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Hardening

Reviewed by Sweta | Updated on Sep 30, 2020

Catalogue

Introduction

Hardening refers to the stabilisation or gradual increase in prices in the commodity futures market. Commodity traders, generally, enter into a futures contract to protect themselves against any unforeseen future volatility in prices.

Understanding Hardening

Hardening is a measure of price volatility. Commodity prices fluctuate when there is no sufficient supply to meet the demand. Commodity prices harden when the supply meets demand. Such commodities include base metals, crops, crude oil, gold, and so on. Base metals such as copper and zinc are inputs for the manufacturing industry. Similarly, food crops like soy and corn form inputs for agro-based industries.

Factors to Consider

  1. Commodities are goods that play the role of inputs to manufacturing companies, making end consumer products.
  2. Commodity prices can be volatile due to lack of supply, insufficient trading volumes, or due to geopolitical tensions.
  3. External factors such as geopolitical tensions cause disruptions in the demand and supply of commodities.
  4. Commodity prices tend to be volatile in a slowing economy. Prices stabilise when the supply meets the demand for a commodity.
  5. Prices in a commodity futures market are volatile due to the benefit of leverage available in a futures market.
  6. The trading in commodities also takes place in the spot market too for a cash settlement in a day or two typically known as T+1 or T+2 settlement.
  7. The futures market help investors to place bets on, or lock-in commodity prices to hedge against losses due to future unforeseen price volatility.
  8. Certain traders use the futures market to purely speculate on future price movements.
  9. The entry of many speculators in the futures market can increase the price volatility of commodity futures. However, there is another line of research that suggests that an increasing number of traders bring stability to the futures market. The liquidity, the traders bring, have a hardening effect on the prices. The margin requirements for futures trading is lower than for equities.

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