18.1 What are commodities?
Commodities are natural products that grow (such as wheat, rice, etc.) or are prospected from the earth (such as gold, silver, iron, crude oil, etc.). A commodity can be any tangible good, but commodities that are traded in the commodity markets are usually bulk goods and food products, including natural gas, gold, silver, etc. In finance jargon, the term ‘commodity’ refers to the market of agricultural goods, energy and industrial raw materials.
A commodity is anything for which there is demand, but which is supplied without qualitative differentiation across a market. In other words, copper is copper. Rice is rice. Stereos, on the other hand, have many levels of quality. And, the better a stereo is, the more it will cost. The price of copper is universal and fluctuates daily based on global supply and demand.
One of the characteristics of a commodity good is that its price is determined as a function of its market as a whole. Well-established physical commodities have actively traded spot and derivative markets. Generally, these are basic resources and agricultural products such as iron ore, crude oil, coal, ethanol, salt, sugar, coffee beans, soybeans, aluminium, rice, wheat, gold and silver.
Key characteristic and trends
Now let us discuss a few key characteristics of commodities. Commodities are voluminous, bulky - thus, there are issues with respect to storage, transportation between place of production and consumption.
In case of agricultural commodities, another added dimension is quality deterioration while in storage (potatoes, etc. contain about 78% water) or extra care that needs to be taken while in transit (cotton). Industrial commodity production cycle is long, with front ended investment environmentally and ecologically sensitive. Thus, supplies cannot be immediately increased, it takes anywhere between 36 to 60 months to create a green-field project, if there are no political and environmental issues. Commodities exhibit clear seasonality in supply and demand. Example, 70% of potatoes (that is 20 million tonnes) in India come in 3 months time. Similarly, there are demand seasonalities too. For instance, the demand for natural gas during winter and petrol in summer goes up in the US. Cement demand slumps during rainy season when construction activities slow down.
Commodities are raw materials or intermediate goods. So, while there is a steady demand, the demand is a derived demand. Hence, it is highly price sensitive in some categories. Substitution, reuse, recycle are continuous process of keeping the prices under check. These cause cycles in production. Extensive production base and consumption base is another characteristics of commodities. So, cross-border trade is vibrant in commodities.
The commodity markets ecosystem includes the following components:
Buyers/Sellers or Consumers/Producers:
Farmers, manufacturers, wholesalers, distributors, farmers’ co-operatives, APMC mandis, traders, state civil supplies corporations, importers, exporters, merchandisers, oil refining companies, oil producing companies, etc.
Storage and transport companies/operators, quality testing and certifying companies, valuers, etc.
Markets and Exchanges:
Spot markets (mandis, bazaars, etc.) and commodity exchanges (national level and regional level).
Depositories/dematerializing agencies, central and state warehousing corporations, and private sector warehousing companies.
Banks, financial institutions.