What are Commodities and How Are They Traded?

A commodity is a product, which is of uniform quality and traded across various markets. There are generally two types of commodities, ‘hard commodities’ and ‘soft commodities’. Hard commodities include crude oil, iron ore, gold, and silver and have a long shelf life. Agricultural products such as soybean, rice or wheat, are considered ‘soft commodities’ since they have a limited shelf life. These commodities have to be similar and interchangeable or ‘fungible’. For example, soybean from one country or market should be of the same quality wise as soybean from another, or gold in one country should be of the same purity as gold from another.
Consumer products like televisions or computers vary from manufacturer to manufacturer and hence cannot be traded as commodities. But now, electricity, bonds, and currencies are also traded as commodities across the globe.

These commodities are traded across markets situated in different corners of the world through commodity exchanges such as the New York Mercantile Exchange, the Chicago Board of Trade, the London Metal Exchange, etc. These exchanges consist of traders who are classified as hedgers or speculators. Hedgers are actual manufacturers or farmers who want to sell their commodities at a guaranteed price, so that they are insulated against any price fall or fluctuations in the market. Speculators are traders who enter into the market solely to make a large profit. If the speculator has information that natural disasters are destroying wheat in a particular country, he will try and purchase wheat as soon as possible, since he would expect the price of wheat to rise in the coming days. Speculating requires a keen business sense and an in-depth understanding of the market or the losses incurred could be significant.

Traders do their trading in any of the above commodity exchanges in the following ways. Spot Trading occurs when the deals are done on the spot regarding price or delivery, or if the delivery takes place in a minimum amount of time after the trade is finalized. Trading is also done by way of ‘Futures Contracts’ where the price of the commodity is decided immediately, but the delivery is made after a certain period of time. ‘Futures Contracts’ benefit either the buyer or seller since the price, which is agreed upon could change marginally or drastically by the time the delivery is actually made. These contracts can give buyers and sellers a way to ‘foresee’ the market in the future, since the rates have already been set. These markets are quite open and transparent, but to prevent fraud and misuse, the government has set up ‘The Commodity Futures Trading Commission’ or the CFTC, which keeps a close watch on the trading market.

The delivery date and the method of payment must be agreed upon before the contract is executed. Since commodities are physically and actually present, the chances of bankruptcy are nil, but profit and losses on a large scale are possible because of the sheer volume involved in trading. You too can directly invest in the Commodities market, but if you do not have experience, then it is better to go through a commodities broker. His vast knowledge and contacts will help you save time and money.

The commodities market is based on the simple principle of supply and demand. Since there is a lot of demand from emerging economies such as India and China, some commodities such as crude oil and steel are in very high demand. Hence trading in these items is also very high.

Commodities are in short, similar items grown or produced in different countries and traded in different markets around the world.
By InvestorGuide Staff

Copyrighted 2016. Content published with author's permission.

Posted in ...