Commodities are basic goods that are used in the production of other goods and services. They can be either natural or man-made, and are traded on commodities exchanges around the world.
Investing in these assets can be a great way to diversify your portfolio and potentially make some money, but it’s important to understand what you’re buying before you do. In this post, we’ll give you a crash course in commodities, explaining what they are and how they work.
Table of Contents
What Are Commodities?
Commodities are physical goods that are used as inputs in the production of other goods and services. They include natural resources such as oil, gas, and minerals, as well as agricultural products such as wheat, corn, and coffee. It is possible to invest in them and they are classed as an alternative asset.
They are traded on dedicated commodity exchanges, such as the Chicago Mercantile Exchange (CME). Trading is typically done through futures contracts, which are agreements to buy or sell a certain amount of the asset at a fixed price on a specific date in the future.
Types Of Commodities
A commodity is a basic good used in commerce that is interchangeable with others of the same type. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. When investors buy these assets, they are betting on the future price of the goods.
Hard commodities are natural resources that must be mined or extracted like oil or metals. This includes both precious metals such as gold, silver or platinum, and industrial metals like copper. These are used to produce consumer goods and industrial products. Prices are volatile, because they are sensitive to global economic and political conditions.
Soft commodities are agricultural products that are grown or farmed. This includes such items as coffee, wheat, sugar or livestock. The prices of these are also volatile, because they are affected by weather conditions and crop yields.
Prices are typically higher when there is high demand and low supply. For example, the price of oil increases when there is a global economic boom, because more people are using cars and planes. The price of corn increases when there is a drought, because farmers have to compete for water to irrigate their crops.
Prices are also affected by speculation. Investors may buy commodities because they think the price will go up in the future. This speculation can drive prices up even if there is no change in the underlying supply or demand.
The difference between hard and soft commodities is that hard commodities are mined or extracted, while soft commodities are grown. Hard commodities are more likely to be affected by global economic conditions, while soft commodities are more likely to be affected by weather conditions.
Investing In Commodities
Somebody might want to invest in commodities because they offer the potential for high returns and diversification. Additionally, investing in them can help hedge against inflation and provide protection against economic downturns.
There are a few ways to invest. One way is to invest in specialized ETFs which can offer exposure to a variety of commodity types.
Another way is to invest in futures, which allow investors to speculate on the price movements of various assets.
You can also invest in certain company stocks. These are the stocks of companies involved in raw material production, for example oil and mining companies.
Finally, you can invest directly in the physical commodity itself. This is relatively simple if you wish to purchase metals such as gold or silver. But becomes quite difficult if you wish to invest in livestock, agriculture or oil for instance.
View our gold investment guide to invest in this precious metal
Commodities Trading
When you trade commodities, you are betting on the future price of a raw material or agricultural product. They are traded on exchanges around the world, and they are bought and sold in futures contracts. A futures contract is an agreement to buy or sell an asset at a set price on a future date.
Most are traded on the exchanges of the Chicago Mercantile Exchange (CME) or the New York Mercantile Exchange (NYMEX). These exchanges offer a variety of futures contracts for different types of commodities.
When you trade, you can take a long or short position. A long position means you are buying the asset now in the hope that the price will go up in the future. A short position means you are selling the asset now in the hope that the price will go down in the future.
You can choose to trade through a broker or a commodities trading platform. A broker is a middleman who will execute trades on your behalf. A commodities trading platform is a website or software application that allows you to trade directly.
When choosing a commodities trading platform, you should consider the fees, the selection of assets offered, and the platform’s ease of use.
Compare the best trading platforms at Supermoney
Should You Trade Them?
The main pros of commodities trading are that it can provide a hedge against inflation, it can be used to speculate on future price movements, and it can provide a way to diversify a portfolio.
The main cons are that it is a highly volatile market, there is a high degree of risk involved, and it is often difficult to predict price movements.
Whether or not you trade this type of asset depends on your portfolio asset allocation, available capital, trading experience and risk tolerance.
Investment Alternatives
If you don’t wish to invest in commodities, there are many different types of investment assets that investors can trade.
Traditional assets include stocks, bonds, and cash. These assets are typically traded on exchanges such as the New York Stock Exchange or the Nasdaq.
Alternative assets include derivatives, and private equity. These assets are typically traded on over-the-counter markets or in private transactions.
Derivatives are financial contracts whose value is derived from the price of an underlying asset. Common types of derivatives include options and futures. Private equity is equity ownership in a company that is not publicly traded. Private equity is often used to finance startup companies or to invest in companies that are experiencing financial distress.
Holding a mix of different asset types helps with diversification. Discover more alternative investments to diversify your portfolio.
Commodities vs stocks: which is a better investment option?
Conclusion
Commodities are physical resources that are essential for the production of goods and services.
They are natural resources like oil, gas, gold, silver, and copper.
This also includes agricultural products like corn, wheat, and coffee.
Investing in commodities can be a great way to diversify your portfolio and protect yourself from inflation. But they can also be highly volatile and risky. Use a comparison site like Supermoney to easily compare the best trading platforms.
Sign up for our newsletter to learn more about investing and find more from our blog posts including 21 types of investment assets to grow wealth.
