The simplest answer to the question is that commodities are the raw ingredients or components of almost everything we consume or use in our everyday life. Some of the most common commodities are corn, wheat, gold, silver, copper, oil, gas, cattle, sugar, coffee and cotton.
Many commodities are produced around the world by many countries. However, some commodities are mainly produced in limited regions of the world. The U.S., China, India and Brazil are major producers of a wide variety of commodities.
Weather can play a large part in the production of many commodities, especially agriculture commodities. Floods and droughts can have a large impact on the production of crops in any given year. The price of commodities also plays a large part in the production of commodities. More commodities tend to get produced when the prices is higher. Oppositely, consumers tend to consume less of the commodity the higher the price.
Commodities for Consumers
As you might have guessed, most commodities are either grown as crops in the ground or extracted from the earth. Once grown or extracted, commodities are usually processed in some for to produce end products for consumers.
Some examples of food products might include wheat being used to produce bread. Oranges in Florida are used to produce orange juice. Sugarcane is processed to produce table sugar. Coffee beans are harvested and eventually roasted to produce coffee. Basically, everything you see at your breakfast table is a commodity.
There are also commodities that are used for industrial and manufacturing purposes. For example, copper is used to produce wiring for homes and automobiles. Cotton is used in the textile industry to produce clothing. Crude oil is a commodity that is sent to a refinery to produce unleaded gas and heating oil – both of which are also commodities.
Commodities for Investors
Once you can easily spot a commodity, you might be looking for a way to invest in commodities. The same way you can spot companies to invest in during your everyday life through publicly traded companies, you can just as easily invest in commodities. The movie Trading Places was probably the best promotional piece the commodity markets ever had. Eddie Murphy broke commodity trading down into simplistic terms, although is was a bit of an oversimplification and the profits don’t come that easy in real life.
Commodities are traded with futures contracts on a futures exchange. The two largest exchanges in the U.S. are the CME Group and ICE Futures. These are highly leveraged investment and they can be very volatile. It is probably not for the average investor and especially not for an investor on a shoestring budget. One should do their homework and practice trading on a simulated platform before they trade real money in commodities.
For those who don’t want to put in the time but still want to trade commodities, a Commodity Trading Advisor is probably the better route. These are professional commodity traders who manage accounts for clients. Some trade individual accounts and other pool money from a group of investors. Your odds of success are probably better with a CTA.
The more mainstream investments in commodities are commodity stocks and commodity ETFs. There are many publicly traded companies that manufacture and produce commodities. They tend to benefit from rising prices of commodities and there is an opportunity to profit from buying commodity related stocks. Oil companies are a good example. Oil drilling companies, or oil producers, will make more money from $100 than $80 oil as long as demand doesn’t drop too much.
Commodity ETFs are exchange traded funds that invest in commodity futures. They are unleveraged, so you don’t have to worry about losing more than your initial investment. A commodity ETF works similar to a mutual fund for stocks. They typically consist of a group of commodities and the prices rise or fall with the relationship to the commodities in the fund.