What a Commodity Is and How Its Trading Market Works
Commodities are traded daily on the market using futures contracts
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, as per the 1958 Public Law 85-839 (7 USC 13-1).
What Are 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.
The energy category includes crude oil, RBOB gasoline, natural gas, and heating oil. Commodities trading is a big determinant in setting oil prices.
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 starting in 2019. 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. It 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. That means that 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 great 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 and is bought primarily because of its low price, not its taste.
United States Commodity Futures Trading Commission. "Commodity Exchange Act & Regulations." Accessed Jan. 12, 2020.
The Wall Street Journal. "Revving Up for Electric Cars: The London Metal Exchange." Accessed Jan 12, 2020.
Securities and Exchange Commission. "What Are Commodities?" Accessed Jan. 12, 2020.
Bureau of Labor Statistics. "The Relationship Between Crude Oil Prices and Export Prices of Major Agricultural Commodities." Accessed Jan. 12, 2020.
Iowa State University. "Commodities Versus Differentiated Products." Accessed Jan. 12, 2020.