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Learn About Commodities and Commodity Trading
Are you interested in commodities and commodities trading? Then you've come to right place because we have everything you need to learn about both.
In this article, we explain what commodities are, how they are traded, and what drives their prices.
Once you have that under your belt, you can check out How to Trade Commodities. There we teach you about trading in these global markets.
Ready to get started? Read on!
What are Commodities?
A commodity is a basic good or raw material in commerce that people buy and sell. Commodities are often the building blocks for more complex goods and services.
Commodities are different from other types of goods in that they are standardized and interchangeable with goods of the same type. These features make commodities fungible. This means that two units of the same commodity should have mostly uniform prices any place in the world (excluding local factors such as the cost of transportation and taxes).
Generally, commodities are extracted, grown, produced, and traded in large enough quantities to support liquid and mostly efficient global trading markets. These markets provide a transparent way for commodity producers, consumers, and financial traders to transact business.
How Did Commodities Evolve?
Commodities trace their origins to the beginnings of human civilization.
Sumeria (Modern-Day Iraq)
Roughly 6,500 years ago, the Sumerians began using clay tokens as a form of money to purchase livestock.
Buyers would place these tokens in sealed clay vessels and record the quantities, times, and dates of the transactions on writing tablets. In exchange for the vessels, merchants would deliver goats to the buyers.
These transactions were a primitive form of commodity futures contracts. Other civilizations soon began using valuables such as pigs and seashells as forms of money to purchase commodities.
Commodities trading was not limited to the Middle East, however. At roughly the same time that the Sumerians were trading livestock, the Chinese were trading rice — thousands of years after it was first cultivated.
Much later, starting around 700 BC, the ancient Greeks (and later the Romans) settled on coinage as the favored way for transacting business in commodities.
They prized gold and silver for their luster and physical beauty. Since gold and silver are rare and can be melted, shaped, and measured into coins of equal size, they began to be used as monetary assets.
Exchanging gold for goods and services became the preferred means of commerce in the ancient world and led gold to become the first widely traded commodity.
In the US, grain commodities were first traded in the 19th century to meet the food needs of the nation. The number of commodities grew greatly in the latter part of the 20th century.
Today, commodities are mostly traded on mercantile exchanges. Most exchanges specialize in one or more kind of commodity. Many only exchange agricultural commodities while others specialize in energy.
Over the past few decades, CME Group has consolidated many of the US commodities exchanges. They now operate the Chicago Mercantile Exchange (from which they get their name), the Chicago Board of Trade, and the New York Mercantile Exchange.
What Are the Main Commodities?
Commodities can generally be divided into four categories:
- Agricultural: This category includes food crops (e.g., corn, cotton, soybeans, and orange juice), livestock (e.g., feeder cattle, lean hogs, and pork bellies) and industrial crops (e.g., lumber, rubber, and wool).
- Energy: These include petroleum products such as crude oil and RBOB gasoline, natural gas, heating oil, coal, uranium (used to produce nuclear energy), ethanol (used as a gasoline additive), and electricity; a subset of energy commodities are the environmental commodities, which includes products such as carbon emissions, renewable energy certificates, and white certificates.
- Metals: Precious metals (e.g., gold, silver, platinum, and palladium) and base metals (e.g., aluminum, nickel, steel, iron ore, tin, and zinc).
- Cryptocurrencies: Although some will dispute them being commodities, they are normally thought of as such; they include Bitcoin, Ethereum, and Litecoin.
These four categories contain dozens of traded commodities. The following are traded the most in financial markets:
Coffee: The global coffee industry is enormous. In the US alone, it accounts for more than 1.6% of GDP and an estimated 1.7 million jobs. As a commodity, it is intriguing for at least two reasons. Most of its supply comes from just five countries. At the same time, demand for coffee continues to grow as emerging market economies develop a taste for it.
Corn: Corn is a commodity with several important applications in the global economy. It is a food source for humans and livestock. And it is used in the production of ethanol fuel. The high cost of sugar in the United States has made corn a key ingredient in sweetening products such as ketchup, soft drinks, and candies. Growing food and fuel demand should drive continued interest in corn as a commodity.
