Commodities

What are commodities?

Commodities are the raw materials that we use in everyday life. From soft commodities like coffee and livestock, to hard commodities like oil and gold, all commodities are traded on an exchange and all must meet a certain minimum standard known as a basis grade.

What is a commodities exchange?

A commodities exchange is an entity designed to implement certain rules and regulations for the trade of commodities and commodity futures, for example The London Metal Exchange oversees the trade of metals in the UK and beyond.

Futures contracts are designed to organise delivery of a certain commodity at a certain price at some point in the future, for example; a farmer growing wheat might sell a future contract on his wheat which he won’t actually harvest for several months, this will guarantee the price he is paid once the wheat is delivered. Of course there is an upside and a downside to this, if the price of wheat on the market rises in the months while the farmer grows, he will be missing out on profit. At the same time though, if the price were to fall while he grows he doesn’t need to worry because he has already agreed his price in the future contract.

Who trades commodities?

There are two main types of commodities traders; the first are buyers/producers using futures contracts for hedging purposes. These traders actually complete deliveries of physical commodities. These are the people growing the crops and producing the metals, and the people buying these raw materials to make secondary and tertiary products.

The second type of commodity trader is a speculator. The only reason they do it is to profit from the price movements in volatile markets, never to physically complete a delivery. Many futures markets are particularly liquid meaning they are tempting for speculators. Commodities may also be used to diversify an investment portfolio due to the fact that the value usually shows no correlation to the equity and bond markets.