What are Commodities? 
Everyone has probably heard the term commodities, but what exactly are they? Commodities are simply goods, real assets, that people demand. They have value and are produced in some uniform quality in large quantities by many different producers.
Some examples of commodities are beef, pork, cotton, corn, iron ore, gold, platinum, aluminum, rice, wheat, and silver. Commodities are considered uniform in quality, so when producer A sells cattle it must meet some minimum standards. It may be above those standards but not below. When quality is considered equal, the market can deal with thousands of producers in the same fashion. Producer A’s cow is the considered the same as Producers B, C, D and so on.
The commodity market has changed from the days when a farmer sold his bushels of wheat and corn to local markets. By the mid 1800’s, demand for uniform contracts to trade agricultural products brought on the development of commodity futures exchanges. Today, futures and options contracts are available on a wide variety of agricultural products, metals, energy products, and soft commodities. These products can be traded on exchanges around the world.
Where are they Traded?
Commodities are traded on exchanges, also similar to the stock market. These exchanges are regulated by various agencies. Some examples are:
- Chicago Board of Trade
- Chicago Mercantile Exchange
- Euronext.liffe
- London Metal Exchange
- New York Mercantile Exchange
- Multi Commodity Exchange
Cows in My Backyard?
Nope, you do not need to own a commodity to participate in the market. Speculators and middlemen trade commodities everyday much like stock market, although there are very distinct differences, even amongst commodities themselves.
Here’s how it works.
Imagine a small field of soybeans is growing on farmer Justin's farm. This particular field of soybeans is still too young to be sold, but farmer Justin has been watching the price of soybeans in the market. He has watched the price of a bushel of soybeans go from $2.01 per bushel to $2.16 per bushel over the last month.
One morning farmer Justin reads in the newspaper that the price of soybeans has gone to $2.25 per bushel. He decides to sell his field of soybeans at that price.
At $2.25 per bushel, he is pulling in a decent profit on his crop. He realizes that the price of soybeans may continue to go up or go lower. He is willing to sell because he wants to lock in that price and needs cash to continue his farming enterprise. Justin calls up his broker and tells his broker that he wants to sell.
However, farmer Justin's soybeans are not going to be ready to harvest for another 3 months. Justin sells his crop with the understanding that he will deliver that amount of soybeans 3 months from that day. But who is going to agree to pay $3.25 per bushel for farmer Justin's soybean crop? Speculators or middlemen step in to trade.
The price of soybeans varies daily. Millions of bushels are bought and sold. There is an opportunity to make money by buying farmer Justin's soybeans at $3.25 per bushel and waiting to sell it to someone else for $3.35.
Seasonal Nature of Commodities
Equities markets have seasonal moves, but seasonal tendencies are more pronounced in commodities trading. Agricultural product prices are affected by the weather and growing season. Oil and gas are affected by the changing seasons. Traders must be aware of seasonal fluctuations in commodities they are trading. Gold prices tend to peak in the fall as the holidays approach and consumption is highest.
As seasons change for different commodities, supply and demand will affect price. Heating oil prices tend to increase in the fall as colder weather approaches. Corn prices tend to decline as harvest time approaches. Knowing the seasonal trend is essential.
Should I Even Be Trading Cows?
Trading commodities is not unlike trading any other financial instrument. Technical and fundamental aspects apply. Commodities are specific in nature and you must know your own limits. If you are interested in commodities, study and learn about the market you wish to trade.
A major benefit to adding commodities is that they are a distinct asset class with returns that are usually independent of stock and bond returns. They allow you to achieve trading diversification, giving you more trading instruments to utilize, and a broader range of markets to profit in.