Coinspeaker
What Is a Commodity? Definition, Types, Examples
Commodities form the foundation of global trade and the economy. They are unprocessed and undifferentiated primary products used as inputs in the production of nearly all final goods and services.
For instance, oil is distilled to obtain fuels and petrochemical derivatives. Metals must be melted down to create materials for building construction, vehicles, and electronic devices. Meanwhile, cattle are raised for meat production. This holds true for every economic sector.
Commodities can be natural resources like natural gas, precious metals, and various minerals, or goods produced in the agricultural sector, such as grains, lumber, cotton, and livestock. Their extraction, cultivation, breeding, and trade move billions of dollars annually in global markets.
In this guide, we will delve into the meaning of commodities, their characteristics, the diverse types of commodities that exist, how their trade functions, and their significance for the development of all productive sectors, among other essential topics.
Commodities Explained
As mentioned above, commodities are unprocessed primary goods used as inputs or raw materials in industrial, agricultural, and service production processes. They can originate from minerals, fossils, agriculture, or livestock. Their main characteristics include the following:
- Homogeneity. Commodities within the same category are interchangeable. There is no differentiation between products from different sources. For example, a barrel of WTI crude oil is equivalent to one of Brent crude oil.
- Standardization. To be traded in futures markets, commodities must adhere to minimum standards of quality, purity, and other technical specifications.
- Quick trading. They are produced, transported, and traded in very high quantities. The global commodities trade moves tens of billions of dollars annually.
- Volatile prices. Values can fluctuate significantly in a short period due to changes in supply, demand, weather conditions, geopolitical situations, and more.
- High returns. Given their potential profitability, commodities attract investments and speculation in futures markets.
Types of Commodities
Commodities are divided into two major categories: soft commodities and hard commodities. Within these two main categories, there are more specific subcategories.
Soft commodities include the following:
- Agriculture. This includes essential crops such as corn, wheat, rice, coffee, cocoa, cotton, and sugar, which are cultivated and harvested. Prices can be highly volatile depending on the time of year and weather conditions. They represent investment opportunities due to growing demand.
- Livestock – animals raised for food or to produce meat, eggs, hides, wool, and other byproducts. Examples include cattle, sheep, and goats. It is a labour-intensive process.
Among hard commodities, which require mining extraction, the two main types are:
- Metals. This category includes precious metals like gold and silver, as well as basic metals like aluminium and copper. Precious metals are often considered safer investments during times of crisis and provide protection against inflation.
- Energy. Commodities related to energy, such as crude oil, natural gas, and electricity. Global economic factors impact their prices. Alternative sources like solar or wind energy can affect the demand for traditional energy commodities.
Furthermore, within these four subcategories, there is a vast diversity of specific types of commodities, ranging from metals like platinum and uranium to agricultural products like tobacco and sugarcane.
Commodity Transactions
Most commodities are traded on commodity exchanges such as the New York Mercantile Exchange (NYMEX), the Chicago Board of Trade (CBOT), the Chicago Mercantile Exchange (CME), the Chicago Board Options Exchange (CBOE), the Kansas City Board of Trade (KCBT), and the Minneapolis Grain Exchange (MGEX).
Investors can access these markets through stocks, exchange-traded funds (ETFs), and mutual funds specializing in commodities. The exchange process involves the following steps:
- Meeting of sellers and buyers. Producers, consumers, and interested investors converge on commodity exchanges.
- Establishment of conditions. Aspects such as quantity, quality, delivery deadlines, price, etc. are defined, all in accordance with market standards.
- Price determination. The price is determined based on the supply and demand for the particular commodity. Generally, a fixed value is agreed upon for the future delivery date.
- Formalization of the contract. The parties involved enter into a futures contract, a legal agreement to buy/sell a specific quantity of a commodity on a future date under predetermined conditions.
- Financial exchange. To manage risk, financial transactions such as margin deposits and daily settlements occur between buyers and sellers.
- Physical delivery or settlement. Upon the expiration date, the physical delivery of the product or its financial settlement, as agreed upon, takes place.
- Recording and clearing. Finally, all transactions are documented in a centralized and standardized register of all executed operations.
Commodities vs Products
Unlike consumer products that reach the general public, commodities are undifferentiated generic goods traded in standardized bulk quantities between businesses.
For example, wheat or soybeans from one producer are interchangeable with those from another, whereas a breakfast cereal or vegetable oil has distinctive packaging, branding, marketing, and so on.
Moreover, commodities are traded business-to-business in spot and futures markets, while final products are sold business-to-consumer through retailers and other channels.
Commodities and Economic Cycle
Historically, the prices of major commodities have exhibited cyclical behaviour, rising during economic booms when both demand and speculation tend to increase and decrease during periods of slowdown or recession.
Many investors turn to commodities during the expansion phases of the economic cycle to hedge against potential inflation. However, their actual performance is entirely unpredictable and depends on multiple macroeconomic, geopolitical, and sector-specific factors.
Bottom Line
Commodities constitute the basic inputs that support the production of goods and services on a global scale. Their extraction, cultivation, transportation, and trade move billions of dollars annually, serving as a fundamental pillar for global economic growth.
Therefore, understanding the dynamics of these markets is essential for both producers dependent on a stable supply, consumers interested in the value chain, and investors seeking opportunities in these assets.
