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What Is A Commodity?

Most of us don’t spend much time thinking about commodities, but they touch nearly every aspect of our lives. Almost everything we use, work with, watch, eat, or wear was made with a commodity or used a commodity in its mining, refining, manufacturing, or transporting. Without commodities, modern civilization wouldn’t exist. 

What is a commodity?

A commodity is a basic good used in trade that is interchangeable with equivalent goods of the same type: crude oil, gold, silver, wheat, etc.

There may be some slight variances in quality. Commodities of the same grade are considered to be the same and therefore interchangeable. One barrel of crude oil or a bushel of wheat is the same as the next, regardless of who produced it or where it was produced. A commodity is a raw product — or product that has undergone a minimum level of refinement to be marketable. 

How are commodities traded?

Ideally, markets should have numerous buyers and sellers to more closely match commodity prices to their actual value. Smaller or limited markets can hold buyers or sellers hostage to unfavorable pricing. Larger markets with more participants provide more liquidity and usually stabilize pricing within a closer trading range.

Commodities are traded on an exchange where these buyers and sellers come together, buying or selling commodities grouped by quality grade and an agreed-upon quantity for trading. In the past, a bushel of wheat was a volume measurement. A bushel of wheat in commodities trading is now a weight measurement.

In the U.S., the leading commodity exchanges are the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBOT) and the New York Mercantile Exchange (NYMEX).

Commodities are traded as futures contracts, and as the name suggests, are agreements to take delivery of a commodity at a specified price on a specified date in the future. Trading is open both to industry that utilizes the commodity and to speculators who believe the price of a commodity will go up or down in the future.

For industry, commodities futures are often used as a way to stabilize costs. For example, if you’re a cereal manufacturer, constant fluctuation in the price of wheat or corn can create cash flow challenges and erratic profit performance.

For traders, the value in the commodities futures contract isn’t in the product itself because the average trader has no use for large quantities of wheat, corn, oil, live cattle, or any other commodity. The value in the trade for commodities traders is in the difference between the price at which the futures contract was purchased and the price at which the contract is resold.

If you want to start trading futures, make sure to check out Benzinga’s How to Start Trading Futures.

Commodity ETFs

While commodities are available for trading on major exchanges, traditional commodities trading can be a high maintenance investment due to the need to track prices and trade investments before contract expiration. The solution is commodity ETFs.

An ETF is an exchange traded fund you can purchase just like shares in any stock. An ETF specializes in one type of commodity or sometimes a group of related commodities, which allows investors to gain investment exposure to commodities without many of the risks commonly associated with traditional commodities trading.

A commodities ETF investor invests in shares of contracts or underlying assets purchased by the fund. Commodity ETFs also do not require margin accounts, because the investor buys shares in the ETF and not the contracts themselves.

Commodities price performance

Pricing can still be volatile for commodities — and volatility creates both risk and opportunity. ETFs also provide the opportunity to go long on a commodity without ever taking possession of the commodity.

The first gold ETFs, for example, reached the market in the early to mid-2000s, promising to track the price of gold. During that time frame, gold has tripled in price, dwarfing the gains seen by broad market investments, like S&P 500 index funds.

Final thoughts

Commodities are everywhere and technological advances promise to turn new or emerging technologies into utilities that can be traded as commodities. Many of the ideas that seem futuristic now, like distributed computing, may become larger parts of our lives — but while happening quietly in the background, much like the commonly traded commodities of today.

When we use energy or products made from fuels, we don’t think about all the trades and futures contracts that made that product or service available. From a consumer perspective, it just happens. As time goes on, there will be more commodities that can be traded, creating opportunities for those with a pulse on market demand and value.

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