Sugar: Sugar is known mostly as a sweetener. But it plays an important role in the production of ethanol fuel as well. Historically, governments across the world have intervened heavily in the sugar market. Subsidies and tariffs on imports often distort prices and make sugar challenging to trade. Although sugar cane is grown all over the world, three-quarters of all production comes from just ten countries.
Soybeans: Soybeans play a critical role in the global food ecosystem. Soybean oil is used in bread, crackers, cakes, cookies, and salad dressings. It also serves as a feedstock in the production of biofuels. The meal from crushed soybeans serves as the main source of food for livestock. The growing need for food and fuel in emerging market economies could drive demand for soybeans. Three countries – the US, Brazil, and Argentina – account for 80% of global production.
Wheat: Wheat grows on six continents and for centuries has been one of the most important food crops in the world. Traders compare wheat prices to other grains such as corn, oats, and barley. Since these commodities can be substituted for one another, changes in their relative prices can shift demand between them and to other products such as soybeans. Demand for cheap and nutritious food sources in developing nations should continue to drive interest in the wheat market.
Crude Oil: This commodity has the largest impact on the global economy. Not only is crude oil used in transportation including in cars, trains, jets, and ships, it is also used in the production of plastics, synthetic textiles (acrylic, nylon, spandex, and polyester), fertilizers, computers, cosmetics, and more. If you take transportation costs into account, crude oil plays a role in the production of pretty much every commodity.
Crude oil has different variations based on geography and physical characteristics: West Texas Intermediate (WTI), also known as light sweet crude, and Brent Crude are two of the most frequently traded varieties.
Natural Gas: Natural gas is used in various industrial, residential, and commercial applications including electricity generation. It is considered a clean fossil fuel source and has seen increasing demand recently. The United States and Russia have emerged as the leading producers of it.
Gasoline: The main use of this refined crude oil product (normally called reformulated gasoline blendstock for oxygen or RBOB gasoline) is as a source of fuel for cars, light-duty trucks, and motorcycles. Gasoline prices can have a large effect on the economy since demand for it is generally inelastic. This means people's use of it doesn't change much based on its price.
Many traders trade crack spreads, which are the differences between crude oil prices and the price of refined crude products such as gasoline.
Gold: Much of the demand for gold comes from speculators. Many market participants see gold as an alternative to paper money, so its price often moves in the opposite direction of the US dollar. Gold is also used to make jewelry and electronics.
Silver: Many people view silver as the poor man’s gold. Like gold, it's also traded by speculators and used in a variety of industries and applications including jewelry. Some traders track the ratio between gold and silver prices since it can show how risk-averse traders are.
Copper: Copper has so many uses that it would be almost impossible to build a modern economy without it. Some refer to it as Dr Copper. They say copper has a PhD in economics because its price is a reliable barometer of the health of the global economy. In fact, some consider investing in copper is a way to express a bullish view on world GDP.
The term cryptocurrency covers a broad variety of digital tokens that can serve a number of different purposes. A traditional cryptocurrency like Bitcoin is designed to act as a form of digital currency and a store of value. Others like Ripple or Ethereum are designed to fulfill a specific purpose and are targeted at niche uses.
There are literally thousands of cryptocurrencies. Here are the most important ones:
- Bitcoin is a decentralized digital currency and is the most valuable and well-known cryptocurrency.
- Bitcoin Cash is a hard fork of Bitcoin designed to process larger numbers of transactions at a faster rate than its predecessor.
- Litecoin is the silver to Bitcoin’s gold and improves on the Bitcoin concept in many ways. It has been tailored for smaller transactions than Bitcoin.
- Ethereum is a smart contract platform that allows developers to create specialized cryptocurrencies. Most ICOs (Initial Coin Offerings) are built using Ethereum.
- Ripple is designed to work as a blockchain solution that allows banks and payment providers to create more efficient cross-currency transactions.
- Monero provides its users with enhanced privacy by using stealth addresses and untraceable transactions.
- Dash uses a unique master-node based consensus system to allow instant payment and private transactions.
- NEO uses smart contracts to build the “smart economy” of the future.
