What Are Commodities?

Commodities are primary resources found in nature that makeup goods. Commodities are interchangeable with other similar interests of the same type. While they may slightly vary, companies produce them uniformly.

Commodity Grade Uniformity

An exchange sets the minimum standard, also known as a “basis grade.”

The term basis grade refers to the minimum required standards a commodity must meet to be delivered for use as the asset of a futures contract. Other terms are “par grade” or “contract grade.”

The basis grade establishes an evenness in quality among materials of different producers. The exchange will reject their products if these makers do not meet the required standards. Producers aim to exceed the minimum requirements, ensure safe acceptance, and achieve improved terms of the contract.

2 basic types of Commodities:

• Hard commodities
• Soft commodities

Commodities are primary resources found in nature that makeup goods.

4 categories of Commodities:

Hard Commodities:

• Energy products
• Metals

Soft Commodities:

• Agricultural products: coffee, corn, cotton, soybean, wheat, and even lumber is considered a “soft” commodity.
• Livestock and meat: cattle, beef, pork bellies, and milk.

How the Commodity Market is Build

The Commodity User

Initially, the commodities market was to solve a problem for commodity users. For example, Kellogs needs corn, a commodity, to manufacture its cereal. Kellogs needs to be able to set up a budget to run its business efficiently. To do that, the company must know what its expenses will be in the foreseeable future. A significant component of a food company, such as Kellog’s, is the price of corn. So, the corporation will enter a futures contract, guaranteeing the company to buy the corn they need at a fixed price, no matter what happens in the market.

If the price goes up, then excellent, Kellogs saved on expenses. However, it doesn’t matter to the company even if the price goes down, and the company will have to pay more based on their commitment to their future contract. Kellogs is not a market speculator but a cereal maker. It intends to control its finances to run an efficient company, which requires a budget, which means it must know how much it will spend on corn, irrespective of the market price. So, when Kellogs or any other commercial entity purchases commodities, they do so to receive delivery of the actual goods, and in Kellogs’ case, that shipment of physical gold.

The Speculator

Institutional Investors & Hedging

Unlike a business that produces goods out of the physical commodity and therefore requires the actual delivery, speculators trade in contracts to hedge against potential losses or profit.

Institutional investors, such as hedge funds, incorporate commodities into their portfolios, which are sensitive to economic cycles and tend to correlate with equities negatively.

Like Kellogs hedging against adverse commodity market changes by locking in a price, savvy investors include this financial asset to hedge against negative stock market changes. In other words, goods producers and smart money use Commodities to protect from losses, not necessarily to incur a profit.

Traders

Commodities provide traders with a target-rich environment, as they sometimes provide significant volatility. Such sharp price changes are very attractive, especially for short-term traders, who are happy to take advantage of the opportunity to enjoy potentially large profits in a relatively short amount of time.

Types of Community Transactions

• Spot price, also known as the “cash” or “market price.” This transaction reflects the current market or exchange. A trader will pay for the commodity’s real-time value for immediate delivery.
• Futures Contract. This transaction will be settled at a future date. It could be for delivery, such as lumber for a home builder, or speculative purposes.
• Commodities ETFs. Those are funds that invest in commodities, enabling non-professional investors an easy and affordable means to access commodities trading and investing. Savvy traders emulate smart money and incorporate commodities into their portfolios to diversify their exposure.
• Commodity Stocks. A simple way for regular people to invest in commodities is indirectly by purchasing shares of companies that produce commodities. Investors who want exposure to commodities buy the stocks of companies that manufacture metals, energy, or meat.

What Affects the Commodities Market?

The commodity market is risky, and it, therefore, requires broad knowledge and in-depth understanding of many different market facets, including supply and demand of the commodity market itself, macroeconomics, and even weather patterns.

However, the higher risk in this market equally provides higher rewards, and for traders or investors willing to take the time and make an effort to gain the necessary knowledge, the rewards are rich.

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