Commodities are naturally occurring resources or goods that are collected and processed for human use. Resources like metals, oil, wheat, and coffee are all commodities.
Commodities have full or substantial fungibility, meaning that any instance of a commodity is treated and valued the same, regardless of who produced it or where it came from. This also means that the supply and demand of commodities are formed by the global market instead of smaller, localized markets like in the case of products or services.
Types of Commodities
There are four main types of commodities.
- Agricultural commodities
Agricultural commodities include resources like corn, cocoa, coffee, sugar, soybeans, maize, and wheat.
- Energy commodities
Energy commodities include resources like crude oil, natural gas, petroleum, coal, and gasoline.
- Precious metal commodities
Precious metal commodities include gold, silver, platinum, palladium, rhodium, ruthenium, iridium, and osmium.
- Industrial metal commodities
Industrial metal commodities include copper, iron ore, steel, aluminum, zinc, lead and nickel.
If you’re new to the commodity investment scene, you may need to familiarize yourself with commonly used terms associated with commodities.
- Arbitrage – The process of trading a commodity or security on two different markets simultaneously to take advantage of slight differences in price between exchanges/markets.
- Buyers – Someone who purchases commodities for use in manufacturing or production.
- Carry Charge – The cost of processing a physical commodity in storage, warehousing and insurance costs.
- Derivative – A financial contract underpinned by the price of a physical commodity, for example, futures or options, traded on derivative exchanges or OTC (over the counter).
- Exchange – A legal entity that determines and enforces rules and procedures for trading standardized commodity contracts and related investment products.
- Traders – Business and sales professionals that help clients buy and sell various commodities.
- Speculator – Someone who makes his or her money through buying and selling assets such as derivatives contracts that allow him/her to control assets such as commodities without ever directly handling them.
- Futures – Futures are derivative contracts in which the purchaser agrees to buy or sell a specific quantity of a physical commodity at a specified price on a particular date in the future.
- Spot Price – Spot prices are what a commodity is trading in the current market or commodities exchange. It's what the commodity would cost you if you bought it today, for immediate delivery.
Hard vs. Soft Commodities
Hard commodities are commodities that are mined or extracted from the earth. Metals, ore, natural gas, minerals, and petroleum are all hard commodities. Hard commodities usually make up the backbone of a country’s economy. Global demand for a specific commodity can be used to determine the future stability of a country’s economy. For example, if the global demand for zinc drops, the stability of a country whose main export is zinc will be directly affected.
Soft commodities are commodities that are grown, harvested, or reared. Examples of soft commodities are soybeans, rice, cotton, coffee, sugar, wheat, and livestock like cows, pigs, sheep, etc.
Agricultural commodities are also soft commodities. Soft commodities are generally far more volatile than hard commodities because they depend on multiple external factors such as environment, weather, etc.
Agricultural/soft commodities are usually very volatile, with varying ranges that can change daily.
Crude oil, gasoline, natural gas, ethanol, and naphtha make up some of the world’s most valuable and important commodities. Because these commodities are crucial to sustaining life as we know it, their demand is almost always high. These commodities usually make solid investment choices, but prices tend to increase consistently because of high demand.
Both precious and industrial metals have relatively low volatility. Metals have wide applications and tend to have a consistent, steady demand. These resources are usually where people begin their commodity investment journey since it tends to be safer than other commodities.
ETCs vs. Non-ETCs
Exchange-traded commodities (ETCs) are commodities for which spot (cash) and futures markets are established and official and settlement prices can be established. They’re considered highly liquid investments with low transaction costs.
Non-exchange-traded commodities are commodities in which spot and futures markets do not exist, and the only price information available comes from data provided by producers, consumers, and traders.
Only significant commodities with higher demands are traded on exchanges since these commodities have the spot and future prices established.
How to Invest in Commodities
There are a few different ways to invest in commodities, here are the two most common/popular ones.
Cash (Spot) vs Futures/Derivatives
Commodities can have two prices at once: their current cash (or spot) price and futures price. The spot price applies to deals happening currently, while futures prices are set for deals that will occur in the future.
Futures contracts are probably the best-known way to invest in commodities. But they’re more complicated than spot/cash investing. Futures allow investors to pay relatively small amounts when opening a contract. And you won’t have to put up more on the contract if the trade goes your way.
Spot prices are the price you pay on immediate deals. This is an excellent option for short trades; the spot price correlates with the futures price. Spot prices are also in constant flux because of the large number of trades that happen daily.
Spot prices are often the simpler investment option of the two, since investing in futures is complicated for a retail investor.
Trading on spot prices or futures can be done through brokers, investment firms, or directly with commodity manufacturers (although this option usually isn’t recommended).Brokers are probably the simplest way to trade commodity spot prices and futures contracts.
Individual Commodities vs Commodity Indices
Investing in a commodity index means investing in a basket of commodities that are often accessible for investing through mutual funds or ETFs. Commodity indices are great options for investors who want to enter the commodity market without entering the futures market.
Most people opt to invest in commodity indices like S&P GSCI and Dow Jones Commodity Index via mutual funds and ETFs. This is because their investment is diversified and the commodities are pre-picked by the index managers.
Individual commodity investment offers you more control over your investment. Still, it can sometimes be an impractical strategy since you have to hand-pick each commodity you want to invest in.
Commodity-related equities are stocks representing an ownership interest in a company that produces commodities, or in an industry or sector related to commodities, such as oil, petrol, and production companies. The prices of commodity-related stocks are based on the supply and demand of the commodity that’s being traded. These stocks are usually traded on commodity exchanges.
Commodities hedge investors against inflation. Because the value of commodities tends to rise when inflation comes in above expectations, any assets being held in commodity equity will benefit from rising inflation levels, protecting you from the adverse effects of inflation on your investments.
The potential for financial growth in commodities cannot be overlooked. Since prices rise and fall in relation to supply and demand, when a commodity is in high demand, the investor stands to make more profit in shorter amounts of time.
Commodities have low or negative correlation with traditional asset classes because commodity prices usually bet on unexpected inflation.
How Hedgeful Invests in Commodities
At Hedgeful, we combine a broad range of commodities to create commodity equity that offers investors low volatility. Our commodity equities make up part of our overall portfolio, giving our investors the right amount of diversification. This approach protects your portfolio from a sudden rise in inflation beyond expectations.
With Hedgeful, investing in a complicated asset class like commodities is easier for retail investors. Moreover, you don’t have to worry about asset allocation and adjusting it dynamically either.