What Are Commodities?

Commodities are raw materials and basic goods that are interchangeable no matter who produces them. A barrel of a given grade of crude oil, a troy ounce of gold or a bushel of a given grade of wheat is essentially the same as any other. Because units are interchangeable, commodities can be traded in standard contracts on exchanges, and their prices are set by global supply and demand.

The main commodity groups#

Commodities are often split into hard commodities, which are mined or extracted like oil and metals, and soft commodities, which are grown like crops.

What makes commodity prices move#

Commodity prices respond to physical supply and demand far more directly than stocks do.

1. Supply shocks. A drought, a hurricane in the Gulf of Mexico, a mine strike or a production cut by oil producing nations can move prices sharply.
2. Demand. Economic growth increases demand for energy and metals; recessions reduce it.
3. Inventories. Stockpiles act as a buffer. Low inventories make prices more sensitive to surprises. See Storage and Inventories.
4. The US dollar. Most commodities are priced in dollars, so a stronger dollar tends to weigh on prices for buyers using other currencies.
5. Seasonality. Crops follow planting and harvest cycles, and energy demand rises with heating and cooling seasons. See Seasonality in Commodities.
6. Investor flows. Funds buying commodities as an inflation hedge or for diversification.

How commodities are traded#

• Futures contracts are the main market. Producers and consumers hedge with them, and speculators provide liquidity. See What Is a Future?.
• Options on futures let traders define risk or hedge.
• ETFs and ETCs offer exposure through a stock account. Some hold physical metal; many hold futures, which means their returns can differ from the spot price because of rolling. See Roll Yield.
• Shares of producers, such as oil or mining companies, give indirect exposure along with company specific risk.
• Physical ownership, mainly for precious metals like gold coins and bars.

Spot prices and futures curves#

The spot price is the price for immediate delivery. Futures for later months often trade at different prices because of storage costs, financing and expectations. A market where later contracts are more expensive is in Contango; one where they are cheaper is in Backwardation. These shapes matter a lot to anyone holding futures based products for long periods.

Why traders and investors use commodities#

• Diversification: commodities sometimes move differently from stocks and bonds.
• Inflation protection: raw material prices often rise when inflation does.
• Hedging: businesses lock in costs or selling prices.
• Trading opportunities: clear supply and demand stories and regular data releases create strong trends and volatile events.

Risks#

• Volatility: weather and geopolitical events can cause large, sudden moves. Oil futures briefly traded below zero in April 2020 when storage ran short.
• Leverage: futures positions are large relative to margin.
• Roll and structure effects: long term returns of futures based products can differ greatly from spot price changes.
• Delivery: physically settled futures must be closed before delivery unless you intend to take or make delivery.

Frequently asked questions#

Is gold a commodity?#

Yes. Gold is a precious metal commodity, traded in futures, through physical bullion and through ETFs, and often used as a store of value.

What is the most traded commodity?#

Crude oil is the most important and among the most heavily traded commodities in the world, followed by other energy products, metals and grains.

Can beginners trade commodities?#

They can, usually through ETFs or micro futures contracts, but should first learn how futures, leverage and rolling work.

Sources#

• Wikipedia, Commodity market
• U.S. Commodity Futures Trading Commission, Learn and protect