Liquidity refers to an asset that has a high level of trading activity. Buying or selling an asset easily without disrupting price in a market will bring you into the asset liquidity.
When it comes to commodities, which tend to be more volatile than other asset classes. Hence, liquidity is a key concern for many investors and traders.
The Definition of Commodities
A barrel of oil, a bar of gold, a truckload of corn or soybeans, a bag of coffee or even a herd of cattle are examples of the physical staples that are at the heart of commodity markets.
Other than these physical assets, everything else that trades is a derivative. It is an instrument with a price that reflects the value of the underlying hard asset, the commodity.
Physical commodity trading generally occurs between producers, traders and the ultimate consumers in most commodity markets.
The Definition of Liquidity in Commodities
When it comes to commodities, different raw materials offer different degrees of liquidity to market participants. The main materials are precious metals (gold) and energy (crude oil).
The most liquid precious metal is gold. This is because gold is the precious metal with the greatest degree of trading activity. Gold trades in the physical market and it trades in the OTC forward and swap markets.
The most possible liquidly traded and ubiquitous commodity is crude oil. Another energy is coal, but it does not trade to the extent or with as many derivatives as crude oil does. Hence, crude oil is better than coal.
The Importance of Liquidity
Liquidity is important for all assets, particularly commodities. Liquidity ensures market participants the ability to buy and sell easily. This attracts speculators and investors to a market.
When it comes to commodities, one can measure the liquidity of specific futures products by examining daily trading volumes and open interest, the number of open but not closed long and short positions. The higher volume and open interest, the more liquid a market.
Make sure that you choose liquid instruments so that you are able to buy and sell without problems and at the cheapest cost in terms of execution.