What are commodities?

Commodities are a product that refers to the various raw materials and agricultural products that are traded in the financial markets.

What are they?

A commodity is a raw material or agricultural commodity traded on markets. Along with bonds and stocks, commodities are one of the most widely used asset classes by investors. But unlike the others, this asset is not defined by its issuer/producer, but by the product itself, because raw materials are homogeneous regardless of their source.  In other words, coffee of the same quality, produced in Colombia or Indonesia has the same value.

These raw materials can be a variety of products, which are part of our daily lives, to exemplify:

  • Agricultural products: cotton, coffee, corn, sugar…;
  • Metals: common such as copper, and precious such as gold and silver;
  • Energy: oil, electricity, and gas;
  • Animal products: livestock;

Futures Market

Commodities are traded on the futures market. And what are futures? Futures is a contract between a buyer and a seller to receive a commodity, or other financial assets, at a future date and at a pre-agreed price. These contracts can be traded repeatedly until their expiration date.

For the purpose of protection against price fluctuations, buyers and sellers use futures contracts. In this way, they obtain a price guarantee at the time of the contract, regardless of the price on the expiration date. Conversely, just as it can protect a seller of goods from a fall in price, it also prevents them from selling at a more profitable price.

Advantages

  • Inflation protection – Unlike other assets, which suffer a small devaluation due to inflation, the opposite is true for commodities. Just as inflation increases the price of goods and services, so will the raw materials used in those goods and services.
  • Increased income opportunity – Occasionally demand for certain commodities can lead to a rapid rise in prices, which leads to good income opportunities

Disadvantages

  • Great volatility – Just as it leads to the possibility of great gains, the opposite can also happen, where a crisis, for example, can lead to a drastic drop in commodity prices.
  • Zero Profit – Taking into account that commodities are usually traded on the futures market as a way to protect against volatility, this asset can sometimes bring zero income.

For whom?

This asset is not advisable for most ordinary investors. It is an asset that can sometimes present high yield opportunities, but also the opposite can happen. Due to its greater complexity, it is recommended for more experienced investors, who actively manage their investments and seek to diversify their portfolios.

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