What Are Commodities?
Commodities are things which can be abstracted from the earth like agricultural products (oranges and wheat), gold and oil and they are bought and sold based on speculation over their price. For example, if there is a frost in Florida during the orange growing season and much of the orange crop is destroyed the price of orange juice will skyrocket even before the crop is harvested. This is because people believe that there will be a shortage of orange juice in the future so the price will go up today. Understanding commodities is especially important in today's market with the rising cost of oil. As there is a world fear over shortages of oil, the price continues to climb, even if the same number of barrels that were produce yesterday is also produced today. Speculation over a shortage is enough to cause the price to rise.
How Are Commodities Traded?
Commodities traders do not actually trade the product but rather trade the understanding to buy and sell the product at an agreed upon price on an agreed upon date. However, since the price of commodities can change daily this can greatly affect whether or not you make money. If the price of the commodity you purchased goes up, then you, the buyer of that future contract, make money. This is because you can now sell your commodity for more than you bought it for. The same is true in reverse. If the price of the commodity goes down then you will loose money.
The Risk Of Commodities
For this reason, commodities are considered future contracts because you forecast the value of the commodity in the future. Commodities traders and analysts are entrusted to set the values of the commodity and they spend their days researching their particular commodity in order to do so. The future price set for commodities is always based on the latest information, today's information. If something happens tomorrow that was not foreseen today then this can cause drastic price changes to the commodity for better or worse for commodity traders and investors. Although it is for this reason commodities investors have the potential to make large amounts of money, commodities are also, for the same reason, a very high risk investment.
Article written by Nicole Sivan