning on trading physical commodities, we hope you were able to get a good idea of how it all works. At PermuTrade, we’re all about working with those who want to trade these tangible goods on the market and include them in their portfolio. We believe that with physical commodities, there is still a lot of potential even in a world where stocks and crypto may reign supreme.

Want to know more about physical commodity trading? Contact PermuTrade today and we’ll be happy to help.