Commodities are raw materials that form the foundation of global trade, from the oil that powers economies to the wheat that feeds populations. This guide provides a comprehensive introduction to understanding commodity price movements, and the various ways investors gain exposure to these markets.
Commodities represent a distinct asset class with unique characteristics, from their standardised nature enabling exchange trading, to their sensitivity to real-world supply and demand dynamics.
This guide will outline the key factors to consider when considering which commodities to invest in, and the pros and cons of the different financial instruments which offer exposure to the commodity markets.
What Are Commodities?
Commodities are standardised raw materials or primary agricultural products used in economic activity that can be bought and sold on global exchanges. Each unit of a commodity is essentially identical to another unit of the same type and grade, making them interchangeable.
Features of Commodity Markets
The concept of standardisation is fundamental to commodity markets. When crude oil is traded, for instance, specific benchmarks like Brent or WTI define exact quality specifications. This means one barrel of Brent crude is functionally identical to another barrel of Brent crude, regardless of its specific origin.
This interchangeability allows commodities to be traded efficiently on
It’s important to understand that while physical commodities exist, in the form of actual barrels of oil or tonnes of copper, most investors gain exposure through financial instruments rather than taking physical delivery. These financial products track commodity prices without requiring investors to store or handle the physical materials themselves.
Types of Commodities
Commodities are typically categorised into three main groups: energy, metals, and agricultural products. Each category responds to different economic forces and market dynamics.
Understanding the distinction between “hard” and “soft” commodities helps clarify these categories.
- Hard commodities are mined or extracted (oil, gold, copper)
- Soft commodities are grown or reared (wheat, coffee, livestock)
The distinct characteristics of how hard and soft commodities are sourced and used also affects how their prices behave.
- Hard commodities prices are heavily influenced by industrial demand and extraction costs
- Soft commodities are more sensitive to weather patterns and growing conditions
The table below outlines the way in which different types of commodities are typically categorised on the exchanges on which they are traded.
| Category | Examples | Common Price Drivers |
|---|---|---|
| Energy | Crude oil, natural gas, gasoline | Geopolitical events, industrial demand, inventory levels |
| Metals | Gold, silver, copper, platinum | Economic growth, currency movements, industrial usage |
| Agricultural | Wheat, corn, coffee, sugar, cotton | Weather conditions, harvest yields, global food demand |
These varying factors relevant to each market mean commodity categories often move independently of each other.
Commodity Case Study: A Cold Snap in North America
An abnormally cold winter in North America might increase demand for, and the prices of, energy commodities such as oil and natural gas. The same weather event could result in damage to orange crops in southern regions, resulting in restricted supply and higher prices.
Why Investors Seek Commodity Exposure
Investors typically seek commodity exposure for three main reasons: expressing a price view, hedging against risks, or diversifying their portfolios. Each approach involves different considerations.
- Speculation involves investors taking directional views on commodity prices without underlying business exposure to protect.
- Hedging. Taking positions in commodities based on the view that their price moves may be
uncorrelated to potential falls in value of other assets held in a portfolio. - Diversification involves developing a portfolio with exposure to different types of asset groups, including commodities, and has the potential to balance out overall performance and result in aggregate returns being less volatile.
Tip: During certain market conditions, commodities may move more closely with other asset classes than historical patterns might suggest.
Ways Investors Access Commodity Markets
Investors can access commodity price movements through several routes, including
Commodity CFDs
CFDs (Contracts for Difference) provide direct price exposure to commodities through derivative contracts.
These instruments involve leverage, which magnifies both potential gains and losses. Trades involve a
Commodity ETFs
Commodity ETFs (Exchange Traded Funds) offer a different approach, typically holding either futures contracts, physical commodities, or a basket of commodity-related assets.
These funds aim to track commodity prices but may experience “tracking difference”—where the fund’s performance differs from the underlying commodity due to management fees and the mechanics of futures rolling.
