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World’s Most Traded Commodity – Oil or Intelligence?

Posted in Finance Articles, Total Reads: 4544 , Published on September 15, 2013

The Article is specifically aimed at those readers who still believe the most traded commodity is Oil or Petroleum Products. It shall question the said belief and help in bringing forth certain issues underlying our economy and the global economy at large which has still not gained enough attention.

Crude oil is the harbinger in all the commodities traded globally. It is also one of the most extensively used fossil fuel. A look into the reserves of Crude Oil globally brings forth the importance of Middle Eastern countries on floor as they lead with a reserve of 796,845 m b (2011)* of a total of 1,481,526 m b (2011)* in the world. Among these Saudi Arabia leads with a proven crude oil reserve of 265,405 m b (2011)*. In addition to this, Crude oil is the world's most actively traded commodity, and the NYMEX Division light, sweet crude oil futures contract is the world's most liquid forum for crude oil trading, as well as the world's largest-volume futures contract trading on a physical commodity. Because of its excellent liquidity and price transparency, the contract is used as a principal international pricing benchmark. The contract trades in units of 1,000 barrels, and the delivery point is Cushing, Oklahoma, which is also accessible to the international spot markets via pipelines.

image: Grant Cochrane, freedigitalphotos.net

On one hand the biggest consumers of Crude oil being US followed by EU, China, Japan and India are together gulping down more than 50% of crude oil Consumption across globe and on the other hand crude oil is being traded in the commodity future market in much more amount wherein there is no physical transfer taking place. The financial innovation has led to an increase in the financial market transactions with a commodity which in the real sector is traded in much less quantity when compared with its financial market counterpart. In addition to this, the market model of pricing has also led to fluctuations in the real sector for the commodity as well.

“I am bullish” said one of my friends a few months back in context of crude oil prices. The rationale was explained too with numbers crunched hard to make meaning out of them. Having understood the rationale I agreed with the bullish outlook on the commodity. However, few months into the trade a sudden supply shock pulled the prices down. And there we were with a loss into our trades. Having crunched all the numbers possible still we could not end up with a profitable trade. Such a hit on my capital made me think that is it crude oil that I am trading or my intelligence?.

According to my intelligence and understanding I picked up a commodity which has good volatility in it. So, it would not have matter me much whether I played in crude oil, cotton, corn or metals. It’s my understanding of the dynamics of the particular commodity is what led me to trade in a certain commodity and not the commodity itself.

Let’s try and understand this with a simple example. I am an options trader and used a short strangle strategy to trade in a particular stock because I believe the stock is going to move around in a particular range in one month. The premium I received is the maximum profit I am going to make while my losses are unlimited if the stock goes beyond the range. The question I am asking after making this trade is that is it the stock I am interested in or the understanding of its prices that has actually led me to believe I have a better understanding than the other players of the market to benefit from it. The answer always is I am not attached to any stock. I am into it for profits from that stock and my understanding and intelligence is what I am trading for.

At any point in time, be it in the commodity market or stock market, there are buyers and sellers standing with their bid and ask prices. The buyer holds a bullish outlook given his idea and understanding of the Economy, Industry and Company or commodity. The seller holds a bearish outlook given his use of intelligence. So a buyer of crude oil future is buying it sensing a price increase, such as what I did, and a seller is forecasting a decrease in its price.

The world’s stock market and the commodity market thus don’t sell and buy stocks, companies or commodities. They bring together people who think they have better intelligence levels than others to exploit the same against them and garner their wealth. Thus, it’s nothing but a trade of intelligence. In all the trades that happen globally in futures, options, swaps, equity or other derivatives wherein no trader is interested in taking home a commodity for consumption is nothing but a trade of intelligence they think they possess more than the semi efficient markets.

The bigger question thus lays in front of us that whether an abstract thing like intelligence should be allowed to be traded. As more and more financial innovations are taking place, we have developed from Equity – Future contracts – Funds – Fund of Funds wherein most players don’t intend to hold any physical inventory of gold, commodity or voting rights(for shares), the greed of belief that my intelligence is at a level higher than the markets is also gaining pace. Financial Markets on one hand serve the purpose of financing for the companies and on the other is encouraging greed and fear at the same time into the nations very sophisticated investors and the retail investors who follow the others to a place where in the spillover might turn out to be devastating for the economy and the real sector as well. Money, being a medium of exchange for real goods is now a medium of exchange for risk, fear, greed and intelligence due to widespread development in the financial markets. The distinction between real sector and financial sector is already blurred and the more the financial market will grow less will be the incentive for investors to invest in real sector.

In a nutshell crude oil is required for industries worldwide and the same is a very vital commodity for any developing or developed nation and thus rightly holds the crown of the most traded commodity. However, in our quest to a better civilization and industrial development we still haven’t developed enough when we look at the other side of these trading transactions and we notice that we are actually not trading crude oil but something so abstract as fear, greed, risk and intelligence. Given the amount of trades and the number of contracts that happen worldwide in Stock exchanges, Commodity markets we can rightly say that Crude oil is not the most traded commodity in the world. Intelligence is the most traded stock in the world.

The article has been authored by Rahul Agarwal, TAPMI, Manipal.

References : OPEC Website.

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