Commodities are fundamental to the global economy and essential for everyday life. They are the backbone of our functioning world. Energies, agricultural products, precious metals, and more, attract significant interest. They are bought and sold each day by companies and traders alike.

They Are Fungible 

Fungibility is a key requirement for a commodity. Each day producers, consumers, and speculators engage in extensive transactions worth billions of dollars. To do so efficiently, traders need to know that each traded commodity must adhere to standard size and quality criteria. This is where fungibility comes into play by ensuring that any given unit of a commodity can be exchanged interchangeably with another of the same type, irrespective of its origin. This standardization allows traders to focus on trading activities rather than the specifics of each commodity’s quality or origin.

Non-fungible products cannot be traded as commodities due to their individual characteristics. Such products are clothing or technology for example.

Categories

Commodities broadly fall into two categories – soft and hard.

Soft commodities are agricultural products and livestock, grown or bred for consumption. They are cultivated globally and are not extracted from the ground.

Hard commodities, in contrast, are generally natural resources. They are mined, extracted, or pumped from the earth, serving as essential raw materials for industrial processes and energy production.

Commodities can also be divided into the following three main categories – energies, agriculture, and metals.

Energy commodities – they are extracted from the ground and significantly impact the global economy. With a power-hungry world, increasingly energy-demanding technologies, the prices of energy commodities are closely tied to economic health. For instance, a thriving economy may increases demand for oil, driving up prices.

Examples of most traded energy commodities include:

• US crude oil (WTI)
• European crude oil (Brent Crude)
• Natural gas

Agricultural commodities – they form the basis of global food supplies for humans and animals. Weather conditions, conflicts, perishability contribute to significant price volatility.

Examples of agricultural commodities include:

• Coffee
• Corn
• Cotton
• Soy Bean Oil
• Wheat

Metals encompass precious metals like gold and silver, valued for their role as safe-haven assets during economic instability. Industrial metals such as aluminum, lead, and copper derive their value from industrial demand.

Examples:

• Gold
• Silver
• Palladium
• Platinum
• Copper

Who trades commodities? 

Four primary types of participants engage in commodity markets, each with distinct goals and strategies:

• Producers: Companies involved in commodity production, such as farmers, miners, or oil companies. They seek favorable prices and secure income through proactive selling.
• Consumers: Industries that utilize commodities in their operations, such as the jewelry sector’s demand for gold or airlines’ consumption of oil. Changes in consumer demand directly influence commodity prices.
• Speculators: Investors who capitalize on commodity price volatility using financial instruments like futures or options, without seeking physical asset delivery.
• Hedgers: Investors who offset risks in other markets, such as stocks or bonds, by taking positions in commodities, which often move inversely to traditional financial assets.

Understanding these dynamics is essential for navigating the complexities of commodity markets and making informed trading decisions.

Markets

Generally, commodities trade in either spot markets or financial commodity markets, which include derivatives. Spot markets, also known as physical or Cash markets, involve immediate transactions of physical commodities between individuals and companies.

Derivatives markets encompass forwards, futures, and options contracts. Forwards and futures derive their value from spot prices, allowing investors to control underlying assets at a predetermined future date for a price agreed upon today. Physical delivery occurs upon contract expiration, though many traders opt to roll over or close out positions without physical settlement. Forwards are customizable and traded over-the-counter, while futures are standardized and traded on exchanges.

Commodities or Stocks?

For many individual investors, participating in the commodities markets, whether spot or derivatives, can be challenging. Direct entry into these markets often requires a specialized brokerage account and specific permissions. Commodities are considered an alternative asset class, and collective funds involved in commodities futures trading, such as CTAs, typically limit participation to accredited investors. However, everyday investors can indirectly access commodities through the stock market. Stocks of mining or materials companies often exhibit correlation with commodity prices, and there are now several ETFs available that track various commodities or commodities indices.

Investors looking to diversify their portfolios can consider these ETFs. However, for most long-term investors, stocks and bonds typically form the primary components of their holdings. Additionally, because commodity prices tend to be more volatile than stocks and bonds, commodities trading is generally more suitable for individuals with a higher risk tolerance and/or a longer investment horizon.

For further reading you can visit our FPT Trading Academy​.