Everyday life revolves around commodities—food, fuel, or minerals. Commodities can affect how much you pay to fill your car, how expensive it is to travel by airplane, and even how much you pay to do your weekly grocery shop. In addition to this, they can be extremely useful for diversifying your investment portfolio.
Commodities are goods that can be exchanged for other goods. This can happen either through buying, selling, or trading. Commodities can be bought, sold, and traded in the commodity market set up and regulated by an authority.
A commodity market allows producers and consumers to buy and sell commodities in a centralized and liquid marketplace. In lieu of taking physical delivery of commodities, traders can trade futures contracts. Futures contracts allow the buyer or seller to exchange a specified quantity of some commodity at a set price and within a predetermined period of time.
Market players can also use commodities derivatives as a hedge against future consumption or production. These markets are also popular with speculators, investors, and arbitrageurs.
Among the most important commodity exchanges are the Chicago Board of Trade (CBOT), Chicago Mercantile Exchange (CME), and London Metal Exchange (LME). In India, we have two significant exchanges Multi Commodity Exchange (MCX) and National Commodity & Derivatives Exchange Limited (NCDEX).
The term commodities refer to many asset classes as an umbrella term. Different subcategories are included within the commodity market.
These subclassifications are determined by how commodities behave. This article will give you an in-depth look at the commodity market.
Understanding these types of commodities is essential for traders. They are as follows:
Hard Commodity
A hard commodity is a product that is extracted from the ground, typically within the mining and energy industries.
Soft Commodity
Commodities classified as soft refer to products produced or cultivated. Examples include livestock, grains, and oilseeds.
As a result of the difference between hard and soft commodities, how you trade them also differs.
Let us dive deep into what hard commodities are.
Commodities that are naturally occurring raw materials are called hard commodities. As a result of the definition, it can be concluded that hard commodities are mostly mined or drilled.
The by-product of these hard commodities also falls into the same classification, although they remain a by-product and not the actual raw material.
The term ‘hard commodities’ refers to natural resources such as gold, rubber, and oil. In contrast, ‘soft commodities’ include agricultural products or livestock, such as corn, wheat, coffee, sugar, soybeans, and pork.
The examples of hard commodities include but are not limited to:
- Precious metals: Gold, Silver, Platinum
- Base metals: Copper, Iron Ore, Aluminum
- Energy: Crude oil, gasoline, natural gas, Ethanol
Characteristics of hard commodities:
- The main characteristic of these hard commodities is that they are highly operationally intensive. A large amount of capital investment is required. As a result, hard commodity producers are usually large multinational companies.
- Unlike soft commodities, hard commodities can be stored for a more extended period of time. Hard commodities, therefore, have lower volatility.
- The majority of trade takes place across national borders.
- A reliable indicator of global economic health is the amount of trade in hard commodities.
- When trading hard commodities, your contract size will differ based on the commodity you are trading. Despite belonging to the hard commodity category, gold and aluminium futures contracts are different.
Factors that affect hard commodity prices
Hard commodity futures contracts are influenced by various factors, including the type of commodity and the supply and demand. Here are some of the factors, including official reports, that commodity traders look out for.
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The Commitment of Traders report:
CFTC (Commodity Futures Trading Commission) publishes weekly commodity reports known as COT reports. Those reports are used to track market positions that are large in size. Institutional holders such as banks are typically included. The reports also keep track of producers’ and consumers’ open positions.
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Reports on Supply and Demand:
Hard commodities are essentially transnational in nature, so supply and demand play a significant role. Crude oil is produced primarily by Saudi Arabia. In contrast, the largest crude oil consumers are countries such as China and India. This means that data on production in one country affects supply. In a similar vein, hard commodity prices are determined by demand from the other side.
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Government regulation and political stability:
Due to their nature as raw materials, hard commodities are typically concentrated in selected countries. So regulation of imports and exports by the government as well as political stability also influence the prices of hard commodities.
To conclude
Though commodity markets are easy to understand, trading in futures contracts and options differs significantly from acquiring a physical commodity; traders should have a thorough knowledge of how commodities work and make informed decisions about where to invest. In order to effectively deal in commodities, you should always work with a well-established, reputable brokerage firm.
