The commodities market – or “commo” as it is usually called in the trading room – is a very specific market.
Indeed, we usually separate all markets into two very distinct asset classes, each with its own characteristics: investment assets and consumer assets.
An investment asset is an asset held for investment purposes. The holder takes a position in the asset with the expectation of earning an income or capital gain. Examples are numerous and include stocks and bonds issued by various financial institutions.
In contrast, a consumer asset is an asset held primarily for consumption and for the needs of the end user. It is therefore generally not treated for investment or resale.
Examples include various types of commodities such as oil, cotton, coffee, copper, iron, etc.
As a result, these two markets behave in very different ways. For example, investment assets can be borrowed and lent, something that is difficult to do in consumer asset markets.
It is still common to divide commodity markets into two main families: hard commodities and soft commodities.
“Hard” commodities are natural resources, such as metal ores, oil reserves, etc. They form the basis of a country's economic health, and the global demand for these resources can be monitored to assess the future stability of an economy.
Precious metals are also differentiated from other metals and have a very specific market setting. Gold is obviously the star of the "precious" market, especially during a downturn, as it is used by investors as a hedge against inflation. For some years now, the palladium market has been overshadowing it with very superior performances due to the strong world demand.
“Soft” commodities are products that must be grown and maintained, such as agricultural products, livestock and related primary products. They are more volatile because their pricing mechanism relies on multiple external factors. The production of these goods depends on environmental conditions as well as supply and demand.
In addition, bumper crops can depress prices by creating a surplus in the market. Because of such vulnerability, countries like India prefer not to be dependent on primary agricultural exports. However, this is not the case for countries that trade exclusively in exotic agricultural products, such as Côte d'Ivoire, a major exporter of cocoa beans, or Madagascar, which accounts for 70% of global vanilla production. These kinds of goods can only be cultivated in specific environmental conditions (soil, humidity, temperature), which gives producers a monopoly on the pricing of these products.
There are several indirect ways to invest in commodities.
One can invest in mutual funds or exchange-traded funds (ETFs) that focus primarily on companies involved in the production, processing or distribution of commodities.
But the most popular way to invest in the commodities market is to buy futures contracts. The contracts are firm contracts and therefore oblige the holders of these contracts to buy or sell a specified commodity at a specified future price and date. The markets are regulated by commodity exchanges, which are the physical epicenters of trading in these investment vehicles.
The largest commodity exchange in the United States is the Chicago Mercantile Exchange (CME), which manages the WTI (West Texas Intermediate) oil contracts.