In trading terms, a commodity is a tangible asset. Commodities can be grouped into one of three categories: agriculture, metals and energy. Metals and energy are raw materials that must be extracted before use, so they are classed as hard assets, while agricultural products are known as soft assets.
Domen Zavrl works in asset management and counts commodities trading among his areas of expertise. The activity of traders affects the prices of commodities, including petrol prices.
Types of Commodities: Agricultural
Agricultural commodities are typically things we can eat or drink, such as grain, coffee, sugar and animals such as cattle being reared for food. They can also include non-edible commodities that are grown rather than extracted, such as lumber and cotton.
Types of Commodities: Metals
Metal commodities are those raw materials that are mined, such as silver, gold, platinum and copper. More recently, metals mined for use in batteries have been added to the commodities market. Experts from the London Metal Exchange predict the market for these will grow rapidly as large parts of the world continue the shift towards electric vehicles.
Types of Commodities: Energy
Energy commodities include the raw products we use to make energy, such as crude oil and natural gas. Renewable energies are also traded as commodities, including solar, wind, biomass, geothermal and hydropower. The embedded infographic looks at some US statistics for energy use.
How the Commodities Markets Work
Commodities markets act as a centralised liquid marketplace for the buying and selling of agricultural, energy and metal assets. Producers and consumers of these commodities can hedge against future price changes or supply chain issues through the use of commodities derivatives. Investors and speculators also trade within the commodities markets and play an active role in determining the prices of each commodity.
Many investors include commodities in their portfolios for diversification. Hard commodities are often seen as relatively ‘safe’ investments, as they can help hedge against inflation. Commodity prices also regularly move in the opposite direction to stock prices.
You can learn more about diversifying an investment portfolio by taking a look at the PDF attachment to this post.
The Role of Speculators
Originally, commodities markets were established so the producers and consumers of those products could access a centralised marketplace. With futures contracts, these producers and consumers can lock in specific prices months or even years in advance, protecting themselves from market volatility. More information about futures contracts can be found in the short video attachment.
Today, most of the activity that takes place within the commodities markets comes from speculators. These types of traders have no products to sell and no interest in buying the tangible assets. They are simply trading off one price against the other in the hope of achieving profit. Speculators provide some benefit to the commodities markets as they increase liquidity, which makes the exchanges more efficient. However, there are some concerns that speculators directly contribute to increased market volatility.
Most Traded Commodities
According to the Futures Industry Association, the most traded commodity in the world is WTI crude oil. Brent crude oil and natural gas are the next most highly traded commodities, followed by soybeans and corn. The most traded metals commodities are gold, copper and silver. The markets for these types of commodities are highly liquid, which means it is usually easy to facilitate a transaction as there are so many potential buyers and sellers.