Hedging against inflation in commodity trading

Hedging is a way for commodity traders, producers and end-users to cover themselves against negative pricemovements. That is to say, it is an insurance against price changes in any specific market – for instance the market for sugar or cocoa beans. We’ve talked about it extensively in our recent article on hedging with agricultural options. In this next piece on hedging we approach price changes on a more general, indeed macro level: price changes due to inflation.

Inflation is defined as a general increase in prices and (therefore) a fall in the purchasing value of money. An inflation hedge in turn is an investment that is considered to protect the decreased purchasing power of a currency that results from that loss of value.

Inflation

The rate of inflation is measured as a percentage of change of a price index – a sample of goods and services – from one year to the next. ‘If you’re not moving forwards, you’re moving backwards’ and ‘stagnation is regression’ are two expressions related to human development, but are said to apply to money as well. Inflation is always with us. Which is not necessarily a bad thing, as economists like to see a slow, steady rise in prices as an indicator of a healthy economy. When prices rise, the same amount of money buys you less. Inflation, in other words, eats away at the value of your bank account. The solution is to invest in anything that yields a higher return than the going rate of inflation.

Conventional wisdom states that gold is the go-to for inflation hedges, as it is an asset that tends to hold a steady value. At the same time, finance data shows that in the long term, stocks are a better bet to protect your portfolio against any inflation to come. The same goes for real estate. However, we are not in the business of hedging with gold, nor are we stock brokers or realtors and estate agents. We serve the trade of soft and/or agricultural commodities, and we’re here to tell you that those commodities too are at the top of investments that make good inflation hedges.

Commodities and inflation

Commodities of course are an especially broad category that cover anything from natural resources like oil and gas to precious metals, electricity, beef and foreign currency. The top five of soft commodities in terms of annual consumption is made up of cocoa, coffee, wheat, sugar and cotton. (On a totally unrelated note: Agiblocks covers all five;).

Commodities and inflation have a very special relationship. As a general rule, commodities are an indicator of inflation on the horizon. As the price of a commodity rises, so does the price of any product where it is used in the production process. Therefore, commodity prices exhibit measurable economic change before the economy as a whole (inflation) is affected. While commodity prices are not a hundred percent indicator of inflation, they can be a good starting point in hedging against inflation. That is why agricultural goods offer value as a portfolio diversifier that serves as a hedge against inflation.

It is possible to invest in commodities via exchanged traded funds (ETF’s), a type of investment fund where the assets are traded on an exchange. It is becoming increasingly popular due to the fact that it combines multiple aspects of the different types of traditional investment funds. ETF are the most traded product on exchanges and therefore an interesting aspect for investors. There are ETF’s for various specific commodities.

Hedging against inflation is an essential part of protecting your wealth, whether that wealth is sitting in a bank account or part of a portfolio of assets – or commodities.

Commodity trading and Agiblocks CTRM Solution

Inflation is also an unavoidable, calculated operational risk, not unlike counterparty risk, credit risk and market price risk. In commodity trading, a price can be settled in many different ways, ranging from a fixed price to a market related price. Of course, our Agiblocks CTRM solution can help you with all those steps, as physical contract management is where it excels; it supports trading management as well as financial management from the same source of data and within the same easily accessible application. Designed by traders, Agiblocks enables its users to focus on the essence of their trading.

Are you a trader, buyer or seller in soft and/or agricultural commodities and do you want to know more about commodity trading and our next-generation CTRM solution? The full range of Agiblocks functionality is available within our newly improved demo environment. Familiarize yourself with the tools and features of our powerful and agile software solution and find out how you can improve your daily routine. Find out more!

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