A commodity is a basic good that is used in commerce and is interchangeable with other commodities of the same type. Commodities can be directly bought and sold in the cash market or by derivatives such as futures or options by investors and traders. High-risk investors might choose to own commodities in a broader portfolio as a hedge against inflation.
What Is a Commodity?
Commodities are mostly used as inputs in the production of finished goods and services. Thus, a commodity that is used to manufacture these finished goods is also known as raw materials. Qualities of a certain commodity may differ slightly but are uniform across producers. When traded on an exchange, commodities must meet a specified minimum standard, known as basic grade.
Understanding What a Commodity Is and Does
Since commodities are the raw inputs used in the production of finished goods, there will be little differentiation in the good whether it is coming from one producer and the same commodity coming from another. For example, a barrel of oil is the same, regardless of if it comes from ExxonMobil or Chevron. However, a consumer’s product quality will be different depending on the producer, like Coke versus Pepsi.
Traditional examples of commodities are gold, oil, beef, grains, and natural gas. The definition has recently been expanded to include financial products like foreign currencies and indexes.
Major U.S. commodity exchanges are ICE Futures U.S. and CME Group. They operate under four major exchanges: Chicago Board of Trade (CBOT), Chicago Mercantile Exchange (CME), New York Mercantile Exchange (NYMEX) and Commodity Exchange, Inc. (COMEX).
How are Commodity Prices Determined?
Commodity prices, like assets, are determined by supply and demand. Prices can be impacted through supply and demand in many ways, like supply chain shocks, economic shocks, and natural disasters. An example can be a booming economy leading to increased demand for oil and energy commodities.
Are There Different Types of Commodities?
Yes, there are two types of commodities: hard and soft. Hard commodities are those that are mined or extracted from Earth, such as metals, ore, and petroleum. Soft commodities are those that are grown, such as agricultural products.
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This overview is for informational purposes only and is not a recommendation. It should not be the sole deciding factor in making an investment. Investing is a risk, and, as with all risks, a positive return is not guaranteed. Past performance does not indicate future results.