What Is a Commodity? (Plus Benefits and Types)
By Indeed Editorial Team
Updated December 29, 2021 | Published June 8, 2021
Updated December 29, 2021
Published June 8, 2021
Assets are useful resources owned by businesses or individuals, and each has its own market and value that it offers to investors and consumers. Some assets are more stable in their value than others, and some are daily necessities. If you're a financial professional looking to invest in stable commodities, it may be beneficial to learn about their characteristics and benefits. In this article, we define commodity and commodities trading, list the benefits of commodities and examine four types of commodities.
What is a commodity?
A commodity is a tangible item that people can buy or sell. Some of the most common forms of commodities include raw materials, precious metals, livestock and food items. Commodities can also serve as a part of production for another unit or item. For example, both beef and corn are commodities, but farmers often use corn to feed their cows. Farmers typically require the growth of corn to produce healthy cows, which then produce food item commodities. Commodities also include things such as crude oil, natural gas and gold.
Related: Guide to How To Become an Investor
What is commodities trading?
Commodities trading is the act of trading for commodities through contracts, such as futures contracts, or directly through a commodity producer. Each commodity has its own standards for minimum trade amounts and minimum quality requirements for a trade. For example, investors typically trade gold by the ounce. You can buy more than an ounce of gold or sell less than an ounce, but that unit of measurement is how a buyer values your gold and offers a fair market price.
There are three kinds of commodity traders, including:
Some investors trade commodities through futures contracts. A futures contract is a written agreement that states a commodity's value after a certain amount of time passes. For example, if a cattle farm wants to compare the value of its cattle against inflation or price drops, as raising cattle takes time, the farm may consider a futures contract. This contract allows a farmer to set a predetermined price for their cattle at the beginning of the production process. This guarantees that despite price fluctuations or inflation, a buyer still purchases the farmer's cattle at the original price established in the contract.
Commodities speculators trade in individual markets by considering the volatility associated with certain commodities. The aim is to establish profits in the short term by speculating on price targets. Because speculators don't control a commodity once a futures contract expires, they aim to make money in the short term and continually invest in other commodities once their current contracts expire.
When the price of basic commodities rises, it's typically due to an increase in inflation costs throughout a certain market. Some investors use commodities to protect against inflation in order to secure their assets. Investing in commodities helps an investor protect the value of their assets by investing into resources that increase in value when inflation rises.
What are the benefits of investing in commodities?
Investing in commodities can be a viable investment strategy for both new and experienced traders. Commodities typically retain value over time and can serve as protection against inflation. Here are some typical benefits of investing in commodities:
Investing in commodities allows an investor to diversify their investment portfolio. Diversification is important because it distributes your assets across a variety of markets and goods, instead of focusing them on one market or item. Diversification can protect investors against market crashes, inflation, supply and demand changes and other economic concerns.
Hedging is the act of protecting yourself against a financial event. For example, you can hedge commodities to serve as protection from market inflation. Inflation occurs for a variety of reasons, including changes in production and raw materials costs, unemployment, social or political upheaval, wages and supply and demand. Commodities typically rise in value when inflation rises, making them a good way to protect your portfolio against inflation devaluation.
Some commodities may experience volatility in their prices, which can allow for higher profitability than other goods. Traders can earn significant profits from the price volatility on commodities such as crude oil and gold. By investing in commodities, you can increase long-term profitability through a resource that's typically stable through financial events and increase short-term profitability by analyzing price fluctuations.
Over the long term, commodities typically remain stable because they're necessary and tangible goods. For example, investing in corn or wheat can be a good long-term investment because both humans and livestock consume these commodities. They're necessary crops and often maintain some or most of their value. Stability in your assets can help ease the concern of fluctuating markets and protect against unforeseen challenges such as inflation.
4 types of commodities
Financial professionals often divide commodities into categories and group them together based on similarities. Here are four different types of commodities:
1. Precious metals
Precious metals are resources mined from the earth's crust. Precious metals are important in industries such as fashion and electronics, as protection against inflation and as stored value. Stored value refers to goods that retain monetary value over time. Precious metals often maintain their value, even during volatile market fluctuations. Here are some examples of common precious metals:
Agriculture includes any crops grown for food. Farmers export crops such as corn both domestically and internationally, which makes them a highly valuable asset. As a commodity, crops typically retain their value, often rising in value when inflation rises. Food is necessary for any society, so many traders invest entirely in agriculture or livestock futures contracts. Here are some examples of agricultural commodities:
Energy commodities are resources that power vehicles, homes, businesses and buildings. Energy is necessary for most people's daily activities functions. Energy commodities can include:
4. Meat and livestock
Meat is an important part of the food chain and provides humans with a balanced diet. Farmers use livestock to produce meat, dairy and other products. Meat is also an important export for farms in different states and countries. Here are some examples of meat and livestock commodities:
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