WHAT IS COMMODITIES?

OVERVIEW OF COMMODITIES

Commodities are natural resources that can be processed and traded, are the basic building blocks of the global economy. They are natural resources traded on dedicated exchanges around the world. Some of the commodities that are tracked in the financial markets include metals, agricultural goods, energies and minerals.

Commodities are the essential components of other manufactured goods, essentially the building blocks for both industrial and domestic products and foodstuff. They are shipped globally to meet demand as not all countries are capable of producing every commodity they need.

The production and consumption of commodities depend on factors like seasonal, climate and resources – both natural and man-made. Demand is also influenced by economic factors and consumer habits. Due to this reason, commodity prices have the potential to fluctuate greatly.

Commodities are generally traded in very large quantities, either on the cash market, or more frequently, on the futures exchanges.

Commodity Terminology

Commodities are grouped according to similar characteristics that they share. Below are some general terms used to classify them:

Soft Commodities

These are typically grown, rather than mined or extracted. Soft commodities tend to be very volatile in the short term as they are susceptible to spoilage which can suddenly and dramatically rock prices.

Producers tend to be heavily involved in the softs markets as they are often keen to lock in prices for their produce. Alongside the natural growing cycle of these commodities, this creates seasonal fluctuations in prices.

Some examples of soft commodities include: Corn, rice, wheat, sugar, cocoa beans, orange juice, cattle

Hard Commodities

These are typically mined from the ground or extracted from other natural resources. The initial commodity may also be refined into another commodity altogether. For example, oil can be refined into gasoline.

Some agricultural products, like cotton, are also considered hard commodities, as they do not spoil quickly and are considered industrial materials rather than foodstuffs. Hard commodities are generally easier to handle than softs, and are more easily integrated into the industrial process. This makes them a popular choice for investors; for example trillions of dollars’ worth of oil futures are traded yearly.

Some examples of hard commodities include: Oil, natural gas, cotton, aluminum, cooper, lead

Emerging Commodities

These are commodities some investors expect to boom in the next few years, but are currently not available to trade as commodity futures. The only way to trade these products are to buy stocks in companies that operate in these fields.

Some examples of emerging commodities include: Water, water rights, ethanol

How do commodities operate?

Commodity markets help to ensure some measure of stability in prices, especially through futures contracts. As of now, we only offer spot contracts.

A commodity’s spot price is the price at which the commodity could be traded at any given time in the marketplace. Spot contracts are basically the price to settle a contract immediately. Think of it as settling the price on the spot, hence it is a “spot contract”.

A futures contract is the price of the commodity taking into account several factors, such as the current spot price, time until delivery (time till expiration), risk-free interest rate and storage costs at a future date.

Generally, futures prices and spot prices differ because the market is always forward-looking. The difference in the commodity’s spot price and future price is due to the cost of carry and interest rates.

Why trade commodities?

Commodities are an important part of everyday life. If you drive a car, you will be significantly impacted by high crude oil prices. If you follow gold, you’ll find that gold prices fluctuate based on the state of the global economy. Trading commodities allows you to take advantage of price movements due to macroeconomic, geopolitical and seasonal factors.

Commodities can also be an important way to diversify your portfolio beyond traditional securities, either for the long term, or as a place to park cash during unusually volatile or bearish stock markets. Commodities are usually inversely correlated to stocks.