What are Commodities? - Definition, Types and Examples

A commodity is a word we hear very often, especially in countries with high production of raw materials such as agricultural products and metals for example. We can also say that commodity is a word that has entered the most common and informal language, imported from the economic and financial language. But … what is a commodity? How can it affect us?

A commodity is any good that is mass-produced by man, or of which there are large quantities available in nature, that has value or utility and a very low level of differentiation or specialization. But this definition is very broad and covers many different goods. However, there are many goods that do not meet our definition of a commodity and therefore are not considered as such. Here are some examples.

In this case, crops such as soybeans, corn, and wheat, fall within our definition. These are mass-produced goods by man and have a very low level of differentiation, as the wheat produced in South America, is not essentially different from that produced in Europe or somewhere in the United States. Gold, silver, and oil also fall into this definition, since there are large quantities available in nature. Regarding the level of differentiation or specialization, the gold mined in different parts of the world will have essentially the same qualities.

Let´s see other examples. The sea water is not a commodity and although it is a good quite abundantly, it has no value or utility. The same can be said about volcanic ash, except in rare cases, it doesn´t have any use or economic importance.

Now, why computers are not commodities? The answer is that the level of differentiation is decidedly higher, and the specifications are also highly variable. What kind of computer are we buying? It is a Dell, Hewlett-Packard, or Toshiba? The computer is a laptop or a desktop? We might also add that each computer may differ significantly in the specifications such as RAM memory, hard drive capacity, speed of the microprocessor, the graphics board, etc..

If we are in the presence of a good with a high level of differentiation, we will be talking about a market with high-profit margins compared to a market that has no differentiation and therefore offers lower profit margins (the latter is the case of the commodities market). Sometimes it happens, however, that when a given industry evolves so that many participants can do something that previously could be performed only by a particular firm, we can speak of “commoditization” of a product or industry.

Examples of this can be found in the pharmaceutical industry where instead of consuming only drugs made by a particular lab, the clients can access the generic drug which is cheaper. If we say “this drug has become a commodity”, we mean that there is no special differentiation or especially wide margins to produce such drugs. We can say that about the aspirin when in its early days it was undoubtedly an innovative product with high margins for those who produced it. Today, aspirin is a commodity, to the point that nobody makes a big difference between taking the one made by a laboratory or another.

Classification of commodities

Within our broad definition of commodities, we find different groups. The main types of commodities are as follows:

Grains: Soybeans, Wheat, Corn, Oats, Barley.
Softs: Cotton, Orange Juice, Coffee, Sugar, Cocoa.
Energy: Crude Oil, Fuel Oil, Natural Gas, Ethanol, Gasoline.
Metals: Gold, Silver, Copper, Platinum, Aluminum, Palladium
Meats: live cattle, live swine, Butter, Milk.
Financial: 30-year Bonds, 10-year Bonds, Eurodollar, 30-day Fed Funds.
Indexes: Dow Jones, S&P 500, Nasdaq100, Nikkei225, E-Mini Nasdaq.
Currencies: US dollar, Pound Sterling, Euro, Mexican Peso, South African Rand, Swiss Franc.

From this classification in groups, are created the commodities related to the financial sector. This is a clear example of how wide is the term commodity today, as we cannot associate this concept only with raw materials like crude oil anymore. After all, the euros that a person can buy in Germany are exactly equal to the euros that another person buys in the United States for example.

Today, commodities have become important instruments for investment and speculation which are traded in specialized markets worldwide. In fact, some commodities like those mentioned above have a daily trading volume of many billions of dollars. Because of its relative stability, some commodities have become a haven for investors.

These instruments are traded directly in the spot market in which are bought and sold like any merchandise, or through various derivatives among which we mention the following:

Futures Contracts
Forward Contracts
Financial Options
Contracts For Difference

In this way, the trader has many options to trade with commodities. Many brokers of different types, including some Forex brokers, allow to trade with commodities directly or through derivatives.

The main exchanges in which commodities are traded are: