A commodity can be broadly defined as “a physical product, natural resource, or chemical that an individual can touch, taste, smell, mine, grow, consume, or deliver” (Lind Waldock, 2011). Commodities are fungible, meaning they are considered equivalent even though they may come from different producers. Because there is little product differentiation, commodity prices are fundamentally driven by global supply and demand (S&P, 2011).
A. MAJOR CATEGORIES OF COMMODITIES
Commodities are tangible physical products that can be broken into three major categories: industrial and precious metals, agricultural products, and energy.
Industrial and Precious Metals
Metals are classified as either industrial metals or precious metals. Industrial metals include base and ferrous metals such as aluminum, copper, nickel, zinc, iron, steel, lead, titanium, cobalt, tin, etc. These physical goods are generally used as production inputs. Precious metals are those that are rare and have high economic value. Precious metals include gold, silver, platinum, palladium, etc. While precious metals can also be used in an industrial capacity, they are generally considered to have intrinsic value. The higher value is driven by many factors including rarity, uses in industrial processes, and as an investment commodity. Investing in metals can be done either by buying the physical asset itself or through futures contracts. Another way to trade in metals is to invest in companies that explore or produce these metals, such as miners. As the economic environment continues to be uncertain, investors have tended place their funds in precious metals because they have an inverse relationship with currency strength and serve as a hedge against inflation (Agarwal, 2010).
Agricultural products represent a large percentage of the commodity market. They are broken down into three main subgroups: meat products, grain products, and soft products. Meat products include pork bellies, lean hogs and live cattle. The price of meat will generally rise and fall with the price of other agricultural commodities such as grains, which are used as livestock feed. Grain products include such things as oats, corn, soybeans, rice, and bushels of wheat. Soft agricultural products include coffee, sugar, cocoa, orange juice, cotton, etc. These subgroups are generally traded in large options and futures markets located near the region where most of the product is produced. The Kansas City Board of Trade (KCBT), the Chicago Board of Trade (CBOT), the New York Mercantile Exchange (NYMEX), and ICE Futures US (formally the New York Board of Trade) are some of the largest commodity exchanges in the US (CME Group, 2011).
Energy commodities include to all types of energy that can be used to power and heat residential homes and industrial operations. Crude oil, heating oil, gasoline, electricity, coal, propane, ethanol, and natural gas are...