Commodities are basic goods and raw materials that individuals and companies buy and sell. Commodities are the fundamental blocks in building complex goods and services. Commodities are very special because they are standardized and can be interchanged with other goods of the same type. So, two equivalent units of the same commodity should have a uniform price around the world, excluding local factors like taxes and cost of transportation.
Nearly all commodities are extracted, grown, produced and traded in large quantities to support liquid and global trading markets. Examples of commodities are corn, wheat, copper, oil and more.
HOW DID COMMODITIES EVOLVE?
Historical facts suggest that rice may have been the first commodity since Chinese started to trade it about 6,000 years ago. After China, around 4,500 and 4,000 BC the Sumerian civilization (nowadays this region is called Iraq) started to use clay tokens as a first form of money to buy livestock. Buyers would place these tokens in sealed clay vessels and record the data for each time something was bought: quantities, times and dates of the transactions on writing pieces of tablets. In exchange for the vessels, merchants would deliver goats to the buyers. These transactions constituted a primitive form of commodity futures contracts.
Later, other civilizations started to use valuable stuff like pigs and seashells as a form of money to buy commodities. And finally, the ancient Greeks and Romans decided to use gold and silver as the most preferred currency for commodities transactions. They also priced gold and silver for their physical beauty. Furthermore, gold and silver are rare, can be melted, reshaped and measured into coins. So, a monetary system was founded. Gold became the most preferred mean of commerce and it became also the number one traded commodity.
WHAT DRIVES COMMODITY PRICES?
Each commodity has its unique factors which causes movements in its price. Big price movements occur when the scarcity or abundance of a commodity is threatened. Overall the main influencers are the changes in supply and demand, however, other elements like US dollar, weather and substitution can also impact its prices.
The supply of a commodity is influenced by different factors, such as government intervention, war, climate conditions. On September 14, 2019 the world biggest oil processing plant in Saudi Arabia was attacked by explosive drones, which caused a reducing in global oil production by 5 million barrels a day. When market opened on September 16 the price was announced at 72.19, comparing to 60.42 the market was closed on September 13. So, it jumped 19.4%. Why?
The demand was the same, while the supply was reduced. This causes an increase in the price.
The demand of a commodity can be influenced by different factors like a change in consumers routine and the health of the economy. For example, many people’s routine over sugar consuming have changed. People are trying to consume less sugar. If the number of people keep giving up on sugar the sugar demand will keep decreasing.
The Relationship between the US Dollar and Commodities
In the same group with supply and demand, the behavior of the US dollar can also impact commodity prices. The US dollar is the currency of the world’s reserve and in international markets, they are priced in USD. This means that when the dollar is devaluated compared to other currencies, it needs more dollars to buy the same number of commodities. Gold is considered as a heaven asset and it is where investors turn when the value of the USD goes down.
Being replaceable means that markets will check to find cheaper alternatives where possible. If a commodity keeps becoming more expensive, buyers will try to find for cheaper alternatives. If they find it good enough, they will spend on it, which results in a reduction of the demand for the main commodity and it leads in the price going down. A good example is copper, which is used in various industrial applications. As copper price has increased, many industries switched to aluminum instead.
How Weather Affects Commodity Prices
Weather is another commodity price influencer. Unexpected changing conditions, like extreme rain or being too hot can have a significant impact on agriculture commodities. Commodities like cocoa, coffee, and orange juice are harvested and grown, and need consistent weather cycles to grow. The weather influences also the energy commodity prices, as during some winters the demand for heading increases. On the other side an extreme warm weather increases the need for air conditioning. This raises the demand for the commodities which are included in electricity production, like natural gas and coal.
WHY TRADING COMMODITIES?
Even if you study deeper about commodities you will find plenty of reasons why you should trade commodities. We find 3 most attractive to start trading today. The growing of world population , inflation rates and portfolio diversification.
The growing of world population
Global population growth is growing 1% per year, each year is climbing. It had an explosion since the beginning of the twentieth century, now reaching a population of 7.7 billion. Population growth means more mouths to feed, which raise the demand for agricultural commodities. Also, people need infrastructure which could have a significant impact on the demand for metal and energy commodities.
Inflation is the rate at which prices increases, it means that with the same amount of money as today, tomorrow you will buy less products of the same type. Saying for commodities, it will need more dollars to purchase the same amount of a certain commodity in the future. So, by investing in commodities directly protect the investors from the higher prices, and if they decide to sell they will sell them with higher prices, which will lead to benefits.
If you keep trading in one type of commodity like stocks or bonds and these two markets had a downturn (if the real estate or stock market had a crash), your portfolio will suffer a significant hit. If you diversify your portfolio in different assets, including various commodities, the damage which comes from crashed markets could be able to recover by other assets which might be stable or even in raise mood. Commodities are one asset class that can be added to your portfolio to create diversification and better manage risk.
MAIN COMMODITY CATEGORIES
Agricultural Commodities: raw goods such as sugar, cotton, coffee beans, etc.
Energy Commodities: petrol products like oil and gas.
Metal Commodities: precious metals such as gold, silver and platinum, but also base metals like copper.
Livestock Commodities: pork bellies, live cattle and general livestock, as well as meat commodities.
When dealing with commodities, you also will hear terms like hard commodities and soft commodities. Hard commodities are those that are mined (gold, oil, etc.) and soft are agricultural commodities or animals (wheat, soybeans, pork, sugar, etc.).