The Meaning of Commodity Market
Commodities mean raw materials needed to manufacture other industrial or domestic goods.
Quite like stock markets, commodity markets allow investors to buy or sell shares of commodities, which may be agricultural or industrial. Commodities can be exchanged, meaning buyers may expect the same commodity from different sources and traders may sell to a number of buyers who would know what they are receiving.
Commodities are generally sold as futures that mean the investor pays for buying a commodity that has not been produced on the date of buying.
Unlike shares of stocks and bonds, commodities are treated as ‘real assets’ because these are supported by real goods and not an anticipated worth.
Commodity futures are traded on forward basis. Simply put it means the investors buy a commodity at an agreed price before the commodity is really produced. That can be to the advantage of the producer as he gets money upfront. It can also benefit the investor is the price of the commodity stays high.
Agricultural commodities include grains and livestock needed by food industry. As on June 30, 2010, agricultural commodities comprised 29 percent of the Dow Jones-UBS Commodity Index. Additional seven percent was made up by livestock commodities like cattle and hogs.
Rice, corn and soybeans and other grains form part of agricultural commodities. Grains are produced in large quantities and can be stocked for a long time. That makes trading more flexible as per market demands.
Agricultural commodities like sugar, cotton and coffee that can’t be stored for a long time are termed as soft commodities.
Industrial commodities are those commodities that are used by manufacturing industries as raw materials for producing other goods. Energy forms the biggest part, comprising 32 percent the Dow Jones-UBS Commodity Index. Coal, gas and oil are all energy commodities. Industrial metals and their ores like steel comprised 18 percent of the index, whereas precious metals like gold and silver contributed to the extent of 15 percent.
Pros and cons of commodities investing
Investors make frequent use of commodity as a cover against inflation. That’s because when inflation goes up, the prices of commodities are likely to go up, which is contrary to the prices of bonds and stocks that could go down.
Commodities are doing fine with globalization of markets with promising countries like India and China needing more commodities to further their industrial outputs.
Commodities could suffer drawbacks when inflation goes down or becomes negative as inflation is a yardstick of prices. In case of economic downtrends, reduced spending by consumers may reduce the demand for all goods, including those made using commodities.
Historically, the commodity markets have been as unpredictable as equity markets and thus involve risks for investors.