Fluctuations in commodity prices directly impact the prices of daily consumer goods, profoundly influencing our lives. From the gasoline we need for daily driving to the food on our dining tables and even the steel used in building houses, the sources of these everyday necessities are closely linked to commodities.

So, what exactly are commodities? By definition, commodities are bulk-traded physical goods that enter the circulation sphere, excluding the retail stage. They possess commodity attributes and are used in industrial and agricultural production and consumption. Characterized by high supply and demand volumes, homogeneity, significant price volatility, ease of storage and transportation, and strong financial properties, commodities hold a vital position in the global economy, influencing both market prices and the global economy.

• High Supply and Demand

Commodities are typically raw materials or basic goods produced and consumed in large quantities. Their trading volumes are usually massive. As the foundation of industrial production, they involve substantial transaction scales.

• Price Volatility

Commodity prices are influenced by a multitude of factors, such as the global economic situation, political landscape, natural disasters, supply-demand dynamics, economic conditions, and policy changes. Consequently, prices fluctuate frequently and by large margins. This volatility endows the commodity market with high risks and speculative potential.

• Ease of Storage and Transport

Commodities are generally easy to store and transport. This enables their efficient distribution and trading on a global scale and also promotes the international development of the commodity market.

• Diverse Categories

Commodities encompass various types, including energy products (such as crude oil and natural gas), basic raw materials (like iron ore, copper, aluminum, and other metal ores, as well as steel and non-ferrous metals), and agricultural and sideline products (such as soybeans, corn, and cotton). These goods are indispensable in industrial production and daily life.

• Homogeneity

Commodities are relatively uniform in quality, with minor differences in the quality provided by different suppliers. This homogeneity makes it easy to standardize and grade commodities, facilitating trading and pricing.

• Financial Attributes

The commodity market is closely linked to the financial market, attracting a large number of investors. Changes in the financial market can significantly impact commodity prices. Investors can participate in the commodity market through financial instruments like futures, options, and ETFs to achieve diversified asset allocation and risk diversification. For instance, as an important safe-haven asset, gold often attracts many investors during periods of global economic instability or geopolitical tensions, driving up its price.

Commodities can be broadly classified into several categories based on their nature and use. The main distinctions are between hard and soft commodities, as well as specific subsections like agricultural, energy, and financial commodities.

Hard Commodities

Hard commodities are natural resources that must be mined or extracted. They generally feature stable physical properties and strong storability.

• Energy Category: These consist of crude oil, natural gas, coal, and natural liquids, which are essential for various industrial and consumer applications. Energy prices are notably volatile due to factors like global supply constraints and fluctuating demand influenced by economic conditions and energy policies.
• Metal Category: This is divided into precious metals and industrial metals. Precious metals like gold, silver, and platinum have monetary attributes, functions of hedging against risks, preserving value, and certain industrial uses. Industrial metals such as copper, aluminum, zinc, and lead are widely used in various industries, including construction, electricity, and automotive manufacturing.

Soft Commodities

Soft commodities mainly refer to agricultural products and some cash crops. These commodities usually have relatively short growth cycles and their production is significantly influenced by natural factors.

• Crop Category: It consists of food crops like wheat, corn, soybeans, and rice. These are the basic food sources for humans and important raw materials for the food-processing industry. Their prices are affected by factors such as planting area, climate conditions, and global food demand.
• Cash Crop Category: These are derived from agricultural processes but are not used for food consumption. Examples include cotton, rubber, and lumber, which are vital for various manufacturing processes.

Financial Commodities

This category includes bonds, currencies, and other financial instruments. Financial commodities play a vital role in trading and investment strategies, enabling investors to diversify their portfolios and hedge against market volatility.

The commodity market refers to the market where commodities are bought, sold, and circulated. It can be broadly classified into two types: spot markets and derivatives markets. Spot markets, also known as cash markets, facilitate the immediate delivery of physical commodities, while derivatives markets deal with contracts based on the future prices of commodities, such as forwards, futures, and options.

How It Works

Trading Mechanisms

• Quotation and Order Placing

Market-maker System: In some markets, there are market-makers. They continuously quote buying and selling prices and are ready to trade with other traders at these prices at any time, providing liquidity to the market. For example, in some over-the-counter (OTC) precious metals markets, large financial institutions act as market-makers.

• Competitive Bidding

Futures exchanges and other platforms adopt this mechanism. Traders input buy or sell orders containing information such as price and quantity into the trading system based on their judgment. The system matches trades according to the principles of price priority and time priority.

• Matching and Execution

In competitive bidding, when the highest bid price of the buyer is greater than or equal to the lowest asking price of the seller, a trade may be executed. The trading system automatically matches and determines the transaction price and quantity according to an algorithm. Under the market-maker system, a trade can be completed as long as the trader accepts the price quoted by the market-maker.

• Settlement and Delivery

Settlement: This is divided into daily settlement and final settlement. During daily settlement, the exchange or settlement institution calculates the profit and loss of traders' accounts based on the settlement price of the day and transfers funds to ensure that the margin balance meets the requirements. Final settlement occurs when the contract expires or is closed, finalizing the fund liquidation.

Delivery: For spot transactions, physical delivery and payment settlement usually occur shortly after the deal is made. In futures trading, most contracts are closed out through reverse operations before expiration, while some are subject to physical delivery or cash settlement. In physical delivery, the seller delivers the goods according to the contract standards, and the buyer makes the payment. In cash settlement, the difference is settled in cash according to the agreed price.

Price Formation

Supply-and-Demand Dominance: In the long run, the prices of commodities are mainly determined by supply and demand. When the economy is growing strongly, demand is high, and supply is tight, leading to price increases. When the economy slows down, demand decreases and supply exceeds demand, causing prices to fall. For example, during the boom of the global manufacturing industry, the demand for industrial metals such as copper increased significantly, driving up prices.

Cost Support: Production costs are an important support for prices. For the mining industry, costs include exploration, mining, and transportation. For agricultural products, costs include seeds, fertilizers, etc. If prices fall below production costs for a long period, producers may reduce production, affecting supply and supporting prices.

Impact of Market Expectations: The expectations of investors and market participants regarding future supply and demand, macroeconomic conditions, and policy changes can affect prices. For example, if the market expects a significant increase in future crude oil demand, oil prices may rise in anticipation, even if current supply and demand are balanced.

Risk Management

Hedging: Producers, consumers, and traders can use the futures market for hedging. Producers worried about price drops sell futures contracts in advance, while consumers worried about price increases buy them in advance. Profits in the futures market can offset losses in the spot market, locking in costs or profits.

Risk-Control Tools: Investors and market participants can also use financial instruments such as options and swaps to manage risks more flexibly. For example, after paying a premium for an option, one can obtain the right to buy or sell a commodity at a specific price at a specific time in the future, which not only controls risks but also retains the opportunity to profit from favorable price changes.