What is a commodity?
A commodity is a basic good that has full or substantial fungibility. This means that the good is interchangeable with other commodities of the same type, with no regard to who produced the good; they are either identical or substantially similar. Commodities on the whole are raw materials, basic resources, agricultural or mining products. In short, a commodity is a type of product with uniform quality and high enough demand to be traded across many markets. There are countless different types of commodities but some commonly traded ones include those such as natural gas, crude oil, gold and coffee.
The most commonly traded commodities have well established markets. Investors go to commodity exchanges to trade in these markets. The exchanges subsequently standardise the minimum quality of a commodity as well as contract size for commodity derivatives.
What is the commodity market?
The commodity market is a place, virtual or actual, where individuals go to buy, sell and trade commodities. There are many commodity markets to trade and an investor can do this in numerous ways, which include, but are not limited to: purchasing the actual commodity, buying shares in companies who mine commodities, buying into a mutual fund, index fund or exchange-traded fund, or buying commodity derivative products such as futures or contracts for difference (CFDs).
There are several major commodities exchanges: the Chicago Mercantile Exchanges, Moscow Energies Exchange and the New York Mercantile Exchange. The Chicago Mercantile Exchange trades a lot of soft agricultural commodities whereas the New York Mercantile Exchange tends to trade more hard commodities such as energy or metals.
Hard commodity market
Commodities, and commodity markets, are categorised into two different types: soft and hard. Hard commodities are those that are natural resources, which are either extracted or mined. For instance, gold, helium, oil, gas and rubber are examples of hard commodities.
The production and supply of hard commodities can be accurately estimated and are commonly referred to as a basis for economic health. This is the idea behind examining copper and oil demand as a proxy for economic stability.
The majority of the hard commodity market consists of energy goods such as oil and gas, but it also includes precious metals like gold, palladium and platinum.
The hard commodity market tends to fluctuate less overall due to the accurate nature of estimating supply of the commodity. However, hard commodities tend to be more popular with your average trader and the market is not shy of sentimental fluctuations. It is worth noting that in times of economic crisis or vast inflationary periods traders have a tendency to invest in gold as a hedge.
Soft commodity market
Soft commodities are those that need to be grown like agricultural goods and livestock. Examples of soft commodities include coffee, sugar, soybean, fruit and milk. Soft commodities tend to have greater price fluctuations than hard commodities and are subject to greater forces that determine their overall supply and demand.
Weather plays a substantial role in the determination of supply in this market. Excessively cold winters or overly warm summers impact livestock and the production of crops. This can lead to shortages and spikes in price. Conversely, crops can produce more of a commodity than anticipated depressing prices due to a supply surplus.
Read more about commodities trading:
Commodity trading: an introduction to the commodities market