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What Are Commodities? Doyou ever think about what goes into that cup of coffee you reach for everymorning? What about the gas that you use to fill up your tank every week? Mostof us never realize it, but virtually all of these goods begin withcommodities. Commoditiesare an extremely important part of the financial market. That's because theyare essential for producers and manufacturers. A commodity is essentially abasic product or raw material used to make all the goods and services that weneed in our everyday lives. 1 Thereare a wide array of commodities, including oil, gas, coffee, soybeans, andrice. These commodities are traded on commodity exchanges around the world suchas the Chicago Mercantile Exchange (CME), the London Metals Exchange, and theIntercontinental Exchange (ICE). Investing in commodities provides investorswith a way to diversify their portfolios, especially during times of marketvolatility. Readon to find out more about the different types of commodities, their pricestructures, and who sets them on the market. KEYTAKEAWAYS Commoditiescome in many forms, including grains, energy products, and metals. Pricesare determined by fundamental factors and supply & demand, which change aseconomic events unfold and trigger waves of buying and selling. Tradersgenerally don't buy and sell physical commodities; rather, they trade inderivatives like futures and options. Commoditiestrade in the cash or spot market, and on organized exchanges as futurescontracts. Commoditiesfutures trade on exchanges and are used for speculation and hedging. Typesof Commodities Sincecommodities are traded on exchanges, their prices aren't set by a singleindividual or entity. In fact, there are many economic factors and differentcatalysts that affect and move their prices each day. Just like equity securities, commodity prices areprimarily determined by the forces of supply and demand in the market. 2 For example, ifthe supply of oil increases, the price of one barrel decreases. Conversely, ifdemand for oil increases (which often happens during the summer), the pricerises. Gasoline and natural gas fall into the energy commodities category. Weather plays an extremely significant role in pricechanges for crop-related or agricultural commodities, especially in the shortterm. 2 If the weatheraffects supplies in a certain region, it has a direct impact on thatcommodity's price. Commodities that fit into this category include corn,soybeans, and wheat. Cotton, coffee, and rice are referred to as softcommodities. Gold is one of the most actively traded commoditiesbecause it is used to produce jewelry and other goods. But is also consideredto be a worthwhile, long-term investment. Silver and copper are other examplesof commodities in the metals group. Livestock is another group of commodities. This categoryincludes live animals, such as hogs, and cattle. Trading in commodities predates that of stocks and bondsby many centuries as merchants would meet along trade routes like the Silk Roadto exchange various agricultural and craft products. Spot vs. Futures Price Commodities are traded via futures contracts onexchanges. These contracts obligate the holder to buy or sell a commodity at apredetermined price on a delivery date in the future. Not all futures contractsare the same. In fact, their details differ depending on the commodity beingtraded. 3 The market price of a commodity that is quoted in the media is often its market futures price. The futures price is different than the spot price or cash price, which is the actual price for the commodity today. 4 For example, if an oil refiner buys 10,000 barrels of oil for $50 per barrel from an oil producer, $50 per barrel is the spot price. The futures price can be more or less than the spot price at any given moment. Many traders use commodity futures to speculate on future price movements. They generally don't trade the physical commodities themselves. That's because buying barrels of crude or bushels of wheat isn't practical. These investors analyze market activity and chart patterns to speculate on future supply and demand. They subsequently enter long or short futures positions depending on which direction supply and demand move prices. 5 Speculators are distinct from hedgers, who are often the end-users seeking to protect interests in the commodity by selling or purchasing futures contracts. If a soybean farmer thinks prices will fall over the next six months, they can hedge their crops by selling soybean futures today. Hedgers and speculators collectively represent much of the buying and selling interest in commodities futures, making them important parties in determining commodities prices from one day to the next. Investors can also purchase stocks in companies that deal in commodities, such as energy companies or mining corporations. In addition, several commodity ETFs are available for trading. What Are Some
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