What are Commodities?
Commodities are basic goods used in commercial activity. They are fungible with commodities of the same type, and serve as important inputs in the production of goods and services.
Different Types of Commodities
Broadly speaking, there are hard commodities and soft commodities. Hard commodities have to be mined or extracted from the earth. These include petroleum products, iron ore, copper, gold, and other metals. Soft commodities are grown, harvested, or fished. These include livestock and agricultural produce.
Various categories of commodities are readily available, including the following:
- Metals such as zinc, copper, iron, cobalt
- Energy commodities such as crude oil, natural gas
- Livestock and meat such as beef, pork, turkey, chicken
- Cultivated products such as wheat, barley, maize, sorghum
The fungibility of commodities requires certain conformity. These standards are determined by the commodities exchange where these products are traded. A single-quoted price is given for commodities, to allow for mass production and distribution.
For example, Gold must meet certain standards on commodity exchanges. It must contain 95% pure gold at a bare minimum. 99.99% purity and 99.9 are common metrics associated with gold traded at commodity exchanges. These include the LME (London Metal Exchange), The Shanghai Gold Exchange, and the COMEX (US Commodities Exchange in New York). Thus, one gold bar can be freely exchanged with another gold bar regardless of where it was created or traded.
There are two benchmarks for crude oil. Brent Crude Oil and West Texas Intermediate (WTI). Brent Crude Oil refers to the North Sea Oilfields while West Texas Intermediate refers to US-based oil products. WTI Crude Oil commonly trades on the NYMEX (New York Mercantile Exchange). It is regarded as sweet with less than 0.42% Sulphur content, with a specific gravity between 37 – 42° API.
How to Invest in Commodities
Investing in physical commodities is extremely rare nowadays. Of course, there are exceptions if these commodities are necessary inputs in the supply chain. However, the costs of the physical acquisition, storage, transportation, and security of commodities are exorbitant. Commodities have been around since the dawn of mankind, and today they are traded by contracts. An ancient Greek olive trader named Thales is generally credited with creating the first options contract. Later on, Tulip Futures Markets gave rise to the world’s first market bubble. The Tulip Bubble burst in 1637, but it is routinely referenced in modern-day financial markets.
Futures markets are geared towards protecting marketers and producers from natural disasters, whipsaw price movements through demand/supply considerations, et al. With futures contracts, prices can be locked-in well ahead of time. As an important global commodity, gold is also highly leveraged such that US$200 – US$300 of contract derivatives are traded for every US$1 actual, physical gold that exists.
Nowadays, derivative financial instruments such as CFDs routinely allow for commodities trading. They were intended for the real estate market at the end of the 20th century, but they’ve been adapted to cover a wide range of commodities, indices, currencies, stocks, and other financial assets. CFDs are traded en masse by retail traders OTC, all over the world. It is easy to understand how this derivative product works – you BUY the CFD if you expect a price increase, or you SELL the CFD if you expect a price decrease.
Profit/loss is determined by the difference between the opening price of the CFD and the closing price of the CFD. These are much cheaper than options and futures since they are leveraged products with lower costs.
A caveat is in order: Since CFDs are traded on margin, they can multiply profits but they can also magnify losses. The degree of profit or loss depends upon the amount of leverage that is offered on these financial instruments. All of the commodities presented to traders on our platforms are based on a CFD format.
Commodity Exchanges Over Time
Commodity markets have existed for eons. Experts have traced the origins of commodity trading as far back as 10,000 years – 15,000 years. Initially, a bartering system ensured that those with excess commodities could trade for commodities that they were in short supply of. Naturally, traders would have to satisfy one another’s needs for these exchanges to take place. A framework for trading commodities was established over time, to accommodate the complexities of these types of trades. Towards the end of the first millennium BC, perfume markets and fish markets started cropping up across Europe. Between the seventh and eighth century BC, coins began appearing on the scene.
It didn’t take long for localized markets to start appearing. Consider Persian bazaars, the Roman Forum, and the markets in Arabia as cases in point. A growing number of goods began appearing on the scene over the years, particularly during the Middle Ages as more products were delivered to market. This gave rise to the Retail Chain, with a clear distinction developing between an Exchange System and a Market System. The exchange referenced markets within the supply chain and the infrastructure for trading these assets. People went shopping at markets to buy goods for personal use.
The Development of Exchanges
- In the early 16th century, the Antwerp Bourse was created. Had the Tulip Mania been subject to a regulated exchange, the bubble could have been guarded against.
- The Dojima Rice Exchange was created in 1697 in Japan. The Shoguns were compensated for their services in rice. They also drew up rice futures contracts.
- Fast forward to 1848 – the Chicago Board of Trade was created. It was focused on agricultural produce and served as the first exchange where regulated futures and options were traded.
Over time, many different exchanges began operating all over the world. This facilitated the smooth buying and selling of the same commodities (interchangeability) across different geographic locations.
Of course, electronic trading exchanges consolidated many of the world’s physical exchanges. Nowadays, the Chicago Board of Trade and the Chicago Mercantile Exchange operate as the CME group. A substantial chunk of global commodity trading takes place through this group.
The European New Exchange Technology known as Euronext is headquartered in Amsterdam, Netherlands, and Paris, France. Euronext also features commodity exchanges in Dublin Ireland, and Oslo, Norway.
In Australia, the Australian Securities Exchange (ASX) is responsible for the trading of grains, energy, and wool.
Across Asia, precious metals are traded at the Tokyo Commodity Exchange (TOCOM). In Africa, coffee is traded at the Africa Mercantile Exchange in Nairobi, Kenya.