Commodities are not only the backbone of all commerce, but they are also a central cornerstone of our financial markets. But what exactly is a commodity? And how might a business owner, investor or market trader see commodities differently?
We look at the role of commodities in both commerce and trading.
What is a commodity?
Commodities are the basic goods used in commerce. They are not necessarily products, and they will typically be interchangeable (in both quality and price) with other commodities with which they share the market. A business may buy and sell commodities wholesale. However, they are most commonly used as inputs in the manufacture of other products.
Traders and investors will also buy and sell commodities on the open market. Commodities are advantageous to trade as they act as a hedge against inflation and can be used to diversify an investor’s portfolio. When inflation rises rapidly, the price of commodities invariably rises with it, while the same cannot be said for all stocks or derivatives.
A commodity is any raw good that can be consumed on its own but is most often used as an input in the manufacture of other items and products.
Examples of commodities may include:
Gas, coal or oil
Livestock or meat
Grains and legumes
Coffee or tea
Hard commodities vs soft commodities
Commodities are broadly divided into two types: hard and soft. Hard commodities include items that have been mined or extracted such as metals, coal, oil or rubber. Soft commodities, on the other hand, are derived from agricultural processes. These include grains, livestock, sugar and coffee.
Commodity markets explained
Trading of commodities does not just occur between businesses and wholesalers. There are also investors and speculators that trade in the commodity markets, profiting when the price of a commodity rises due to demand or inflation.
An investor may trade commodities directly or trade derivatives such as futures.
Commodity futures contracts are financial derivatives whereby investors agree to either buy or sell a fixed amount of a given commodity at a predetermined price on a set date. Commodity futures allow investors to diversify their portfolios while speculating on the direction the price of a commodity will go, taking either a short or long position.
What is the difference between a commodity and an asset?
A commodity is an item that is consumed by its use (e.g. an ingredient in a manufactured food or the metal in a tool). An asset is something that persists after it has been used and is subject to normal asset turnover (e.g. equipment, machinery and plant).
Is a commodity the same as a product?
Commodities and products are different, although they are closely related. Commodities are the raw materials that are used in production to manufacture finished products that are then sold to customers.
What is a commodity market?
A commodity market refers to when investors and speculators trade in commodities such as oil, energy, gas, grain, livestock, coffee etc. They may trade in these directly by buying and selling or trade in commodity derivatives such as commodity futures.