Commodity

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What is Commodity Market?


The commodity market is a physical or a virtual market place where market participants meet and buy or sell positions on commodity products like oil, gold, copper, silver, wheat, barley. Though started with Agri commodities initially, commodity markets today trade in all types of commodities like base metals – gold, silver, copper, infrastructure like oil, electricity, and even weather forecasts. There are about 50 major commodity exchanges worldwide which trade in more than 100 commodities.


Types of Commodity Market


The commodity market can be categorized under two major categories based on the type of commodity. These two categories are:

Hard Commodities


Hard commodities consist of the commodities that are required by the manufacturing industries. These should be mined and are manually extracted from the land or the ocean. They have limited reserves and are affected the most by the geopolitical and economic conditions. Possible examples of such types of commodities are Gold, Oil, silver, rubber, copper, etc. The major part of the pricing is because of the process that is carried out to extract them.

Soft Commodities


Soft commodities constitute the commodities that are mainly Agri related or livestock. Unlike hard commodities, they are not mined or extracted but are produced through proper procedures. They have virtually unlimited reserves and are not affected by geopolitical conditions but by the weather or by natural occurrences. Possible examples of such commodities are corn, wheat, barley, sugar, pork, coffee, tea, etc.

  • ADVANTAGES OF INVESTING IN A COMMODITY MARKET


    • Hedging Mechanism: The biggest advantage of investing in the commodity market is for the producers, importers, and exporters as it provides them with a mechanism to hedge the price fluctuations. For example, a farmer can protect itself from the price fluctuations in the wheat by selling its futures contract with an expiry date three months down the line. A retailer, on the other, can protect itself by buying a futures contract.
    • Fewer Manipulations: Compared to the financial market, commodity marker deals in proper tangible products that are raw materials for the manufacturing industries. Hence the commodity markets are governed by demand and supply and are less prone to manipulations compared to financial markets.

  • DISADVANTAGES


    • Risky: Commodities investments are very risky as the geopolitical factors play an important role in their pricing. For example, any suspicion of a political crisis in the middle east leads to a sudden spike in crude oil prices. Because of such a systematic risk, commodity markets are very prone to operational failures and need to be regularly monitored to avoid any unfavorable circumstances.
    • Leverage: Unlike financial markets, commodity markets thrive on low margin requirements and high leverage. Though it helps in better potential profit, high leverage ratios in times of economic recession or unexpected volatile movements can lead to increased losses.

  • Important Points


    • The commodity market is much older than the financial money market and has evolved over time. In fact, the very first trading known to mankind was barter trading, where commodities like food grains would be traded between farmers and the consumers. The earliest known full functional commodity market was set up in Amsterdam in early 16th
    • The pricing of commodities traded in the commodity market is quite complex and depends on their individual characteristics. For example, for goods like wheat, barley, there is a storage cost involved in addition to the forces of demand and supply. The storage cost is required as these commodities require proper storage mechanisms to save them during transportation or from natural calamities.
    • There are certain criteria’s that a commodity must possess to be fit for trading in the commodity exchanges. These characteristics are homogeneity, price fluctuations, open supply, and durability.
    • The commodity market, though, differs from money markets in terms of the underlying instrument; the underlying concepts of trading are pretty much the same. The concept of spot price, future price, expiry, strike price are pretty much the same.
    • The commodity market, though, in general, trade-in generic commodities like coffee or wheat, but with time it has evolved to include certain differentiated products too. These differentiated products are a generic commodity but with certain peculiar characteristics. Example of high octane gasoline for which a generic commodity would be gasoline.
    • Commodities are highly volatile assets compared to financial assets. They are governed not only by geopolitical tensions, economic expansions, recessions but also by natural forces like floods or calamity.
    • The major commodity exchanges across the world are the London Metal Exchange, Dubai mercantile exchange, Chicago Board of Trade, Multicommodity exchange, etc.