What Is The Commodity Market and Its Types

Commodities, steeped in history, trace their roots back to the earliest civilisations. From the ancient bartering system to today's complex global markets, commodities have played a pivotal role in shaping economies and societies. 

The earliest recorded evidence of commodity exchange dates back to 3000 BCE. Later, as civilisations expanded and trade routes developed, commodities became a vital medium of exchange, facilitating commerce across continents. Marketplaces were organised where traders could buy and sell or exchange commodities, laying the foundation for today's commodity markets. 

The whole quest for commodities not only transformed economies but also shaped the course of world history. The Industrial Revolution later brought about a new era for commodities as countries underwent rapid industrialisation. 

But what exactly is a commodity? Are wheat and iron both commodities? How can one classify an asset as a commodity? Are all assets commodities? Where can you buy commodities? 

We answer these questions and more in this chapter. We will also explore the commodity markets, their derivatives, and more in the forthcoming chapters. 

What Is a Commodity in Trading?

Commodities are a form of asset class, similar to stocks and bonds, that play a crucial role in global trade and investments. They are essential goods or products that are derived from the earth and are produced in large quantities, generally. 

These goods, or what we commonly call commodities, are extremely essential in everyday life and range from different agricultural products to precious metals and more (we explore the types in detail below). 

Imagine this – the food you consume daily, the fuel that fills your car, and the jewellery you wear are all commodities! As you must have guessed, they also serve as raw materials in most manufacturing industries and also in the production of refined goods. 

Note that commodities are standardised by nature, i.e. two units of the same commodity, regardless of its origin and production, are identical in quantity and quality. This allows for easy exchange and trading of commodities across the world. 

Commodities also serve as an important benchmark for economic performance and can provide useful insights into supply and demand dynamics as well as geopolitical and environmental factors that impact global markets. In true essence, the importance of commodities in global trade and everyday life cannot be overstated. 

Types of Commodities Traded in India

• Agricultural Commodities: These include products derived from agricultural activities such as grains – wheat, rice, corn, soybeans, oil and oilseeds such as – castor oil and seeds, mustard seeds, cottonseed etc, crude palm oil, refined soy oil, spices such as pepper, turmeric, cardamom and pulses such as yellow peas, tur dal, chana etc
• Energy Commodities: These consist of resources used for power generation and fuel, such as crude oil, natural gas, and coal.
• Precious Metals: These may include gold, silver, platinum, and palladium
  Industrial Metals: They are of three types –
• Base Metals: Copper, aluminium, zinc, nickel etc
• Bulk Commodities: Iron ore, cooking steel, bauxite, etc
• Others: Chemicals, rare metals etc.
• Live-Stock: These include live cattle, meat, pork etc
• Soft Commodities: These may include coffee, sugar, cotton, etc

All these commodities, their supply and demand and prices can be impacted by a multitude of factors. For instance, weather conditions or changes in government regulations and policies can heavily impact agricultural commodities. Similarly, energy commodities may be affected by Organization of the Petroleum Exporting Countries (OPEC) policies and global trade conditions. 

Key Characteristics of Commodities

Commodities, as we covered above, play a pivotal role in the global economy, serving a wide variety of materials and tradable goods. But how does one quantify and qualify an asset as a commodity? Or, what are some common noticeable characteristics of a commodity? Well, let’s find out below. 

Note: The below-mentioned characteristics have been commonly observed across a class of commodities. Certain asset types may not have all the characters but can still be classified as a commodity. 

• Fungible

Fungibility is a fundamental characteristic of commodities. But what exactly is fungibility? The concept of fungibility refers to the interchangeable and indistinguishable nature of units with a particular category. So, when you say something is fungible, it means each unit is identical and can be exchanged or replaced with another unit of the same kind without any difference in value or utility. 

For example, gold is considered a fungible commodity because one ounce of pure gold is essentially the same as another ounce of pure gold. You can exchange one ounce of gold with another and still have the same intrinsic value. But think of another asset here, like an NFT, which stands for ‘Non-Fungible Token’. It is a digital asset created on blockchain technology. Unlike gold or most commodities, each NFT is unique, holding different values and cannot be exchanged without a difference in value. 

Do you now see the difference between fungible and non-fungible?

Returning to commodities being fungible enables smoother interchangeability and helps in standardisation. 

• Liquidity

Liquidity is another important feature of a commodity. In the context of commodities (even stock markets), the term' liquid' refers to the ease of buying and selling. A commodity is considered ‘liquid’ if it can be bought or sold quickly without significantly impacting the market price. 

This characteristic is particularly important for traders who wish to spot potential entry and exit points in the market. Let’s again take the example of gold. Now, gold is considered to be a liquid commodity because it can be traded across financial markets and other commodity exchanges. Investors can easily buy or sell gold contracts, and as you may also agree, the physical gold market is well established. 

Now, imagine an investor who wants to sell gold and raise cash. Due to its liquid nature, this investor can easily find buyers in the market without significantly impacting the market price.  

Can you think of a similar liquid commodity? Hint: Think of your car fuel. 

Remember this: Highly liquid commodities possess deep and active markets, allowing for swift transactions and minimising the risk of price manipulation. 

• Durability and Storability

An essential trait of a commodity is durability. It refers to the ability of a commodity to withstand wear, decay, or damage over a period of time.  

Unlike perishable goods (think of vegetables, for instance) that have a very short shelf life, commodities such as metals, energy resources and many agricultural products have high durability. This aids their utility and marketability, making them attractive for trading besides other common consumption needs.  

Now, let’s talk about storability, which, in common terms, is the capability of a commodity to be stored for an extended period without significant loss or deterioration in quality. Think of wheat grains or rice. Both these commodities have high storability and, if done correctly, can be preserved for a long time without any loss in quantity or quality. 

This characteristic is significant in industries where commodities are produced in large quantities or those that have fluctuating supply and demand.

Should You Invest in Commodities?

Investing in commodities has long been a topic of interest for individuals seeking to diversify their portfolios and potentially capitalise on price movements in global markets. But why? Because commodities possess several distinct characteristics that make them worthy of consideration in an investment strategy. 

Firstly, commodities are tangible assets with inherent value derived from their use in various industries. This tangibility provides a sense of security as investors can physically own the asset, unlike other financial instruments (Think of a stock you own; is it physical? No, right?)

Secondly, commodities have historically exhibited a low correlation with traditional asset classes. This low correlation means that commodities often move independently from other investments, helping minimise risk and enhancing portfolio diversification, thereby increasing the likelihood of consistent returns. 

You should also note this about commodities – As an asset class, they may have the potential to act as a hedge against inflation. So, while inflation may erode the purchasing power of currencies, commodities, particularly those with limited supply, tend to increase in value. 

Also, commodities can provide attractive returns during periods of market volatility. When supply and demand dynamics shift due to different reasons, investors can capitalise on the subsequent price movements. Also, think of it this way – when you invest in, say, a commodity like oil or gas, you participate in the energy sector’s performance and growth, thereby having targeted exposure to certain industries.

However, do note commodities carry inherent risk. They can be highly volatile, and prices can be influenced by unpredictable factors such as weather conditions, geopolitical tensions or even regulatory changes. Moreover, commodities require careful consideration of storage and transportation costs and the impact of currency exchange rates. 

Now that you understand what a commodity is and its types, do you want to know how they are traded in real life and how you can invest in them from the comfort of your house? If yes, go to the next chapter, where we will explore the types of commodity markets and exchanges, contracts and more!