Commodity

A commodity is a class of raw materials and products admitted to organised trading on terms under which the subject of the trade is not a specific batch from a specific seller, but a standardised contract for goods of a set quality, volume and delivery point. Oil, metals, grains, sugar, gas and electricity fall into this category; a unique item such as a painting, a building or a patent never does.

What makes a good a commodity

Several properties are needed at once. Quality must be described by measurable parameters: density, sulphur content, share of impurities, moisture, fineness. Production and consumption must be large-scale and spread across many participants; otherwise the price is set through negotiation rather than through trading. The good must withstand storage and transport, at least for the life of the contract. The exchange sets all of this out in the contract specification: lot size, permitted quality deviations, the basis delivery point, the delivery period and the settlement method.

The physical nature of the good gives rise to something securities do not have: a commodity has a cost of existence. Warehouse fees, insurance, shrinkage and freight are captured as storage costs and are built into the relationship between prices for different delivery dates. Available inventories work in the same direction: when storage is full, near-dated contracts become cheaper relative to deferred ones; in a shortage, they become more expensive.

How to read the price

A commodity quote is the price of the standard at the basis point, not the price at which a particular plant will ship. That is precisely why it works as a benchmark: off-exchange supply agreements are usually linked to the exchange indicator by a formula rather than negotiated from scratch. The higher a contract's liquidity, the narrower the spread and the more reliable that benchmark.

Commodities on the exchange

A common confusion

"Commodity" is not a synonym for "anything traded on an exchange". Shares and bonds trade on the same venue, but they are an equity security and a debt security — claims on rights, not a physical good with a warehouse and a quality grade. The second confusion runs the other way: trading in raw materials almost never means owning the raw materials. Cash-settled futures and spot gold provide exposure to the price without delivery, and a commodity line in a trading terminal does not turn into a railcar at the carrier.