Commodities

What is a commodity?

A commodity is a primary product such as a raw material usually traded globally on a specialized exchange. Each commodity generally is the same as every other commodity of its kind, meaning that when someone buys a commodity, she already knows what she’s going to get and has a good idea of how much it’s going to cost.

Deeper definition

Commodities are goods that are virtually interchangeable with like kinds of each other, frequently represented by agricultural products, raw materials, industrial or precious metals, or chemicals like ethanol and sulfuric acid. If someone buys a barrel of oil, she can expect that it’ll be just like any other barrel of oil. She doesn’t really want to own the commodity — what would she do with 1 million barrels of oil unless she owns a refinery? — but she is banking on consumer demand generating a good return on her investment.

Commodities are traded on an exchange that specializes in one or more types of them. With some exceptions, the exchange may cover various industry sectors rather than a specific good: metals might be on one exchange, meat on another, or an exchange might have some combination of industries. Investors frequently diversify their portfolios by putting money in several exchanges.

The price of a commodity reflects how much people want or need it rather than its quality. That means they reflect market factors like speculation and supply and demand, making the price of some commodities more volatile than others. However, commodities rarely fluctuate, meaning that their price can usually be pinned to a simple up or down trend. When a commodity is sold at a specified price for delivery at a designated point in time, this is called futures trading and it’s enforced by a contract between buyer and seller.

While commodities have traditionally been thought of as tangible goods, they’ve recently expanded to include such abstract products as electricity, as measured in megawatt-hours. Even cryptocurrencies can function as both a financial instrument and a commodity, with bitcoin having been designated a commodity by the U.S. Commodity Futures Trading Commission (CFTC).

Not quite ready to start buying commodities? Invest your cash in a money market instead.

Commodity example

All kinds of commodities are traded: coffee, soybeans, currency, even energy emissions. But a precious metal like gold is different from other commodities like oil or wheat that meet peoples’ specific needs because it’s considered to have what’s called intrinsic value. That means gold’s value is relatively secure in times of financial crisis, like a recession or depression, and its value goes up when other commodities become more volatile. For example, if a county’s currency starts depreciating, people may invest in gold to protect their losses. When the currency starts picking up again, they may attempt to sell off their gold, which depreciates gold’s value instead.

Other Investing Terms

Prudent investor rule

Prudent investor rule is a term every investor should understand. Bankrate explains it.

Fiduciary rule

The fiduciary rule describes what a financial advisor can do with your money.

Repurchase agreement (repo loan)

A repurchase agreement is a short-term loan to raise quick cash. Bankrate explains.

Derivative

Derivative

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