Lets now look at a slightly better definition of commodities! A commodity is a basic good and usually a naturally occurring material that can be collected for human use. Some examples of Commodities are Gold, Oil, Natural Gas and Coffee. All of these goods can be freely sold and bought.
Similar to stock trading – Commodities are also traded on an ‘Exchange’. A marketplace where buyers and sellers come together to trade. Two of the most popular of these exchanges are the CME (Chicago Mercantile Exchange) and NYMEX (New York Mercantile Exchange).
What are Commodities: Hard Vs Soft
Commodities can be broken down into a couple of sub-categories:
- Hard Commodities. Natural resources like metals that needs to be mined and oil that needs to be refined.
- Soft Commodities. These commodities are usually grown or looked after. Think Soybeans need growing and livestock needs to be looked after!
Commodity prices are largely driven by global supply and demand and as mentioned earlier are traded on exchange.
What are Commodities: Category Breakdown
3 other ways commodities are popularly broken down are as follows:
- Metals – Like Gold, Silver, Platinum and Palladium.
- Energies – Like US Crude Oil, Brent Crude Oil and Heating Oil.
- Agris (Agriculturals) Like Soybeans, Coffee and Sugar.
Traders can buy and sell commodities on exchanges by trading Futures contracts (A futures contract is an agreement to buy or sell a product at a specified price and time in the future)
You can also trade commodities OTC (over the counter) by trading forward contracts.
Not many commodity traders will actual take physical delivery of the products they are trading. And remember that if you are trading commodities as a CFD contract or a spread-bet, then you can never own the underlying asset. You are purely trading the price differential of the contract itself.
So what drives the prices of commodities? We mentioned earlier how Supply and Demand affects commodity prices (like it does in all markets). Here are a few other driving factors:
- Storage Costs / Warehousing
- Geo-Political Conditions
- Imports / Exports
- Adverse Weather
- Seasonal Changes
So we now know that we can trade commodities as futures, forwards, trade CFDs and also trade by spread-betting. Are there any other methods we’ve missed? Sure. Let’s look at a couple of other vehicles that can come in handy.
If you are now set to tackle one of the 3 commodity categories mentioned above, please click here to open your account today.
What are Commodities: Commodity ETFs
An ETF is an Exchange Traded Fund (A fund that’s traded on exchange!) They trade just like stocks do on a stock exchange but they differ from stocks as they are a collection of securities that usually track an underlying index.
The securities that the ETF can trade aren’t limited to stocks however. They can invest in stocks, bonds, commodities and more. There are many types of ETF out there but we will specifically stay focused on commodity ETFs here. If you purchase a commodity ETF – You don’t actually own the underlying commodities. You own the contracts that are derived from them.
So to sum up, Commodity ETFs are a great way to gain exposure to a variety of commodity markets without ever having to own the physical commodity itself and they trade like stocks on an exchange.
Let now look at a final way to gain some exposure to a commodity linked market.
What are Commodities: Commodity Currencies
A commodity currency is a currency pair that has direct links with the commodities exported by the country or countries in question. These countries usually have large commodity reserves and produce large quantities of various commodities.
The main commodity currencies are as follows:
- CAD – The Canadian Dollar – This currency when paired with USD is highly correlated to oil with oil being its largest export. Trading this commodity currency pair is called trading the ‘Loonie’.
- AUD – The Australian Dollar – Australia counts iron ore as one if its largest exports as well as being rich in energies and other metals. Trading this commodity currency pairs is known as trading the ‘Aussie’.
- NZD – The New Zealand Dollar – New Zealand is renowned for its large exported dairy products. Some of the most volatile data releases from NZ revolve around its milk exports. Trading NZDUSD is known as trading the ‘Kiwi’.
- RUB – The Russian Ruble – Exports in minerals account for a large proportion of total exports in Russia. The country has large copper reserves. On the trading desks we have worked on we’ve always just called it trading the ‘Ruble’ although a newfound nickname is said to be trading the ‘Barnie’
- BRL – The Brazilian Riyal – Known to be one the biggest exporters of base materials. No known nicknames here. But an extra point to know about USDBRL – Its often traded as an NDF – A ‘non-deliverable forward’
What are Commodities: Most Popular Commodities
Lets finish by look at some of the most popular commodity products traded today:
- XAUUSD / Gold – The main precious metals that everyone knows. Can be traded as ‘Spot’ or as a ‘Future’. Usually traded in 100 ounce contract size and quoted against the USD
- XAGUSD / Silver – Runner up on the precious metal front only to gold itself. Again quote as ‘Spot’ or a ‘future’. This product is usually traded in contract sizes of 5,000 ounces. Also quote against the USD.
- Brent Crude – The European oil contract. A futures contract that usually trades in a contract size of 1,000 barrels. Can be a very volatile product to trade, especially when inventory numbers are released.
- US Crude / WTI – The North American oil contract. Again this a futures contract that is usually based off of a 1,000 barrel contract size. Like its counterpart, some strong market moves can be seen on inventory releases.
- Copper – Now on to a red metal – copper! Copper is usually traded in a contract size of 25,000 lbs on the CME futures exchange. Not quite as popular as Gold and Silver though.
- Natural Gas – Natural gas is usually traded as a future in 10,000 MMBtu. MMBtu stands for one million British thermal units!
- Soybean – Now for a few ‘Agris’. Soybean futures are traded in bushels. 5,000 bushels is the standard contract size for the futures contract.
- Cocoa – Cocoa has a contract size of 10 metric tonnes. That’s a lot of chocolate!
- Coffee –Coffee futures are traded on exchange with a contract size of 37,500 lbs
This article will help you build a solid foundation of commodity knowledge and will help your commodity market trading significantly. Remember that if you get stuck or need a reminder to refresh yourself with this article.
Thanks for reading our ‘What are Commodities’ article – If you’re now ready to open your trading account and begin trading some commodity products, please click here.
Good Luck and Happy Trading!