Part 1

What Are Commodities?

The price of a commodity will never go to zero. When you invest in commodities futures, you’re not buying a piece of paper that says you own an intangible piece of company that can go bankrupt.

Jim Rogers

Open any business news publication and you’ll see the commodities markets discussed throughout. The same goes for many of the reports here on FS Insight, even when we are discussing the stock market or a specific company.

But what, exactly, are we talking about when we talk about commodities?

Well, the dictionary definition of a commodity is any widely traded good or service that is differentiated primarily by price, rather than any idiosyncratic characteristic conferred by the producer or seller. For example, gold is a commodity: pure gold ingots from one producer are no different from pure gold ingots from another, except for the price. Art, on the other hand, is not: for buyers, there is a significant difference between a Picasso and a kindergartner’s finger-painting efforts.

Beyond that, the definition can get a little fuzzy. You will sometimes see it argued that laptop computers have become commoditized, with some saying that (with the exception of Apple) all laptops use the same components and run the same software, so the only thing that matters is price. Even love has been deemed by some cynics to be a commodity, though that debate is beyond the scope of this article.

What Are Commodities?
We will NOT be talking about this. (Source: Unsplash)

But in investment or economic terms, commodities are clearly defined. Commodities are the widely traded raw materials used by companies across business sectors to produce the goods and services that customers and consumers require. For the purposes of our discussion, we will use the word, “commodities” in this sense. The category includes both “hard commodities” – natural resources such as oil or gold that are extracted from the ground – and “soft commodities,” typically agricultural products like wheat or sugar that require human labor to bring to fruition.

So what?

It’s obvious why some people care about commodities prices. The owner of a trucking company is going to be directly impactedby the price of crude, and a farmer has obvious reasons to be concerned about how much a bushel of wheat goes for on the commodities exchanges. But why should you care about commodities and commodities prices?

We live in a holistic system in which everything affects and is affected by everything else. Take the price of energy commodities. When they fluctuate, retail consumers see the difference in how much it costs to drive their cars and how much it costs to heat and power their homes. This in turn affects their ability to purchase other goods and services. But energy prices have a much broader effect. Manufacturers and shipping companies also see their costs impacted, and the result can hit profits, stock prices, and inflation. And all of those influence the economy as a whole and politics in general.

Even companies not normally associated with the energy sector can be affected. In discussing its Q3 2022 results, for example, Microsoft explicitly warned that rising energy prices would result in an estimated $800 million in additional costs (presumably related to the powering of its data centers) and impact its 2022 results.

Energy costs have also been one significant underlying factor underlying the high food costs Americans experienced in 2022. Modern farms consume a lot of fuel to power machinery and irrigation systems, and natural gas is an essential raw material used in the production of many synthetic nitrogen fertilizers.

What Are Commodities?
Source: Trading Economics

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