What Are Commodities?
Simply put, commodities are essential materials used extensively in industrial production and everyday life, such as crude oil, soybeans, and copper.
They share a key characteristic: they are not sold directly to consumers like retail products but are traded in bulk like wholesale items. For instance, buying 1 liter of gasoline constitutes a retail transaction, while gas stations purchasing from refineries is an example of commodity trading.
What Are the Six Major Characteristics of Commodities? Why Are They Considered the "Barometer" of the Economy?
1. Massive Supply and Demand Scale — The Fundamental Fuel of the Industrial Economy
Commodities serve as essential raw materials for large-scale global production and consumption, encompassing key sectors such as energy, metals, and agricultural products.
Daily trading volumes are often expressed in "hundreds of millions of tons" or "thousands of barrels."
For example, global daily crude oil consumption exceeds 100 million barrels, while annual iron ore trade surpasses 2 billion tons.
As the backbone of industrial production, fluctuations in supply and demand directly affect manufacturing costs and end-product prices, acting as a "thermometer" for economic activity.
2. Significant Price Volatility: Dynamic Balance Driven by Multiple Factors
Commodity prices frequently experience considerable volatility influenced by the global macroeconomic landscape.
Factors such as supply-demand imbalances (e.g., extreme weather diminishing agricultural yields), geopolitical tensions (e.g., shifts in energy-exporting countries' policies), and economic cycles (e.g., inflation-induced demand for safe-haven assets) can provoke sharp price movements.
This volatility presents both risks and opportunities for market participants to engage in price discovery and arbitrage.
3. High Storage and Transportation Convenience
Commodities are generally easy to store and transport, facilitating effective allocation and trading on a global scale.
Crude oil can be shipped across oceans in giant tankers; iron ore is transported worldwide by massive bulk carriers; even wheat can be sealed in containers for long-term storage.
This characteristic significantly contributes to the international development of commodity markets.
4. Diverse Categories — The Material Foundation Covering the Entire Industry Chain
Commodities can be classified into three core categories based on their applications, deeply embedded in both production and everyday life.
Energy Commodities: Such as crude oil and natural gas, are essential sources of industrial power as well as energy for households.
Basic Raw Materials: Metals like iron ore, copper, and aluminum support vital industries including construction, machinery, and electronics.
Agricultural Products: Items such as soybeans, corn, and cotton are crucial for food security and serve as lifelines for the textile industry.
5. High Degree of Quality Homogeneity
Within each commodity category, products often appear nearly indistinguishable from one another.
For instance, whether the crude oil comes from Saudi Arabia or the United States, oil of the same grade will have minimal quality differences.
Similarly, Chicago wheat and Ukrainian wheat can sell for the same price if they meet identical grade standards.
What’s the advantage? This "homogeneity" simplifies trading—there’s no need to scrutinize every detail; checking the grade and contract specifications suffices—much like purchasing standardized LEGO bricks: it’s efficient and stress-free.
6. Prominent Financial Attributes — A Dual Channel Connecting Real Economy and Capital Markets
Commodities are intricately linked with financial markets, positioning them as critical instruments for asset allocation.
Investors can engage in trading through futures, options, and ETFs to hedge risks or seek returns.
A prime example is gold; possessing both commodity and monetary attributes, it frequently acts as a safe-haven asset during periods of economic uncertainty, with its price significantly influenced by capital flows.
What Are the Classifications of Commodities?
Hard Commodities — Core Raw Materials Extracted from Nature
Hard commodities primarily consist of natural resources that are mined or extracted from the earth.
They are characterized by stable physical properties and suitability for long-term storage, forming the backbone of economic activity.
These commodities can be mainly categorized into two subcategories:
1. Energy Commodities — The Driving Force Behind Industry and Daily Life
Energy commodities, such as crude oil, natural gas, and coal, are essential to the functioning of modern society.
Industrial production heavily relies on these resources (for example, coal is critical for steelmaking), while daily life depends on them for activities like refueling vehicles and heating homes.
Prices for energy commodities can be highly volatile due to global supply and demand changes; factors such as production cuts by oil-exporting countries, surges in demand driven by economic recovery, or shifts toward renewable energy policies can lead to significant price fluctuations.
2. Metals — Essential for Stability and Industrial Demand
Precious metals like gold, silver, and platinum serve not only as jewelry but also as safe-haven assets.
During times of economic uncertainty, investment often flows into gold; for instance, in 2020 during the pandemic, gold prices soared above $2,000 per ounce, providing an important hedge against inflation.
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(Source: Pixabay)
Industrial metals such as copper, aluminum, and zinc are vital for construction (including rebar), electrical systems (like copper wiring), and lightweight materials used in automobiles (such as aluminum alloys).
The prices of these metals directly reflect trends in industrial demand.
Soft Commodities — Flexible Resources Dependent on Agriculture
Soft commodities primarily consist of agricultural products and cash crops, characterized by relatively short growing cycles.
However, their production is highly reliant on natural factors such as climate, soil quality, and pest outbreaks, making them a classic example of "farming by the weather."
1. Crops — A Barometer of Global Food Security
Grain crops like wheat, corn, soybeans, and rice are not only staple foods for humanity but also serve as essential raw materials for food processing.
Prices are significantly influenced by factors such as cultivated acreage, weather-related disasters (like droughts and floods), and global demand.
