How to trade seasonality in commodities

Introduction

There are different types of commodities, I like to classify them into three groups: energies, metals, and agriculturals. Each group has different characteristics, but high volatility is the common characteristic of all the groups. It is higher than in another kind of assets, the reasons are the following:

• There is less liquidity than other assets
• The supply of these commodities depends on the weather and another less probable natural disasters such as earthquakes, hurricanes, floods, and droughts
• The Supply and demand relationship is more important than in other assets
• There is geopolitical risk
• Some commodities are correlated with the economy (in a positive way or negative if they are considered as a safe haven)

Would you buy a winter coat in August? I’ll be able to do it without any problem because it´s cheaper than in autumn and winter. The demand for this product is lower in summer, the fashion world moves quick and maybe the style of the coat won´t be as trendy as the last season. As soon as the winter comes the demand increases and I can re-sell it and get more money than I paid. This is a humoristic explanation and I hope that you got the point. You can use the same rational process to analyze commodities. Let’s check some examples:

Energy Commodities

Heating Oil Futures

    Source: TradingView, Heating Oil Futures

I have highlighted some seasonal trends I saw during the last 3 years. You can see that May and August are the most important. In 2015, this market was bearish this is why the first trade didn’t work. The August trade was successful in the period shown.

According to other websites, the ideal trade would be: buying in July and selling in December. I’d like to recommend Moore Research Center Inc because they have done research since a long time ago and they offer very interesting services. I don’t have any business relationship with them.

Heating Oil Nov17 vs Aug18

    Source: TradingView, Heating Oil Nov17 vs Heating Oil Aug18, Daily

The November contract is represented by the blue area while the August contract is represented by the orange line. As you can see in the warmer period, Spring and Summer, the winter contract trades below the summer contract. But this relationship reverses as soon as the weather becomes colder.

    Source: TradingView, Heating Oil spread Nov17-Aug18, Daily

This is one of the best examples of how the spreads trend better than the outrights. It´s been going up since July.

Agriculturals

Soybean Oil Futures

     Source: TradingView, Soybean Oil Futures, daily

The soybean oil usually trends up between February and April, and between October and November. The successful trades would have been 66% or 4 out of 6 times. This is why we always should question the online and published research before trading. Every day in the markets is different.

Precious Metals

The seasonality in precious metals is driven by the demand. The Gold and Silver prices usually rise between November and February due to the Christmas, New Year’s holiday season and the Wedding season in India. Another period of rises is between August and September. It´s difficult to see in a candle chart but if you calculate the monthly change and compare with the previous years.

Gold Futures

    Source: TradingView, Gold Futures, daily

As you can see the strongest seasonality is in the first two months of each year.  The Aug-Sep seasonality is not as strong as the beginning of the year. As you can see it didn´t work in 2014. Gold is considered a safe haven, so its value will rise if the risk is increasing because the most part of the people will buy gold to hedge their portfolios.

                                       Source: commodityseasonality.com, 20 Year average performance for Gold

This chart confirms what I said before and I believe that is one of the best ways to check seasonality. That’s a great job by the commodityseasonality.com authors.

                                       Source: commodityseasonality.com, 20 Year average performance for Silver

This is another example to show that Silver seasonality has the same pattern as Gold.

How should we trade it?

After this brief explanation, we understand how the seasonality works and why the prices go up during some months. There are a lot of possibilities but I’m going to propose two of them:

Trade the outright of the one of the strongest month. This involves a lot of risks, you need to deposit a high margin and the size of your portfolio should be big, the transaction cost is lower than a calendar spread or another kind of spread.

Trade the spread between a high demand month and a low demand month, for example, February vs April. It´s less risky, the trading fees are higher, the margin you need to deposit is lower than if you trade the outrights. Is it worth?

Gold Spread February18-April18

     Source: TradingView, Gold Spread Feb18-Apr18, Daily

This is a trader’s dream. It doesn’t matter the seasonality in this spread, the most important thing is choosing the levels and applying good risk management.

Conclusion

The commodities world is very interesting and offers a lot of opportunities to trade. You can apply different strategies, this post is based on seasonality. One of the disadvantages is the high volatility. As I explained before, you can use spreads in order to reduce volatility and limit the risk involved.  You shouldn’t base your decisions on only one factor, remember that can be affected by different factors: weather, supply and demand, geopolitical situation, economic growth. I hope it helps.

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverages involved