commodities what are Commodities Commodities are usually raw materials that are either consumed directly or used to produce other Goods while there are many types of Commodities. We can distinguish two main types soft and agricultural Commodities and hard commodities.

Soft Commodities are Commodities that are usually grown as for example coffee corn soybeans or pork bellies.

Hard Commodities are Commodities that are usually mined or extracted as for example crude oil and precious metals.

What all Commodities have in common is that they are real or physical assets as opposed to Classic Financial assets like stocks or bonds that represent a claim on future cash flows because Commodities are either a central Goods or important input factors for the production of other goods and are often difficult to substitute at least in the short term demand for Commodities is relatively inelastic.

This means that demand for the commodity does not change when the price changes which is especially intuitive for food items. We have to eat even if food feels to be too expensive in contrast when investors believe that stocks are overvalued they can simply decide not to buy anymore or even to start selling in addition for most Commodities. There is some sort of limitation in Supply. There's obviously not an infinite amount of oil or gold available for extraction on this planet new Bonds in stocks on the other hand can be issued Whenever there is sufficient demand from investors.

All of the features just mentioned taken together explain why commodity prices can be very volatile as an example see here how the price of Western Texas intermediate oil has developed over the last 20 years or so.

The low was around 20 US Dollars and after reaching an all-time high of around $150 in 2008 prices collapsed during the financial crisis to below 40 US dollars per barrel and impressive example of Market volatility in this volatility explains exactly why Commodities are so actively traded but who trades Commodities first there are producers for example oil companies Farmers Etc as well as the consumers of Commodities the buyers that use Commodities as input into their production process because of their business activities. These companies are directly exposed to price swings in Commodities and trade Commodities and commodity related products to mitigate these risks.

Commodity producers for example have a natural long position in Commodities and look to secure prices for future output consumers on the other hand seek protection against future price surges for example, in case of a poor harvest nowadays Commodities also play an important role in many investment portfolios and consequently the second group involved in commodity trading are investors in speculators. They all trade Commodities in order to generate investment returns, but of course the applied strategies and investment Horizons might differ significantly.

So how exactly are Commodities traded first there is the spot Market also referred to as physical trading. This is the market where participants exchange commodities for cash.

So Commodities are bought and sold for immediate delivery and payment while for Pure Financial assets immediate delivery usually means two business days from the trade date and commodities. We often need a longer settlement period this is due to the fact that often Commodities are produced in one location but consumed in another And as Commodities are real Goods, they actually have to be transported to the location where they are needed. This also means that a significant amount of infrastructure and special logistic expertise is required to facilitate this kind of trading which is why investors often prefer to get exposed to commodity prices via the Futures markets Futures are contracts to buy or sell a certain amount of a specific commodity. The price of the transaction is agreed upon on the trade date but settlement occurs at a specified date in the future.

As positions in Futures can generally be closed through offsetting trades prior to the settlement date, even if the contracts for C physical settlement buyers and sellers do not have to make or take delivery of the underlying Goods consequently Futures offer a convenient way for producers and consumers to hedge their natural risk positions as well as investors to build exposure to commodity prices without having to deal with the physical goods and most commodity trading in practice takes place in the future's market for that reason.

In order to trade in a market Commodities have to be defined and standardized in order to be exchangeable. This is especially true when traded on an exchange.

Here is an example of the crude oil Futures Contract specs also known as WTI Futures. The contract size is 1,000 barrels in the price is quoted in US Dollars and cents per barrel. In other words. If you were to buy one Futures Contract at 56 US Dollars, this means you agree to buy 1,000 barrels of oil at a price of 56 US dollars per barrel at Futures expiry. This gives the contract a value of 56,000 US Dollars The Tick size, which basically defines the smallest possible price change of the Futures Contract is one US Cent and is each contract is for 1,000 barrels. The smallest possible change in value of the contract is 10 US Dollars. There are monthly contracts for around nine years into the future which means it is possible for producers and consumers to hedge their exposures quite far out. The underlying assets of these Futures is light sweet crude oil that meets the quality specifications to find in the The nymex rulebook chapter 200 like for example a sulfur content of 0.42% or less the important thing to remember when trading these Futures is that they are actually physically settled. So if positions are not closed before expiry Traders have to make or take delivery of the physical oil in this case and delivery shall be made free on board at any pipeline or storing facility and Cushing, Oklahoma.

as commodity Futures are so important for hedging and speculation Market participations pay a lot of attention to the shape of the Futures curve in general a Futures curve links together the Futures prices for the different expiry dates and shows how the prices at which Commodities can be bought or sold at different times for the various expiry months to describe the shape of the commodity Futures curve Market participants use the terms contango in backordation contango describes an upward sloping curve, which means that prices increase with time to expire backwardation describes a downward sloping curve so future prices decrease with time to expire