Commodities are naturally occurring, physical products which are often the raw materials used to create other products. Most commodities are either grown on farms or extracted from the earth. Corn, cattle, copper, gold, oil, and wheat are all examples of various types of commodities.
What makes a commodity a commodity?
A defining characteristic of a commodity is that it is interchangeable, regardless of where in the world it was sourced. So, all gold of a similar grade, is the same – regardless of where in the world it was mined. Similarly, an oil trader will not be concerned where in the world the oil being traded was originally sourced. To an oil trader, all oil of a specific grade, is the same. This standardisation helps ensure that prices for the same grade of a commodity remain consistent. It also means that large volumes of a commodity can be traded without requiring inspection or investigation. This concept is known as fungibility.
Types of commodity
Commodities can be classed into four broad categories. i. Agricultural: this category includes grown crops such as coffee, sugar, corn, wheat, and soybeans. Animal livestock commodities such as cattle and hogs are also classed as agricultural. ii. Energy: these commodities include crude oil, gasoline, natural gas, coal, and heating oil. iii. Metals: this includes precious metals such as gold and silver, as well as base metals such as aluminium, steel and iron. iv. Environmental: carbon emissions and renewable energy fall under this category.
Factors influencing commodity prices
Many factors can impact commodity prices. The value of the US Dollar can influence commodity prices, as exchange-based commodity futures are usually denominated in US dollars. Frequently, and all other things being equal, there is an inverse relationship between commodity prices and the US Dollar. For example, as USD strengthens against other currencies, dollar-denominated commodity prices often drop. The general reason for this is that non-dollar holders first must purchase more expensive dollars to buy the relevant commodity.
If for any reason, the supply of a commodity decreases, this could cause an increase in price, especially if there is perceived scarcity amongst buyers. Regulatory, environmental and political factors can also contribute to the flow of supply for a commodity.
Commodity prices can also be significantly affected by extreme weather conditions. For example, flood/drought can impact agricultural output, while stormy weather can disrupt drilling or refinery operations in the energy sector. If, for example, a colder than usual winter is predicted in a major country such as the United States, then there is an expectation that more energy will be required to heat homes, businesses, shopping centres, hospitals, schools etc. The estimated increase in demand could cause the price of all energy commodities to rise as a result.
