Methodology

Investing Basics

Module 2

What is a portfolio?

Understanding Commodities

Commodities are basic materials that are widely used in business. Examples include natural resources like gold, meat, oil and natural gas.  Commodities are typically used as inputs in the production process of other goods or products. For example, gold is commonly used as a key element of computer chips, with the average computer containing gold that is worth around $12.

 

Although it may seem a bit unusual, commodities are actually traded on the stock market. It is possible for investors to buy and sell different commodities, making them part of their portfolio. Investing in commodities is often seen as a beneficial thing as commodities are useful in terms of overcoming the negative effects of inflation. 

 

Technological advances have led to the development of new commodities. It is now possible to trade things like internet bandwidth or smart phone minutes across commodity markets. 

Types of Commodity Market

A commodity market is a marketplace where the buying, selling and trading of raw materials takes place. Commodities generally trade in either a spot market or derivatives market. Spot markets are physical markets, where buyers and sellers exchange physical commodities for immediate delivery. Derivatives markets are where commodities are bought and sold using derivative contracts, on a stock market.

 

Most investors are likely to participate in the derivatives market, as taking part in the physical exchange of commodities is inconvenient – unless they run a manufacturing business. On derivative markets, investors typically trade in futures contracts without intending to actually take ownership of the underlying commodity, trying to profit from short term changes in commodity prices instead.

 

This will be discussed in more detail in future lessons.

Determining Commodity Prices

Similar to most other types of investment, commodity prices are driven by supply and demand. If demand for a particular commodity rises when there is limited supply, the value of the commodity will increase. Likewise, if demand falls and there is a large supply of a particular commodity, the value of the commodity will fall.

 

The supply of a commodity can be affected in a number of different ways, including employment issues (not being able to hire people to farm the commodity), poor weather or new regulations (i.e. bad weather may damage crops and disrupt the supply of corn).

 

The demand for a commodity can also change due to economic shocks, natural disasters or political issues (i.e. when inflation increases, investors will often turn to gold to protect the value of their capital).

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