Understanding the Basics of Commodities

Commodities are defined as raw materials that are used to make other products. They are often classified into agricultural, metals, and energy commodities. Agricultural commodities are basic crops and animals that are produced on farms or plantations. Agricultural commodities are important because they are a source of food for people as well as animals across the globe. They include wheat, coffee, cocoa, sugar, livestock, cattle, soy, dairy, and fruit.  Agricultural products that have industrial applications such as lumber, timber, wool, and lanolin are also commodities.

Precious metals are both used as industrial elements and investments. Precious metals that are active in the commodities market include gold, silver, platinum, copper, and palladium. Among these, gold is seen as the main metal that is used as an investment vehicle.

Energy has also attracted a lot of interest from investors who seek to profit from the world’s never-ending need for energy – whether from fossil fuels or from renewable energy sources. Energy commodities include crude oil, natural gas, coal, uranium/nuclear power, electricity, solar power, ethanol, and wind power.

Cryptocurrency: Now Considered a Commodity

Now there is a commodity newcomer: cryptocurrency. This means that in the cryptocurrency market, virtual currencies can be traded as commodities – similar to how one trades gold, oil, coffee, or wheat. In a landmark ruling last September 2018, United States Federal Judge Rya Zobel declared that virtual currencies meet the definition of a commodity under the Commodity Exchange Act (CEA). What this signifies is that the Commodity Futures Trading Commission (CFTC) has regulatory jurisdiction over cryptocurrency trading and is subject to the same regulations as commodity trading. Some of the most highly-traded cryptocurrencies are Bitcoin, Ethereum, and Ripple.

Investing In Commodities

If you are considering investing in commodities, there are several ways to do so. One way is to buy different amounts of physical raw commodities.  An example of this is purchasing precious metal bullions.  Another way that you can invest in commodities is through futures contracts or ETPs (Exchange-Traded Products).  Other ways of investing in commodities include mutual funds, index funds, and stocks. These investments are highly complex because of their volatile nature.  Consulting an experienced broker is recommended. Commodity investing is usually done by more seasoned investors. For those who are interested in commodities, you need to first get involved with the more basic areas of investing.

There are many commodities exchanges around the globe. Many specialize in specific commodities.  For instance, you can only trade in metal commodities at the London Metal Exchange. In the US, some of the most popular commodities exchanges are the New York Mercantile Exchange and the Intercontinental Exchange which is based in Atlanta.

Investing in oil, gold, and other base metals is an ideal place to begin for commodity investors. Before you invest in commodities, consider asking three key questions.  The first question is ‘what is the current level of world production?’ The second question is, ‘are there new supply sources?’ The third question to ask is ‘is there undergoing exploration for potential supplies?’ The basic economic principles of supply and demand govern the commodities market.

Benefits of Investing in the Commodity Market

Why invest in the commodity market? Here are the benefits of commodity investing:

Diversification

Commodities are able to diversify an investment portfolio.  Commodity returns usually have minimal or no correlation with the returns of other stocks and bonds. In fact, when bonds and stocks fall, then the price of commodities rise. This movement may or may not be connected at all. This is because the factors that affect other assets do not affect the returns on commodities. Therefore, a diversified portfolio with a low relationship between its assets will have less tendency to have volatile returns.

High Returns

Since commodity markets are volatile and individual prices can fluctuate based on current supply and demand, they can have massive swings in prices. Good investors who study the commodities market well can take advantage of these huge price swings in order to make a profit.

Inflation Protection

Inflation can erode the value of stocks and bonds, but it has a different effect on commodities. When there is inflation, the prices of commodities will remain the same or even increase.


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