Understanding Commodities: A Beginner's Guide to Investing

Commodities are another class of assets just like stocks and bondsBondsBonds are fixed-income securities that are issued by corporations and governments to raise capital. The bond issuer borrows capital from the bondholder and makes fixed payments to them at a fixed (or variable) interest rate for a specified period.. Most commodities are products that come from the earth that possess uniform quality, are produced in large quantities, and by many different producers.

Major commodities include cotton, oil, gas, corn, wheat, oranges, gold, and uranium. Basically, they are the raw materials needed by large manufacturing companies in running their businesses.

It is believed that commodities of the same type can be interchanged for as long as they are of the same grade. For example, a company that manufactures chocolates can buy cocoa produced in Ghana or in Cameroon, still producing the same quality of chocolates.

Types of Commodities

1. Agricultural

Agricultural commodities are those such as coffee, corn – an important source of food for livestock and humans, sugar, soybeans – whose oil is used for making crackers, breads, cakes, and cookies, and wheat – one of the most important food crops in the world.

2. Energy

Energy commodities include crude oil used in transportation activities and production of plastics, natural gas used for electricity generation, and gasoline, which powers light-duty trucks and cars.

3. Metals

Metals include gold, used in making jewelry; silver, also used for jewelry and many other industrial uses as well; and copper, the most widely used form of electrical wiring.

How are Commodities Traded?

Most commodities are traded on commodities exchanges, which include the New York Mercantile Exchange (NYMEX)New York Mercantile Exchange (NYMEX)The New York Mercantile Exchange (NYMEX) is a commodity futures exchange located in Manhattan, New York City. It is owned by CME Group, one of the largest, the Chicago Mercantile Exchange, the Chicago Board of Options Exchange (CBOE), the Kansas City Board of Trade, the Minneapolis Grain Exchange, and the Chicago Board of Trade (CBOT).

Investors may opt for indirect exposure through stocks, exchange-traded fundsExchange Traded Fund (ETF)An Exchange Traded Fund (ETF) is a popular investment vehicle where portfolios can be more flexible and diversified across a broad range of all the available asset classes. Learn about various types of ETFs by reading this guide., and mutual funds.

Differentiated Products

Commodities and differentiated products are both traded in the commodity markets, but they differ in a few ways, as discussed below.

Commodities are interchangeable, and every kind is the same regardless of their source. This means that crude oil from one producer is the same crude oil from another producer. The goods can be combined without affecting the quality of the commodity.

Differentiated products, on the other hand, are unique products or those that are not like the generic version of the products. For example, regular gasoline is priced in the same way across all oil companies. However, if they produce high-octane gasoline, the product becomes better than what the competitors are selling.

Related Readings

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