Commodities For Dummies
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Trading commodity futures contracts certainly isn’t for the fainthearted. Even the pros can run into lots of trouble in the futures markets. Consider what happened in the 1990s to a company called Metallgesellschaft. Metallgesellschaft (MG) was a German company partly owned by a conglomerate led by Deutsche Bank that specialized in metals trading. In 1993, MG lost a staggering $2.2 billion trading futures contracts.

In the early 1990s, MG set up an energy division to trade futures contracts in the United States. Its motive was to profit by betting on the price fluctuations of crude oil. MG’s strategy was based on taking advantage of the price differential between crude oil on the spot markets and futures markets.

Specifically, MG sold long-term futures contracts to various parties and hedged its long-term risk by buying short-term contracts and rolling them on a monthly basis. This strategy works beautifully — but only when the long-term prices are lower than the short-term prices. In other words, this is a good strategy when the markets are in backwardation.

However, in 1993, long-term crude oil prices started increasing, and MG was caught short with these contracts. When the markets moved to contango (prices for future months were higher than the current month), MG found itself unable to hedge the long-term contracts and was forced to meet the obligations on those long-term contracts.

Because it held such large open positions, MG eventually lost a mind-numbing $2.2 billion! The parent company pulled the plug, and MG was forced into liquidation.

The moral of this story is that futures trading can be volatile and risky, even for seasoned professionals. Fortunately for investors like you who are interested in commodities, the futures market is only one way you can invest in this asset class. If you’re interested in accessing the futures markets, you should seek the help of a commodity trading advisor (CTA) or a commodity pool operator (CPO).

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Amine Bouchentouf is an internationally acclaimed author and market commentator. You can follow his market analysis at www.commodities-investors.com.

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