Commodity

Quick definition

A commodity is a raw material or agricultural product that can be bought and sold.

Key details

• Commodities are one of the most popular investment classes
• You can invest in commodities by purchasing them outright; investing in futures, options or CFDs; or buying shares in companies that produce commodities such as gold mining companies
• The most popular commodities to invest in and trade with are crude oil, coffee, natural gas, gold, wheat, cotton, corn, and sugar

What are commodities?

Commodities are natural goods that are used in human activity, and they can be traded on exchanges. While some commodities occur naturally, such as gold and oil, others are manmade, such as orange juice and chemicals.

A key thing to bear in mind about commodities is that they are fungible. What this means is that it doesn’t matter where a commodity comes from or who produces it – the value remains the same. So, gold of a certain quality that is mined in South America has the same value of gold of that same quality mined in Africa.

Because of this market interchangeability, the commodities market is able to operate fluidly on a global basis, allowing millions of people to speculate on the value of commodities every day by trading them internationally.

By far the most popularly traded commodity right now is crude oil, and as a result, it is a benchmark for the overall performance of the commodities market. If crude oil is up, commodity traders are generally bullish, whereas if the price falls, they are typically more bearish.

In the event of a recession, most commodities tend to fall in price due to reduced expenditure and a subsequent tail-off in demand. However, some commodities are referred to as safe-haven assets, since investors often flock to them in times of economic uncertainty. Perhaps the most prominent example of this is gold, which has historically performed well during market crashes. Its resilience is derived from the fact it exists outside of the traditional financial system.

How can I invest in commodities?

Some commodities, such as gold, can be purchased outright and stored at a secure location of your choice. This could include gold bars, coins and bullion, which you could keep in a safe or storage facility.

However, some commodities are impractical to store because of their scale or required storage conditions, and others are hazardous, such as uranium. As a result, there are alternative ways to gain exposure to the price of commodities without purchasing them.

The simplest way to get involved is to invest in the shares of a company that produces or otherwise deals with a certain commodity. For example, if you want to speculate on the price of copper because you believe battery metals will rise in value as electric vehicle production ramps up, you could invest in a copper mining company.

Another popular way of investing in commodities is futures contracts. For instance, some investors will speculate on the outcome of an upcoming corn harvest, and futures allow investors to guarantee a trade will be made at a set date in the future. If an investor would like the ability to choose whether or not to make the trade when the time comes, they can use options instead.

Perhaps the most flexible way of trading commodities is with CFDs. These are financial instruments that represent a commodity, and they allow investors to speculate on the prices of commodities without the inconvenience and potential security risks of owning them outright. In addition, you can use leverage with CFDs to boost the size of your trades without having to use any more capital upfront, though this is a strategy that should only be employed by experts.