In many ways, the stock market and commodity market are linked. In theory, the stock market rises and falls based on the reported earnings and projected earnings of the companies with stock trading on an index. When business slows, or the cost of producing products rises, earnings will fall and so will stock prices. Most of the time, when the commodity markets are rallying, the increase in prices of those commodities means corporate earnings of users of those commodities will decline. Sometimes intervention by central banks creates a situation where both commodity markets and stock markets rally or drop, but historically, this is unusual.
Commodities prices trade on the interplay between supply and demand. For example, developing countries such as China and India require heavy investment in commodities such as steel and oil to build their infrastructures, cotton and metals to manufacture products and food-related commodities to feed their increasingly middle-class populations. These trends have created heavy demand and higher prices for commodities. High demand has also attracted investors, who formerly invested in only stocks and bonds, to take advantage of commodity market strength and its normal inverse correlation to the movement of the stock market.
When manufacturers can purchase commodities inexpensively, their earnings rise and their stock prices often follow. High commodity prices tend to choke an expanding economy because they make the price of goods too high for continued strong consumer buying. When consumers stop buying manufactured goods, manufacturers' earnings drop and their stock prices also drop. However, high commodity prices can be offset by cheaper manufacturing costs, such as when a manufacturer outsources production to countries where the labor is much less expensive. Further, consumer demand in developing countries can also keep manufacturers' earnings and stock prices high.
When the global economy goes into decline, central banks from different countries often try to boost their economies by keeping interest rates low. Low interest rates reduce the cost of manufacturing because companies can borrow money cheaply to fund operations. Low rates also reduce the cost of producing commodities for the same reason. This means continued high demand for commodities and continued high earnings for manufacturers. Commodities markets and stock markets both tend to rally when central banks try to stimulate the economy through lower rates.
How Commodities Trade
Commodities futures trade in the United States on the Chicago Board of Trade (CBOT). The CBOT is part of the CME Group, which also includes the Chicago Mercantile Exchange (CME), New York Mercantile Exchange (NYMEX) and COMEX commodities exchange. Futures are contracts to buy or sell commodities at a specified date in the future and require delivery. Each futures contract represents a specified amount of the commodity such as the numbers of barrels of oil or bushels of corn. There are also options on commodities futures, which are contracts to buy or sell the futures at stated prices. Unless these options are exercised, however, they do not require delivery of the commodity. Options are traded on the Chicago Board Options Exchange (CBOE). To trade futures or options on commodities, you must apply and be approved for a special commodities or options account with your broker.
How Stocks Trade
Stocks trade on stock exchanges such as the New York Stock Exchange and on trading platforms such as NASDAQ and the various other over-the-counter, or OTC, platforms. Each stock represents a fractional share ownership in its issuing company. To trade stocks, apply for a cash account at your broker. If you want to trade them on margin, allowing you to borrow a portion of the purchase price, apply for a margin account.
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