- Verge builds on other privacy-based coins to aims to be more convenient for the everyday user.
- Zcash uses a shielded pool to protect the privacy of its users.
How Commodities Are Transferred
Most people who trade commodities never actually possess them. There are many ways that commodities get their prices adjusted on their way to their final destinations.
- Commodity CFDs: Contracts for difference (CFDs) allow traders to speculate on price movements between the time the trade is entered and exited.
- Commodity futures: Contracts that promise to purchase a set amount of a commodity at a time in the future. These are usually traded on the futures market before the purchase date.
- Options on Futures: These allow you to speculate on futures using less money but they require even more accuracy in your trading.
- Commodity Shares: This is an indirect way of trading commodities by owning shares in companies that mine or produce the assets.
- Commodity ETFs: Many ETFs (Exchange-Traded Funds) grant exposure to commodities via investments in commodity futures, options on such futures, or shares in companies that mine or produce commodities. Some also invest in physical bullion. (ETFs trade as shares on exchanges.)
- Physical delivery: Commodities eventually are delivered to their final owners. But there are other cases, such as gold, where an investor may hold the physical product — often for an extended period — without taking delivery of it.
What are the Main Drivers of Commodity Prices?
Commodity prices are usually a matter of supply and demand.
Supply shocks — like a bad harvest — can cause prices to go up. An example of a recent demand shock is the reduced use of fuel due to the recent global coronavirus pandemic. Indeed, the pandemic has caused a concurrent supply and demand shock.
In addition to these general economic issues, there a number of things that affect commodity prices.
- Emerging Markets: The past couple of decades have seen enormous rises in the standards of living in developing economies. So changes in these conditions can have large effects on commodity prices.
- US Dollar: The value of the US dollar is also a big issue because it is the world's default currency. If the dollar increases in value, people buying in other currencies may not be able to purchase as much of a commodity.
- Substitution: Especially as a commodity's price increases, the viability of alternatives increases. This can have a big effect on prices.
- Weather: A significant factor, especially with agricultural products.
How To Trade Commodities
Commodity trading is an exciting field where fortunes are made and lost. To be successful at it, you need knowledge — about trading itself as well as the individual commodities traded.
Learn the basics in our guide, How To Trade Commodities. From there, you can learn specifics about commodities like gold and oil. And when you think you are ready, we can provide guidance in finding the right CFD broker.
Here's a summary…
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 76%-80.6% of retail trader accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Commodities are the building blocks of our economy. The vast and intricate trading system we have developed over the last few hundred years works to bring commodities to where they need to be in the cheapest and most efficient way.
Below are the answers to some of the most frequently asked questions about commodities.
What is a commodity?
A commodity is a raw material. It is used as an input for the production of other things. For example, steel is used in the construction industry. Another important aspect of a commodity is that it should be interchangeable. Roughly speaking, the source of a commodity doesn't matter. So steel made in the US should be the same as steel made in India.
What are examples of commodities?
Examples of commodities include steel, oil, and rice.
Steel is a metal commodity used in a wide variety of industries including in construction of highways and buildings.
A typical energy commodity is crude oil, which is primarily used to create RBOB gasoline but also has applications far outside energy production.
Rice is used in many ways like the manufacture of breakfast cereals. Like most agricultural commodities, however, rice is also consumed directly.
Are cryptocurrencies commodities?
Cryptocurrencies aren't usually considered to be commodities nor are they usually considered to be currencies. They defy classification.
However, given that most of them can be used in one of the three ways that define a commodity (i.e., they can be used, speculated on, and traded) we believe that cryptocurrencies are best classified as commodities.
What are the commodity prices today?
Commodity prices are constantly changing — throughout the day of trading and over the course of decades. Prices change because of changes in the supply and demand of a commodity.
Some of these are predictable like the yearly price cycle of many agricultural commodities. Others are not, like the greatly reduced demand (and price) for metals after the housing crash of 2008.
Brokers provide access to real-time commodity prices so that you can make buying and selling decisions based on up-to-date information.
Credits: Original article written by Lawrence Pines with contributions from Commodity.com team. Major updates and additions in May 2020 by Frank Moraes.