Why Commercials Matters?
The first thing to have in mind: “Commodity Markets were created by and for commercials”. This player controls the vast majority of the open interest in most markets.
Also, control 3/4 of both and long open interest in options markets.
Commercials Commodity Traders most of the time hold an informational edge over other players, why? Well, firstly because they have the product that is being traded, long-standing relationships, and understanding of their industry. Secondly, they have really deep pockets and are capable to trade big enough to stabilize prices or make markets move in their advantage, like running stops. And if deeps pockets are not enough to get the advantage they need, commercials operate with the safety net of an offsetting cash position. Losses on future positions are offset by equivalent inventory gains.
Commercials Types:
Shorts:
These are producers who sell forward production in futures with the intent of locking in currently quoted selling prices.
Longs:
These are users of the product, like a jewelry producer buying gold. They are the customer of the producer(short commercial type) and they buy future contracts in order to fix inventory costs.
Let’s see some more examples:
Imagine a cotton merchant who contracts with farmers to buy crops for future delivery at a set price. Once the purchase cost is fixed, our merchant primary goal is to market the crop at profit, so if forward future prices are offering a favorable margin, he sells sufficient futures contracts to cover obligations until they are all marketed, otherwise if Cotton prices fall he only have to wait and make the physical delivery on the futures contracts.
Another example, consider the situation of a Cotton clothes producer. Cotton clothes shipments presumably are not influenced by seasonal factors and are easily predicted. Also, we all know that the quantity sold of a product will vary inversely with the price(supply/demand). In order to predict factors like sales and production schedules, with a certain profit margin the manufacturer seeks to lock future production costs, how? If his sales do not vary what can make this manufacturer have profits or losses? It’s how well/bad he buys the raw material for his production and in this case cotton. Cotton, as any other soft commodity is subject to a big variety of seasonal factors, so he uses the futures markets to buy Cotton contracts with a fixed price to future delivery. The same contracts being delivered by the cotton merchant in the first example.
Conclusion
If prices are going up they and you are a producer you will sell against the trend and this will make you profit, and if you are a user of the product you will buy when it’s going down because it will make your costs lower. This is the reason why these guys trade against the trend.
That’s it’s my friends! Stay tuned for more!
Best Regards
Leo Hermoso
