Introduction to financial markets
What are commodities?
Commodities are essential to the global economy – and humankind overall. Let’s take a closer look at how companies and traders buy and sell energies, agricultural products, precious metals and more.
What are commodities?
Commodities are natural products that are consumed or used by people, animals or industry: such as oil, sugar, gold and wheat. They have been traded for thousands of years, feeding people and livestock, fuelling manufacturing and more.
Commodities trading is just as important today, with commodities playing a crucial role in global economics. They are the building blocks of the modern economy – which makes them an enticing prospect for many traders.
Defining a commodity
Producers, consumers and speculators buy and sell billions of dollars’ worth of commodities each day. With so much trading going on, buyers and sellers need to know that every asset is of a standard size and a standard quality.
To cater to this requirement, any commodity traded has to be fungible. This means that it can be swapped with another commodity of the same type – regardless of its origin.
A gold bar mined in South Africa, for example, must be precisely the same quality and size as a gold bar mined in Australia. That way, commodity traders can focus on trading, instead of having to inspect and evaluate each and every commodity they want to deal.
If a product isn’t fungible – for instance, clothing or technology – then it can’t be traded as a commodity.
Soft vs hard commodities
Commodities come in two broad variations: soft and hard.
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Soft commodities are grown or bred for human or animal consumption. Soft commodities are farmed all over the world; they are never mined or extracted. |
Hard commodities are mined, extracted or pumped out of the ground. These form the basis of the industrial process – powering machines and providing raw materials. |
Commodity categories
In addition to being classed as soft and hard, many traders today split commodities into three main categories: energies, agriculture and metals.
Energy
Energy commodities are pumped out of the ground. The prices of energies can have a significant impact on the global economy – and are in turn often driven by the health of the global economy. A booming economy, for example, can lead to increased demand for oil, which will in turn drive its price up.
Examples include:
- US crude oil (known as WTi or Nymex)
- European crude oil (known as Brent Crude)
- Natural gas
WTI vs Brent crude
Did you know? There are several different oil commodity markets, because different areas will produce different qualities of oil.
The two main types, however, are West Texas Intermediate (US oil) and Brent Crude (European oil). While the prices of both will be similar, they are not exactly the same.
Agriculture
Agricultural commodities form the basis of the world’s food supply, for both humans and animals. They are all grown or bred and are less popular among traders than the headline energies or metals. Weather and spoilage can often have a significant impact on their prices, causing significant volatility.
Examples of soft commodities include:
- Coffee
- Corn
- Cotton
- Orange Juice
- Soy Bean Oil
- Wheat
Metals
Metals come in two main types: precious (such as gold, silver or platinum) and industrial (such as aluminium, lead or copper). Gold is seen as a ‘safe haven’ by global investors, so will often see its price rise during turbulent periods. The prices of industrials, on the other hand, are driven by demand from the industries that use them.
Examples of hard commodities include:
- Copper
- Gold
- Palladium
- Platinum
- Silver
Who trades commodities?
There are four main types of participant in the commodities market. Each has their own goals and requirements from trading.
Producers
These are the companies who make or extract the commodities themselves: farmers for softs, miners or oil companies for hard commodities. Producers want to get the best possible price for their products and guarantee income ahead of time.
Consumers
Consumers use the products sold by producers. The jewellery industry, for example, is a significant consumer of gold – while airlines tend to use a lot of oil. If consumer demand for a commodity drops, its price will probably soon begin to drop too.
Speculators
Speculators aim to use volatility in commodity prices to earn a profit – with no intention of taking delivery of any actual physical assets. Instead, they use derivatives such as futures or options.
Hedgers
Commodities will often move in the opposite direction to other markets, such as stocks and bonds. A stock market crash, for instance, can cause gold’s price to rise. Hedgers are investors who use this relationship to protect against negative moves in their stock or bond portfolios.
