A commodity is a basic good that is standardized enough for one unit of a given grade to be swapped for any other, whoever produced it. A tonne of copper cathode of a set purity or a barrel of a particular crude oil is treated as the same as the next, so buyers choose mainly on price. Most commodities are raw materials from mining, energy production and agriculture, and they are traded in large volumes worldwide.
Economists use the word in two ways. In the narrow sense used in markets, it means these standardized primary goods. In a broader sense, any product is said to be "commoditized" when competition has made brands irrelevant and only price counts. Commodities are traded on spot markets and on the commodities market through futures contracts, and in the United States the futures side is supervised by the Commodity Futures Trading Commission.
Commodity in plain terms
Think of buying bottled water versus buying salt. You may care a lot about one brand of water, but a kilo of plain table salt is a kilo of plain table salt; you take whichever is cheapest. Salt behaves like a commodity, the water brand does not.
Oil, wheat and copper work like that salt. A refinery does not care which oil field a barrel came from, as long as it is the agreed type. Because everyone is selling the same thing, the price is set by the whole market, not by any one seller, and it moves quickly when supply or demand changes.
Main types of commodities
- Energy. Crude oil, refined products, natural gas, coal and power. Benchmarks include Brent and West Texas Intermediate crude.
- Industrial metals. Copper, aluminum, zinc, nickel, lead and tin, with prices led by the London Metal Exchange.
- Precious metals. Gold, silver, platinum and palladium; gold also serves as a store of value and is held by central banks, see Gold (Investment).
- Agricultural. Grains and oilseeds such as wheat, corn and soybeans, and "softs" such as sugar, coffee, cocoa and cotton.
- Livestock. Cattle and hogs.
Traders often split these into "hard" commodities that are mined or extracted and "soft" commodities that are grown.
How commodities are traded and priced
For a commodity to trade at scale, its grades, quantities and delivery points must be defined precisely. Exchanges publish contract specifications, and industry bodies set standards such as London Good Delivery for gold and silver bars. Physical goods change hands in spot and forward deals at the spot price, while futures and options let producers, consumers and investors fix or bet on future prices. Major venues include CME Group's exchanges in Chicago and New York, ICE in London and New York, the London Metal Exchange, and China's Shanghai, Dalian and Zhengzhou exchanges; India's MCX and Pakistan Mercantile Exchange serve local markets.
Prices reflect supply and demand, inventories, the cost of storage and finance, and expectations. When futures prices sit above spot the market is in contango; when they sit below, it is in backwardation. A miner or farmer uses futures for hedging, while funds and traders add liquidity and take risk through speculation. Investors can also gain exposure through broad indices and exchange-traded funds, or treat commodities as a separate asset class for diversification.
Commodities and the economy
Commodity prices have wide effects. Energy and food prices feed quickly into inflation, so central banks track them closely, and a sudden jump can act as a supply shock. Prices also move in long waves, known as the commodity cycle, as investment in new mines and fields lags behind demand.
For producing countries the stakes are higher still. UNCTAD counts a country as commodity-dependent when commodities make up more than 60 percent of its merchandise exports, and by that test most developing countries qualify. Their terms of trade, government budgets and currencies rise and fall with world prices, and some suffer the resource curse. Producer groups such as the Organization of the Petroleum Exporting Countries (OPEC) try to influence prices by coordinating output, while many exporters save windfalls in a sovereign wealth fund.
Commodities as money and collateral
Commodities have long doubled as money. Gold and silver coins, and later the gold standard, tied currencies to a physical good; bimetallism tried to use two metals at once. Today commodities underpin financing: banks lend against stored goods through a warehouse receipt, and commodity trade finance funds the movement of cargoes between producers and buyers.