Commodity Stocks
Commodity-linked equities, such as oil producers such as Shell (SHEL.L), or mining companies such as BHP (BHP.L) provide indirect exposure. The extent to which the stock price is correlated to the underlying commodity will vary from company to company and over time.
The characteristics of these instruments which are commonly used to trade commodities are outlined in the table below.
| Access Route | What it tracks | What is held/owned | Common cost types | Key risk notes |
|---|---|---|---|---|
| CFDs | Direct commodity price | Derivative contract | Spreads, financing fees | Leverage magnifies gains/losses |
| Commodity ETFs | Commodity or index prices | Futures/physical assets/stocks | Management fees | Tracking difference possible |
| Commodity-linked equities | Company share prices | Company shares | Brokerage fees | Business-specific risks |
Tip: An oil company stock price might fall even as oil prices rise if it reports company-specific operational problems.
What Drives Commodity Prices?
Commodity prices move based on the fundamental forces of supply and demand. Factors which might have an influence include inventory levels, weather events, geopolitical developments, and macroeconomic conditions.
Understanding these drivers helps explain price movements, though their relative importance varies by commodity and time period.
Inventories act as a buffer; low oil inventories for example, might amplify price reactions to supply disruptions.- Weather affects agricultural commodities dramatically. Drought conditions in major wheat-producing regions can trigger significant price movements.
- Geopolitical events can cause
supply shocks , such as conflicts affecting oil-producing regions.
Tip: Different commodities respond to different price drivers and in different ways at different times.
- Currency moves can also impact commodity prices. Since many commodities are priced in US dollars, when the dollar strengthens, commodities become more expensive in other currencies, potentially reducing demand.
- Economic growth rates influence industrial commodity demand, rapid growth typically increases demand for energy and metals.
- Inflation levels can influence commodity prices as many investors consider commodities a hedge against inflation and may find investing in commodities more attractive in a high-inflation environment.
Final thoughts
Understanding commodities requires grasping both their role as standardised raw materials which form the cornerstone of economic activity and the various financial instruments that provide price exposure without physical ownership.
Variables such as weather events, geopolitics, and macroeconomic factors create the price volatility that characterises the commodity markets. The situation is given more nuance by these factors affecting different commodities in different ways and having varying influence over different timespans.
The ways to gain exposure to commodities also have their pros and cons. Each approach carries different cost structures, risk profiles, and degrees of correlation to underlying commodity prices.
Visit the eToro Academy to learn more about commodity investing.
FAQs
- What’s the difference between commodities and futures?
-
Commodities are the actual raw materials like oil or wheat, while futures are financial contracts some investors use to buy or sell a specific amount of a commodity at a predetermined price on a future date. Most commodity trading occurs through futures contracts rather than physical commodity transactions. Futures provide price exposure without requiring physical storage or delivery.
- Who invests in commodities?
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Speculators, or retail investors, make up a large percentage of commodity investors. In some markets, the total size of speculative trades can be greater in size than positions taken by commercial firms trading futures for business reasons. Often, the greater the number of speculators in a market, the higher the price volatility.
- How does commodity trading differ from stock trading?
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One important difference between these two markets is the nature of the factors which drive price changes. The price of raw materials might be influenced by macroeconomic cycles, geopolitical events, or even the weather. Stock prices are to a larger extent based on how investors predict a particular company, or the stock market in general will perform.
- Can commodities be used to hedge against inflation?
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Yes, this is a common characteristic of commodity markets. Gold in particular has a strong reputation for being a hedge against inflation but other commodities also come into scope.
- What is a supply shock?
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A supply shock occurs when there’s a sudden, unexpected disruption to the normal supply of a commodity. Examples include natural disasters affecting agricultural regions, geopolitical conflicts disrupting oil production, or mine closures reducing metal output. Supply shocks typically cause price volatility as markets adjust to the new supply-demand balance.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments.
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This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments.This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
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