Commodities are the basic raw materials used by people and industries.
They include minerals, such as metals and oil, foodstuffs such as oil, sugar, wheat and meat, and energy stocks.
Commodities have been traded for thousands of years and may have been among the first materials exchanged between people on a large scale. Commodity trading remains crucial to global economics today.
Commodity markets can be simpler to understand than other financial markets because prices are influenced by supply and demand factors that are obvious in the real world.
Most commodities traded today can be split into three main areas:
Energy commodities
Energy includes the fossil fuels – oil and gas, and the renewables, like wind power and biofuels. Although ethanol and electricity generation are growing in importance as tradable commodities, the most developed commodity trading markets are in non-renewable energy resources such as petroleum.
Agricultural commodities
Most agricultural or soft commodities are staple crops grown or raised for human consumption, and include grains, coffee, corn and livestock.
Some experts consider livestock and meat to be a separate category from other types of agricultural produce. Live cattle, feeder cattle and pork bellies are all part of this sector.
A proportion of agricultural commodities such as timber have purely industrial applications, and some biofuels stocks are now grown. Soft commodities are important in futures markets where people speculate on price fluctuations as supply and demand changes. They are also used by farmers who produce these commodities to lock in the future price of their produce, and by commercial consumers and resellers of these goods.
Metals and mineral commodities
Metals and minerals are referred to as hard commodities. These are resources that are generally extracted through mining, specifically metals. Metals that are traded include precious metals such as gold, silver or platinum, and industrial metals. These include nonferrous metals, such as aluminium, lead or copper, and ferrous metals, iron and steel.
How are Commodities traded?
Commodity trading often takes place within specialised commodity exchanges, and the oldest dates back to Amsterdam in 1530. Since then, commodity exchanges have developed around the world, and many specialise in commodities. For example, the London Metal Exchange (LME) only deals with metals. The Chicago Mercantile Exchange (CME) deals with livestock commodities including milk, cattle, pork bellies and lean hogs.
These exchanges were once physical marketplaces where traders gathered, but these days the definition is broader. A commodities exchange is now more likely to be a legal entity that has been formed to provide trading facilities and enforce rules for the trading of standardised commodity contracts and investment products based on commodity trading. You can now trade commodities online in a number of different ways – one of which is CFDs (contracts for difference.)
What drives Commodity markets?
Commodity prices can fluctuate wildly because of changes in supply and demand. For example, when there's a big harvest of a certain agricultural crop, the price usually goes down. When harvests might fail prices rise as buyers to pay more to secure the supplies they need. A food manufacturer will want to ensure that the price it pays for wheat will be consistent – or at least predictable.
Hard commodities and particularly energy can fluctuate with the economy in general. During a downturn, for example, the price of petroleum will tend to fall, as there is less demand for fuel of vehicles, from aircraft and shipping to road transport.
There will also be short term seasonal fluctuations in commodity prices. During cold weather, demand for natural gas for heating rises, causing prices to rise too.
Commodity markets exist to provide more efficient prices and security for consumers of those commodities. The ability to buy a supply of wheat, for example, at a known price in six months’ time allows bread manufacturers to make more accurate financial projections for their business, and protect themselves from the effects of a bad harvest which would put up the price of their raw materials.
How can you profit from commodities with CFDs?
Simple commodities trading is the buying and selling of stocks of raw materials and involves the physical trading of goods.
CFDs (Contracts for Difference) allow traders to speculate on the way the price of a commodity will change, without ever owning the commodity itself.
A CFD is a contract between a trader and a broker. Traders who expect the price to go up will buy CFDs in commodities. Those who expect a fall will open a sell or ‘short’ position. The profit (or loss) comes when the trader decides to close their long or short position, and the contract is closed.
At the end of the contract, the two parties exchange the difference between the price of the commodity at the time they entered into the contract, and its price at the end. Being able to make a profit in a falling market as well as a rising market is a feature of CFDs and particularly attractive when markets are volatile.