What are commodities?

Introduction

Commodities are basic physical goods used throughout the global economy. They include energy products such as crude oil, metals such as gold and copper, agricultural crops such as wheat and corn, and livestock such as cattle.

Unlike a stock, a commodity does not represent ownership in a company. Unlike a bond, it does not represent a loan to an issuer. A commodity is the underlying physical good itself, although investors often gain exposure through financial instruments rather than owning and storing the commodity directly.

Understanding commodities can help investors see how raw materials fit into financial markets, what drives their prices, and why their behavior can differ significantly from stocks and bonds.

What is a commodity?

A commodity is a basic good that can generally be bought and sold according to standardized grades or specifications. Units of the same grade are intended to be largely interchangeable regardless of who produced them.

For example, financial markets do not usually treat one company’s shares as interchangeable with another company’s shares. In a standardized commodity contract, however, the focus is on whether the underlying product meets the required specifications.

This standardization helps producers, commercial users, traders, and investors participate in large markets for physical resources.

Main types of commodities

Commodities are commonly grouped into several broad categories. Each category has its own sources of supply, demand, and price risk.

How commodity markets work

Commodity markets bring together businesses that produce physical goods, businesses that need those goods, and financial market participants. Their objectives can be very different.

A farmer may want to reduce the risk that crop prices fall before harvest. A food manufacturer may want more certainty about future input costs. An investor or trader may take exposure because they expect prices to change.

Futures markets play an important role in connecting these participants. A futures contract establishes terms for buying or selling a specified commodity at a future date. Although many contracts are closed or offset before physical delivery, their prices provide important information about market expectations.

Spot prices versus futures prices

The spot price generally refers to the price associated with buying or selling a commodity for near-term delivery. A futures price applies to a standardized contract for delivery at a later date.

These prices do not have to be identical. Storage costs, financing, inventories, expected future supply and demand, and the value of having the physical commodity available today can all affect the relationship between spot and futures prices.

This distinction matters for investors because many commodity funds use futures rather than owning the physical commodity. Their returns can therefore differ from changes in the spot price.

What drives commodity prices?

Supply and demand are at the center of commodity pricing. When available supply becomes tight relative to demand, prices can rise. When supply is abundant or demand weakens, prices can fall.

The specific forces behind supply and demand depend on the commodity. Weather can have a major effect on crops. Mine disruptions can affect metals. Production policy and geopolitical events can influence oil. Disease can affect livestock markets.

Economic growth, currencies, technology, government policies, inventories, and changes in consumer behavior can also matter. This variety is one reason individual commodities often behave very differently from one another.

Examples of important commodity markets

Gold is widely followed as both a precious metal and investment asset. Its price can respond to interest rates, currencies, investment demand, central-bank activity, and physical demand.

Silver is also a precious metal but has substantial industrial demand, giving it a different supply-and-demand profile from gold.

Crude oil is closely connected to transportation, industry, global economic activity, and geopolitics. Storage and transportation constraints can also be particularly important in energy markets.

Why investors consider commodities

Commodities can provide exposure to economic forces that differ from those affecting corporate earnings and bond yields. This can make them relevant when thinking about diversification.

Some investors also consider commodities because raw-material prices can rise during certain inflationary periods. However, the relationship between commodities and inflation is not consistent enough to treat every commodity as a guaranteed inflation hedge.

Commodity exposure can also be used to express a view on a particular market, such as energy demand, precious metals, or agricultural supply.

Commodities do not produce cash flows

A major difference between physical commodities and productive assets is the absence of inherent cash flow. A barrel of oil, bushel of wheat, or bar of gold does not generate earnings simply because an investor owns it.

Stocks can represent a claim on business profits, while many bonds make contractual interest payments. Commodity investors generally depend more directly on future market prices for their returns.

That does not make commodities inherently better or worse. It simply means they should be evaluated differently from assets whose value can be analyzed partly through expected future cash flows.

How investors gain exposure

Physical ownership is possible for some commodities, particularly precious metals, but it is impractical for many others. Storage, transportation, insurance, and quality requirements make direct ownership of oil, grain, or livestock unrealistic for most individual investors.

Instead, investors can use futures, exchange-traded products, or shares of commodity-producing companies. Each approach introduces different risks and may behave differently from the commodity’s spot price.

Our guide to how to invest in commodities explains these methods in more detail.

Key takeaways

• Commodities are basic physical goods such as energy products, metals, crops, and livestock.
• Commodity markets connect producers, commercial users, traders, and investors.
• Supply and demand are central to prices, but weather, currencies, geopolitics, inventories, and economic conditions can also matter.
• Spot prices and futures prices are related but are not necessarily identical.
• Physical commodities generally do not generate earnings, dividends, or interest.
• Investors can gain commodity exposure through physical ownership, futures, exchange-traded products, and commodity-related companies.