What are Commodities?
A commodity is a physical asset that fulfils a need, is produced in substantial quantities and is fungible – i.e. its individual units are entirely interchangeable.
What Are the Types of Commodities?
Commodities are characterised across two main axes: hard/soft and categories.
Hard commodities are those that are extracted from the earth, such as mining products – metals and oil products, for example. Soft commodities are those that are grown – primarily agricultural, including livestock.
Separated into categories, commodities can be metals, energy, livestock & meat, and agricultural (cultivated products).
To be interchangeable, these products must conform to a set of characteristics as determined (usually) by a commodities exchange where the specific commodity is traded. The characteristics are set in order to enable large-scale production and distribution based on a single quoted price. Thus, for example, Gold that is traded on the Shanghai Gold Exchange, the London Metal Exchange and COMEX (the US Commodities Exchange in New York), must be of 95% purity minimum, and 99.9 and 99.99% purity are common. Its price is quoted in dollars per 1 troy ounce. Thus, each bar of tradeable Gold will be the same no matter where it was created and/or traded or at least priced with reference to it.
Oil is traded under (mainly) 2 benchmarks – West Texas Intermediate for most US products and Brent from the North Sea oil fields. WTI, as traded by NYMEX (the New York Mercantile Exchange) for example, is light (between 37 and 42 degrees API gravity) and sweet (less than 0.42% Sulphur content).
How to Invest in Commodities
Very few people actually invest in physical commodities. Unless they are directly related to the supply chain in one way or another, the outlay for storage and transport can be quite inhibiting. However, ever since commodities have existed (since prehistoric times, in fact), contracts have been created for their exchange, as well. The first options contract is believed to have been created by Thales, an ancient Greek who took an option on the country’s olive presses. Tulip futures were the first case of a market bubble bursting. And what these usually had in common was the desire to protect the interests of producers and marketers against natural disasters, gluts and so forth by locking in prices ahead of time.
In fact, the situation today is such that Gold, for example, is leveraged to the extent of $200-300 worth of contract derivatives for every $1 of physical gold in existence.
Contracts-for-Difference (CFDs) are the latest innovation in this respect – a sort of swap contract created, actually, for the real estate market towards the end of the 20th Century. Since then, they have become one of the most popular types of derivative traded, primarily by retail traders trading over-the-counter with online brokers around the world. They are simple to understand (the profit/loss being the difference between the opening and closing prices of the contracted asset) relatively cheap (the transaction cost usually covered by the open/close spread) and traded on margin, which opens the gates to people of more limited resources, on the one hand, but also increases the potential profit/loss in accordance with the leverage offered. All commodity instruments available on 1Market platforms are CFDs.
The History of Commodity Exchanges
Alongside the local temple, proof of markets exists in the earliest archaeological remnants of colonised humans – about 10,000-15,000 years ago. At first, people bartered what they had too much of for what they had too little of. As this trend developed, value had to be ascribed to articles in order to facilitate more complex aspects of the trade. Thus, by the end of the 1st millennium BC, specialised markets (fish markets, perfume markets, etc.) appeared in Europe while coins appeared in the 7-8th Century BC.
As shopping centres appeared (the Roman Forum, for example, bazaars in Persia, Suqs in Arabia, and so forth), specialised markets re-emerged in the Middle Ages to supply growing networks of local markets with more and more products.
And so, the retail chain developed.
At the same time, the terms ‘market’ and ‘exchange’ began to separate – a market becoming the place where people went shopping and the exchange those markets within the supply chain and the infrastructure that governs an asset’s trade.
The world’s first dedicated bourse was the Antwerp Bourse, built in the early 16th Century. The Dutch Tulip mania could perhaps have been inhibited by a regulated exchange. On the other side of the world, the Japanese understood this and created the Dojima Rice Exchange in 1697 by the Shoguns, who were traditionally paid for their services in rice. There, rice futures were also drawn up, and woe unto him that went back on his commitments.
The Chicago Board of Trade was created in 1848 and, besides being dedicated to the trade of agricultural products, was also the first exchange where options and futures were traded in a regulated manner. In the interim, many exchanges have opened around the world, so that the same commodity may be traded in several locations.
The advent of electronic trading has led to the consolidation of most of these, and today, the CME group (a result of the consolidation of the Chicago Board of Trade and the Chicago Mercantile Exchange) owns a large proportion of the world’s commodities exchanges. Euronext (European New Exchange Technology) is centred in Amsterdam and Paris, and operates commodities exchanges in Oslo, Dublin and more. For precious metals in Asia, TOCOM (the Tokyo Commodity Exchange) is the target of choice, and the Africa Mercantile Exchange in Nairobi is a major magnet for coffee trading.