Definition
In economics, a commodity is an economic good or service that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a commodity good is typically determined as a function of its market as a whole: well-established physical commodities have actively traded spot and derivative markets. Most commodities are raw materials, basic resources, or agricultural products, such as iron ore, sugar, or rice.
Commodity
A commodity is a basic good that is utilized in commerce and is also used with other commodities of the same type interchangeably. The quality of each may differ but it is basically the same across producers. Commodities should also meet certain standards when they are traded in an exchange. They can be found all over the world and can be traded in the global marketplace in order to diversify a portfolio.
Most commodities are not traded as products but futures in that what is being traded is a contract which can be bought or sold for a certain price by a predetermined future date. While market fluctuations can have an effect on the value of the commodity, it also presents a number of great opportunities for investors who wish to ride out volatility for rewards.
There is little difference between commodities that come from different producers. A barrel of oil for instance will be as useful as a barrel from some other supplier. However, commodities have expanded to include financial products such as indexes and foreign currencies. Plus technological advances have also expanded to include new commodities that are exchanged in the marketplace such as smart phones, bandwidth etc.
Commodities are generally sold and purchased on exchanges via future contracts that regulate the minimum quality of the commodities that are traded. For instance, a single wheat contract is worth 5k bushels according to the Chicago Board of Trade. They also determine the quality and type of the wheat that can be traded.
The Pros and Cons of Commodity Funds
Commodities allow owners to diversify their portfolios by investing in future contracts or other commodities. This can result in a portfolio that that is not a traditional stock, mutual fund or a bond.
However, commodities do not always remain in tandem with market movements, and many investors try to acquire this correlation when they want to expand their portfolios.
They also provide upside potential. Investors can profit if supply and demand of agriculture, construction etc change in their favor. In other words, if demand for a certain commodity rises, prices are not far behind which only profit the investors who own them.
Commodities also provide investors a ‘hedge’ against inflation. This is basically an investment which can reduce unfavorable price movements in an asset. In other words, investing in commodities is not a bad idea if you are a new investor or need a sustainable source of income.
Further Reading
- Facts and fantasies about commodity futures – www.tandfonline.com [PDF]
- Commodity prices and money: lessons from international finance – www.jstor.org [PDF]
- Factor Contract is Superior to Commodity Contract [J] – en.cnki.com.cn [PDF]
- 10 Commodity policy: price stabilization versus financing” – books.google.com [PDF]
- The uses and misuses of commodity murabaha: Islamic Economic Perspective – mpra.ub.uni-muenchen.de [PDF]
- Commodity options purchasing and credit financing under capital constraint – www.sciencedirect.com [PDF]
- Price discovery in commodity markets – www.tandfonline.com [PDF]
