What is a Commodity?
Commodity is a basic good used in commerce that is substitutable with other commodities of the same type. Commodities are often used as inputs in the production of other goods or services.
Take note that the quality of a given commodity may differ slightly, but it is fundamentally uniform across producers. When commodities are traded on an exchange, it must also meet specified minimum standards, which is also known as a basis grade.
Now, let us dig a little deeper to know more about Commodities.
There is a small differentiation between a commodity coming from one producer and the same commodity from another producer. A barrel of crude oil is the same product, regardless of the producer. By contrast, for electronics merchandise, the quality and features of a given product may be completely different depending on the producer.
Here are some traditional examples of commodities; oil, natural gas, gold, grains and beef. More recently, the definition has stretched to include financial products, such as foreign currencies and indexes. Technological advances also led to new types of commodities being exchanged in the market place. Good examples of this are cell phone minutes and bandwidth.
Brief History of Commodity
You should remember that commodity dealing is an old profession – far older than dealing in stocks and bonds. The ancient civilizations traded a wide range of commodities, from seashells to spices.
Commodity trading was an essential business. The might of empires can be viewed as a bit proportionate to their skill to make and achieve complex trading systems and facilitate commodity exchange as these served as the wheels of commerce, economic development and taxation for a kingdom’s treasuries.
Types of Commodities
Let’s get into the different types of commodities. Today, tradable commodities fall into four categories, which are:
- Energy – energy commodities is probably the commodity whose trading has the greatest effect on traders and non-traders. Variations in the prices of any given energy commodity can have a substantial effect on the prices the consumer pays for heating, electricity and for transport. Examples for energy commodities are gasoline, natural gas, heating oil and crude oil.
- Metals – this includes precious and non-precious metals. These metals are used as raw components in manufacturing, electronics, and jewelry. Examples are gold, silver, platinum and copper.
- Agricultural – this commodity come from the raising of crops and animals. However, some agricultural commodities such as corn or beef, are direct products on earth, others, like high fructose corn syrup, are derived from them. Examples are soybeans, rice, wheat, coffee, cocoa, sugar, and cotton.
- Livestock and Meat – this refer to commodities in the form of livestock. Examples are feeder cattle, live cattle, pork bellies, and lean hogs.
Where to Invest?
There are still multitudes of commodities exchanges around the world, although some have merged or gone out of business. Most traders or investors carry a few different commodities, though some specialize in a single group. For example, the London Metal Exchange it only carries metal commodities, as it says in its name.
While in the U.S., the most popular exchanges include those run by CME Group, which resulted after the Chicago Mercantile Exchange and Chicago Board of Trade have merged in the year 2006. Other popular ones are the Intercontinental Exchange in Atlanta and the Kansas City Board of Trade.
Another thing you should know is that commodity trading in the exchanges can require agreed-upon standards so that trades can be executed. You don’t want to buy 100 units of cattle only for you to find out that the cattle are actually sick, or maybe you discover that the sugar you purchased is a bad quality.
How to Invest in Commodities
Okay maybe you are wondering now hot to invest in commodities, a well-known way to invest in commodities is through a futures contract, which is an agreement to buy or sell, in the futures, a specific quantity of a commodity at a specific price. Futures are available on every category of commodity.
There are two types of investors in the futures markets:
- Commercial or Institutional Users of the Commodities – they use futures as part of their budgeting process, to normalize expenses and reduce cash flow-related headaches.
These hedges are using the commodity markets to take a position that will reduce the risk of financial loss due to a change in price.
- Speculators – they are the one who hope to profit from changes in the price of the futures contract.
They are typically close out of their positions before the contract is due and never take actual delivery of the commodity itself.
Pros and Cons of Investing in Commodity
Every investment has its own pros and cons. So does investing in Commodities.
When you invest into something, you should know its background first. What are the rules, risks, and of course the pros and cons of your investment.
Now, here are some of the pros and cons that you could encounter while investing in commodities.
- Exposure to different growth of opportunities. The growing demand in a commodity can see its prices rise significantly over time. One good example of this is the iron ore prices rose by more than three times in 2008–2010 driven by huge demand in China and its supercharged economic growth.
- Portfolio diversification. When you invest in commodities it provides you a portfolio component that is not a traditional investment like a bond or stock.
- Protection from inflation. Commodities usually benefit from inflation, while the inflation affects other investments in a negative way. Because when the price of goods and services rise, the prices of commodities that needed to produce these goods and services will rise as well.
- Low entry capital. The online trading platforms allow the investors to trade even with a small amount of capital.
- Upside potential. As a subject to the laws and demand, when the demand rises or the supply shrinks, the prices of commodity usually soar, offering potential profits for traders who have their pulse on the market and make the precise calls.
- Easy accessibility. The new technology makes the use of online trading platforms easy. It also allows individuals to trade in commodities easily and quickly from the comfort of their home.
- Keeping up with the times. Trading in commodities also offers a hedge against inflation.
- No income generation. Commodities do not generate any income for the investor, unlike the other asset classes.
- The commodities markets can be volatile and subject to wild price swings or long lulls and it could even remain range bound for months or even for years.
- Finger on the pulse. Investors in commodities are needed to keep track of the diverse factors that could affect the commodities they are trading and have to constantly update its information.
- Whole new ballgame. Commodities can offer some interesting strategies and investments, but the commodities markets are complex and not as familiar to most investors as the bond market or stock market.
- Highly volatile. Commodity is considered as one of the most volatile asset classes around. Commodities are twice as volatile as stocks and nearly four times as volatile as bonds. Because of its extreme volatility it could make the commodity risky for certain investors.
- Concentrated assets. Many of the commodities mutual funds concentrate assets in certain sectors such as energy, which is resulting in a greater exposure to risk that the particular sector would experience a slump.
These are just some of the advantages and disadvantages that could help you make the right decision. It can also give you awareness of what could possibly happen along your journey in investing in commodities.
Therefore, investing in commodities is not that easy. Just like the other investment. It takes time and energy to be on top.
However, before you could reach it, you have to learn the background of the investment you will be entering. You have to know the risks that are waiting along the way. As well as the rewards you could attain with your journey through success.
Always remember that a good investor should have the knowledge about his or her investment. He or she should also know what are the things that should and should not be done along the journey of his success.
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