A commodity is a type of product of uniform quality that has high-enough demand to be traded across multiple markets. Commonly found in the futures market, commodities are usually traded by speculators and investors who seek only to make a profit, and hedgers who are usually manufacturers of a particular commodity trying to hedge their positions against adverse risk.
There are two main types of commodities: hard and soft. Hard commodities consist of natural resources, such as oil or gold. While soft commodities are agricultural goods or livestock that must be grown and cared for in order to be produced. Both markets trade on supply and demand, and are heavily influenced by macroeconomic events.
The Hard-Commodity Market
Hard commodities are usually the ones that make headlines, or are referred to as a basis for economic health. Because the production and supply of these assets can be predicted fairly accurately, they are used to gauge global-economic health. Copper and oil, in particular, are often looked at to determine where the economy is headed by observing total-worldwide demand for these products.
The majority of this market is made up of energy goods like oil and natural gas. It also includes metals like gold, silver, copper, aluminum, steel and other commonly-used materials. Countries that rely heavily on the exportation of commodities may also have their currency tied to its value. Chile’s economy, for example, is heavily dependent on copper exports, which make up 49% of the country’s total exports, while the state-owned CODELCO exists as the largest copper-production company in the world.
Metals can be used for a variety of purposes. Gold trades as an inflation hedge and wealth preservation asset for investors who seek a safe haven during times of high-market volatility. Industrial metals like copper, steel and aluminum on the other hand are reflections of global economic growth through future supply and demand curves.
Read the previous week’s article to understand How Dr. Copper Measures Economic Health.
The Soft-Commodity Market
On the other side of the commodities exchange are the soft commodities like agricultural goods and livestock. Unlike hard commodities, these goods can fluctuate quite a bit and are subject to additional forces that determine their overall supply and demand.
Weather plays a large role in the soft commodity space. Unseasonably warm summers, cold winters or strong storm seasons impact crop production and livestock, making it nearly impossible to accurately predict where prices will go and giving soft commodities a high level of volatility.
Crop production can also vary due to many other factor. Bumper crops, or crops that produce more than anticipated, can depress prices by creating a surplus. Unlike hard commodities that can be found in various regions around the world, soft commodities can only be produced in specific regions that are ideal (temperature, humidity, soil quality, etc.) for a particular crop.
Commodities have very low – and in some cases negative – correlation with other asset types. When currencies, bond prices and stocks are up, commodities may often be down, and vice versa. Right now, commodities are at a multi-year low, while the US dollar and stocks are near all-time highs.
Investors looking to invest in commodities have options other than trading on the futures exchange. Many companies operate in the commodities space, such as oil drillers, mining companies and food producers. ETFs and mutual funds are other ways investors can partake in this space without subjecting their portfolios to undue risks.