A Beginner’s Guide to Commodity Markets

In fact, there is some evidence that futures in rice may have been traded in China over 6000 years ago, and more recent commodities crises have led to conflicts around the world – as in Japan’s drive to secure oil supplies in World War II.

Commodities have an impact on our day-to-day lives

More recently, the impact of major commodities such as oil has had a significant impact around the world. While we’re in a period of depressed oil prices today, events such as the oil embargo by OPEC in the 1970s have had a huge impact on Western economies. Rising commodity prices, particularly in agriculture in the wake of natural disasters or crop failures have also significantly affected Third World economies.

The major types of commodities

While there are a huge number of different commodities, most of them fall into four major categories – energy, agricultural products, metals and livestock. These have been the staples of economies for many centuries, although other commodities such as spices and even seashells have played a major role throughout history. The influence of major empires has often been linked to commodities – the ability to trade in things such as wheat, gold and copper has driven economic power since time immemorial.

Standards are key

To trade commodities successfully, suppliers need to guarantee the quality of what they are providing. This is one of the reasons that things such as the sterling standard was created in the England, and why the gold standard was so important around the world. Commodities are only valuable if there is some way of measuring their value – for example, no one wants to buy diseased livestock or other poor-quality commodities.

How investing in commodities is different

While investing in stocks, bonds and other types of securities is often driven by local financial performance, commodities are influenced by a much broader range of factors. For example, demand for commodities is driven by economic performance around the world. Emerging economies such as India and China create additional demand for basic commodities such as oil, steel and aluminum – creating strong upward price pressure that drives the price of these commodities. Global disasters also play a major role – including crop failures, environmental issues and health crises.

The risk of investing in commodities

Unlike stocks whose price is often linked to long-term corporate performance, commodity prices can be much more volatile. There are a host of unpredictable factors that can dramatically increase or decrease commodity prices. For example, prices of wheat and other grains can vary widely depending on short-term weather patterns. Investors need to be wary of this and allocate an appropriate amount of their portfolio to commodities.