Commodities are hard assets ranging from wheat to gold to oil. The U.S. government defines commodities in the 1936 Commodity Exchange Act. The Act covers trading in agricultural and natural resource commodities. Although the Act treats financial products like commodities, it doesn't consider them to be commodities. The Act also bans trade in onions as a commodity.
- Commodities are hard assets you can touch.
- They are grouped into agricultural, energy, and metals.
- Their prices are traded every day in the commodities market.
- As a result, the prices of gasoline and many food products change frequently.
Types of Commodities
Since there are so many commodities, they are grouped into three major categories: agriculture, energy, and metals.
Agricultural commodities include:
- Things you drink, such as sugar, cocoa, coffee, and orange juice. These are called the softs markets.
- Grains, such as wheat, soybeans, soybean oil, rice, oats, and corn.
- Animals that become food, such as live cattle and pork (called lean hogs).
- Things you wouldn't eat, such as cotton and lumber.
Metals include mined commodities, such as gold, copper, silver, and platinum. The London Metal Exchange announced it would launch futures contracts for metals used in batteries. The exchange expects there will be a large market for such metals as the demand grows for electric vehicles.
How the Commodities Trading Market Works
Commodities trading determines the prices of all commodities. As a result, the prices of the most important items you use every day are volatile. In some cases, like gasoline, they change from day to day.
Dealers trade commodities on an exchange. That means the prices change every day. This can be challenging for the consumer, who must face price variations in everyday products such as gasoline, meat, and grains.
Commodities trading especially impacts lower-income people around the world, who pay more of their limited income on food and transportation. It also makes farming riskier. It's one reason why the U.S. government provides farm subsidies.
A significant amount of trading occurs in oil, gold, and agricultural products. Since no one wants to transport those heavy materials, they trade futures contracts instead. These are agreements to buy or sell at an agreed-on price on a specific date. Commodities contracts are priced in U.S. dollars. So, when the dollar's value rises, it takes fewer dollars to buy the same amount of commodities. That makes commodity prices fall.
Financials are also traded in the futures markets. These include currencies such as the 3-month Eurodollar and the euro FX. It also includes interest rates, such as the 10-year Treasury note. There are also futures on stock indices such as the S&P 500. But the Commodity Exchange Act doesn’t define these as commodities.
The CFTC decided that virtual currencies like Bitcoin are commodities. This means virtual currencies are subject to CFTC oversight.
Commodities Markets and Oversight
The U.S. commodities markets are in Chicago, New York, and Atlanta. The CME Group owns all but one. The Chicago Mercantile Exchange focuses on agricultural commodities, while the Chicago Board of Trade specializes in grains. The New York Mercantile Exchange focuses on energy and metals.
The Commodity Exchange is located in New York, although the Chicago-based CME Group owns it. The Atlanta-based Intercontinental Exchange now owns the New York Board of Trade. It trades mostly in the softs markets.
In 1975, the Commodity Futures Trading Commission began regulating commodities. The Commission replaced the Commodity Exchange Authority and the Commodity Exchange Commission. In 1936, the Commodities Exchange Act had established those bodies to administer the Act and to set federal speculative position limits.
Commodities as a Business Term
In business, commodities can be defined as any good or service that is bought and sold purely on price. These include the traded commodities. They can also include products that are not differentiated from others based on brand, benefits, or other distinguishing features.
For example, Coca-Cola is a branded product that receives loyalty, and a higher price, because of its perceived differentiation from other cola drinks. A low-cost store brand is more of a commodity because it isn't much different from other store brands. It's bought primarily because of its low price, not its taste.
Frequently Asked Questions (FAQs)
What are commodity stocks?
Commodity trading is often associated with futures contracts, but there are also stocks and ETFs that give traders exposure to commodities. It's important to track exactly how the stock or ETF replicates commodity exposure. For example, a gold ETF may be backed dollar-for-dollar with gold stored in a physical location somewhere. Other ETFs may contain futures contracts, swaps, and other derivatives that offer commodity exposure. Some ETFs and stocks are not technically commodities, but they invest in businesses that operate in the commodity space, such as a gold mining company.
Why is it considered relatively risky to invest in commodities?
Part of the reason commodities trading is considered risky is that it is often done with futures. The futures market is more complex than the stock market, and traders typically have access to more leverage that can enhance those risks. Also, consider the technical differences between investing in a commodity compared to a business. During tough times, a business can cut costs, pivot to new market niches, or issue bonds to reinvest in the business. Commodities are harder to control due to the huge amount of factors that go into both the supply and demand side of the market.