On an average day you might sip a cup of coffee, put on a cotton t-shirt, drive your car to work, eat a bowl of cornflakes and use coal to heat your home. Coffee beans, cotton, oil, corn and coal are all examples of commodities. We use them all day, every day. They are the base of almost any product. They are a very necessary part of the American economy.
What is a Commodity?
A commodity is a good that is bought, sold or traded for products of similar value. They are easily replicated and maintain about the same shape and consistency, no matter where they are produced. They also must meet minimum standards to be traded on the open market. It is a raw material used to create a finished product. Their prices fluctuate based on supply and demand.
Types of Commodities
The following are examples of commodities: grains, oil, gold, beef, coal, sugar, iron ore, silver, coffee, bananas, and more.
Its definition of it now includes elements of finances like currencies and indexes. A pair of Ralph Lauren Jeans is a product. Cotton is the raw material used in the finished product.
How are They Traded?
Commodities are bought and sold through futures contracts. These contracts state the number and quality of the raw material. It is then delivered at a future date for an agreed upon price.
Futures Contract
A futures contract is a legally binding agreement. It states a predetermined price that a commodity will be bought or sold for at a future date.
The parties involved in the contract do not know each other. The delivery and payment date are specified in the contract. The delivery date is the specified date in the contract when the raw material is delivered. There are a few groups that participate in their trading. They are the buyers and producers and the speculators
Buyers and Producers
This group produces commodities. They also make or take delivery of a contract at the time it needs to be fulfilled.
For example, a cotton farmer plants a crop. The farmer is the producer in a futures contract. The farmer is protected if the price of cotton falls before the crop is harvested, since the price and delivery specifications were already set. However, the farmer misses out on extra money if the price of cotton is higher in the future.
Speculators
Speculators trade in the commodity market to make money. Its market is very volatile. Weather, politics, supply and other factors affects their prices.
Speculators may make or take delivery of raw materials.
Markets
Futures markets are liquid. Their prices change daily. Some portfolio managers and brokerages use index futures to prevent a loss in the stock market.
Their prices and returns are listed in a commodity index.
Commodity Index
A commodity index tracks the price and return on a category of commodities. These indexes are usually traded on exchanges. The value of the indexes fluctuate. The Dow Jones futures began tracking their prices in 1933.
Now there are six major commodity exchanges in the U.S. Commodity index investing grew popular in the early 2000’s.
Trading
Tradable commodities are divided into four groups: energy, metals, livestock and agriculture. There are many that are not tradable. This is because of its nature or demand. An example of one that is non tradeable, is if a country cannot keep up with demand for wheat. The country must import wheat. Future trading cannot be used for this instance. Wheat is not a commodity in this instance.
Commodity vs. Product
Commodities are the raw materials used to make a product. Products are also called “consumer goods” or “final goods.” Consumers purchase them. Products have variable price changes because of the price changes of commodities.
Daily Life
Commodities are used every day. A world without them means no clothes, cars, books, electricity, bread, and many more things. Daily life would be entirely different. They are a vital part to a countries’ economies.
Summary
Commodities are easily replicated and easy to produce. They are the raw materials used to make a finished product. Producers and buyers create futures contracts to sell them at a future date for a predetermined price. Speculators trade on their index to make money. Daily life would not be the same without them.
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