What are commodities?

As one of the oldest financial markets, commodities are highly traded around the world and are fundamental to national economies. They are goods that occur naturally in the ground or can be harvested, and when it comes to trading, are affected by various fundamental factors.

Commodities are a vital part of the economy, as they are raw materials that are used to manufacture other products including food, energy and clothing, that are all essential in everyday life. The most common investment on the market is oil trading, and they are bought and sold via exchanges, or through financial derivatives on an online trading platform.

Types of commodity

Commodities fall into two categories, which are known as soft and hard. A soft commodity can be agriculturally produced, such as coffee, corn, cotton or wheat. This also includes the rearing of livestock, such as pigs and cattle.

On the other hand, hard commodities are raw materials that you can find in the ground, and require an extraction process such as mining. Commodities such as iron ore, crude oil and precious metals fall into this category.

For a commodities trader, the type of asset is important, as this will alter the angle of the fundamental analysis. For example, a certain weather pattern can affect the supply of a crop-like commodity, whereas keeping up to date with geopolitical events will improve your strategy for trading oil.

The commodities can then be separated into further sub-classifications:

• Agricultural products — such as wheat, soybeans and sugar
• Energies— refers to crude oil, gasoline and natural gas
• Metals— like gold, platinum, copper, aluminium and silver
• Livestock— mainly refers to meat products such as hogs and cattle

These sub-categories witness the highest volume of trade, are the most liquid in the market, and tend to have a continuous amount of supply and demand.

How can you trade commodities?

There are several ways in which you can trade commodities, but the most common of these is through futures contracts on an exchange. The most well-known exchanges for trading in futures, are the Chicago Mercantile Exchange, New York Mercantile Exchange and London Metal Exchange.

Future contracts are mainly used when the buyer physically requires the asset, although they can be speculated on by financial investors. A futures contract is where the buying and selling of a commodity takes place on a specified future delivery date and at a fixed price. This is usually to ensure that the budget and supply of the commodity coincides with the overall plan of the company.

Alternatively, commodities can be traded using financial derivatives such as contracts for difference (CFDs). CFD trading allows investors to speculate on the price movements of the commodity, without owning the underlying asset. This means there is no requirement to receive and store the commodity itself, which can help when there are issues with supply and demand, and investors can take a position on both a rising and falling market.

The profit or loss through CFD trading is calculated from the difference between the opening of the contract, and its closure, with their value based on the price movements of the commodity instruments from the major exchanges.

What factors affect the price of commodities?

Due to their nature, production and impact on the rest of the financial markets, commodities have several fundamental factors that can affect their value. Although some are unpredictable, the use of an economic calendar to predict the likely price movements as a result of impactful events, make the commodities market highly attractive to traders.

Here are just a few of the factors that are the main drivers of commodities’ prices:

• Competition — this includes the introduction or production of something new that can reduce the demand for an older commodity. For example, the demand for more renewable energy may drive down the value of oil and gas. Likewise, any government policies that promote sustainability may deter the value of oil.
• Policies and economics — a good investor will always keep an eye on the policies introduced by governments, as this can affect the prices when it comes to importing and exporting. A nation that is a main producer of a particular commodity may also have an impact on production, if they are facing political turmoil. When it comes to the economy of a country, a prosperous nation would imply more demand or manufacturing of the commodities they are known for — both of which would have an effect on supply and demand and drive prices.
• Weather — this is particularly notable with agricultural commodities, as they are dependant on seasonal cycles. Extreme weather and natural disasters can also affect the production and transportation of goods, and subsequently impact the rest of the supply chain and price movement.