For instance, in 2023, extreme heat in India led to a decrease in rice production, which resulted in a global price increase of over 20%.
This impacts not just food availability but also feed costs—an increase in corn prices can ripple through to the livestock sector, indirectly raising meat prices.
(Source: Freepik)
2. Cash Crops — The Agricultural Roots of Industrial Products
Cash crops such as cotton, rubber, and timber may not be directly edible but are vital raw materials for manufacturing industries.
Cotton is transformed into clothing fabrics, while timber is crucial for construction and furniture production. Production levels are often heavily influenced by natural conditions; for example, heavy rainfall in Thailand can reduce rubber output and lead to increased costs in the global tire industry.
(Source: Pixabay)
Financial Commodities — Connecting the Real Economy with Investment
While financial commodities do not represent physical goods themselves, they play an essential role in commodity markets. They primarily include bonds, currencies, and financial derivatives like futures and options.
Companies frequently use these tools to hedge against risks; for instance, airlines may purchase crude oil futures to lock in future fuel costs and mitigate profit fluctuations caused by rising oil prices.
Individual investors can also access these markets via ETFs (such as gold ETFs or oil funds), enabling them to diversify asset allocations without engaging directly in physical trading.
During periods of strong inflation expectations, many investors choose to allocate funds to gold ETFs.
What is the Commodity Market?
The commodity market refers to the marketplace where commodities are bought, sold, and circulated.
This market is broadly divided into two main segments: the "cash-and-carry" spot market and the derivatives market, which speculates on future prices.
Market Classification: Spot Market vs. Derivatives Market — What’s the Difference?
Spot Market (Cash Market): This segment is straightforward and direct, where buyers and sellers exchange cash for goods immediately. For example, if you go to a steel market, pay for a ton of rebar, and take it away on the spot, that transaction occurs in the spot market.
Derivatives Market: In this market, actual physical goods are not traded directly. Instead, contracts are created based on "future prices." Common instruments in this space include futures and options. For instance, if an automobile manufacturer anticipates rising steel prices next year, it might spend 1 million dollars to buy a futures contract that allows it to purchase steel at current prices next year, effectively locking in its costs.
How Does the Commodity Market Operate?
Trading Mechanisms
- Quoting and Ordering:
Market Maker System: This functions like a market intermediary. Large banks, for example, continuously provide buy and sell quotes in precious metals trading.
If you want to sell gold, you can do so at their quoted price. Similarly, if you're looking to buy, you can purchase at their quoted price as well. This ensures there's always liquidity in the market.
Bidding Process: This resembles an auction where participants place their offers.
For instance, in a futures exchange, if you think crude oil will rise, you might quote "Buy 100 barrels at $100 per barrel," while someone who expects it to fall could quote "Sell 100 barrels at $99 per barrel."
The system matches orders based on the principle of "higher bids fulfilled first and lower bids next," completing transactions when prices align.
- Settlement and Delivery — How Are Money and Goods Exchanged?
Settlement
Daily Settlement: In the futures market, accounts are settled daily after the market closes.
If your oil futures position increases in value on that day, your profits are credited directly to your account. If it decreases in value, funds are deducted from your margin account to ensure that you have enough capital to manage risk.
Final Settlement: When a contract expires, traders can either close their positions (sell off the contract) or fulfill the contract by paying for and taking delivery of goods (physical delivery).
However, 99% of traders usually opt for closing their positions since few want to take delivery of thousands of tons of crude oil.
Delivery
In spot trading, cash and goods are exchanged simultaneously.
In futures trading, most contracts are typically closed out rather than resulting in physical delivery.
How Are Prices Determined?
Supply and Demand Dynamics
The primary driver of price determination is the relationship between supply and demand.
During economic upswings, increased activities such as factory construction and vehicle purchases lead to a surge in demand for industrial metals like copper and aluminum, causing their prices to rise.
Conversely, in economic downturns, falling demand can result in surplus inventories, leading to price declines. For instance, in 2021, global infrastructure spending pushed copper prices to a ten-year high due to exceptionally strong demand.
Cost Support
The costs associated with resource extraction—such as the expenses involved in gold mining (including exploration, extraction, and transportation) or corn farming (requiring seeds, fertilizers, and labor)—establish a price floor.
If crude oil prices remain below production costs for an extended period (e.g., dropping to $20 per barrel), oil companies may halt production rather than sell at a loss. A reduction in supply typically leads to price rebounds.
Market Expectations
Investor expectations regarding future supply-and-demand trends, macroeconomic factors, and policy changes can significantly impact prices.
For example, if there is anticipatory news of an increase in crude oil demand, prices may rise even if the current market balance is stable.
Risk Management: How to Mitigate Risk?
Hedging
Producers (like farmers) who are concerned about potential price declines after a bumper harvest can hedge by "selling corn futures" on the futures market. Even if spot prices fall later on, their profits from futures contracts can compensate for those losses.
Consumers (such as feed manufacturers) worried about rising corn prices can hedge by "buying corn futures," locking in costs without fearing upstream price increases impacting their margins.
Options — Cost-effective Insurance
For instance, if you invest in a gold ETF but worry that gold prices might drop, you could spend roughly 1% of your investment on a "put option." If gold indeed declines, you can use gains from this option to offset your losses; if gold rises instead, your maximum risk is limited to that 1% premium paid—effectively providing “insurance” for your investment.
