- A commodity is a physical and raw product which are used interchangeably with other products within production processes
- Some traditional examples of commodities include grains, wheat, oil and gas
- Commodity prices are generally uniform and therefore don't tend to fluctuate in value
- You can invest in them through Exchange Traded Funds (ETFs) or by investing in a company which is orientated around a particular commodity
How to invest in commodities
There are a number of ways to invest in commodities. You can do this by purchasing Exchange Traded Funds (ETFs) which track a particular commodity index. This means you will invest in a broad range of commodity-related businesses and provide a good way of diversifying your assets.
Another way is by directly purchasing stocks of a business orientated around a particular commodity. An example of this would be investing in a company like BP or Shell which are two of the world’s major oil and gas players. Commodities are renowned for being volatile, so being fully aware of the risks you’re taking before making an investment is key.
You can also invest in commodities through a futures contract. That is a standardized contract whereby the buyer agrees to purchase some underlying commodity (or the seller to sell it) at a predetermined future price and date.
What determines the price of a commodity?
Prices of commodities are determined by a number of push pull factors listed below:
- Macroeconomic trends: When the economy is booming, there is more demand for materials needed for building and transportation projects which influences higher prices. However, if the economy is weak, demand is lower resulting in a drop in prices.
- Seasonality: The prices of agricultural commodities, such as wheat and barley, fluctuate during different points of the seasonal cycle. Prices tend to increase during harvesting season for example and drop when the crops have been sent to the markets.
- Politics: Big policy changes around imports and exports can have knock-on effects on prices. An example being the implementation of import tax on certain goods.
- Technology: Technological advances can cause a commodity which was once upon a time the main player, from being shunned by another advancement. A good example is the expansion of renewable energy and how it has reduced the demand for oil and gas.
Examples of commodities
In addition to supply chain commodities, foreign currencies and indexes are examples of financial commodities. Technological advances have also led to new types of commodities being exchanged in the marketplace. For example, cell phone minutes and bandwidth.