You've probably heard talk about commodities in the business media, and you might be able to think of some examples of commodities -- but how much do you actually know about them?
Commodities often describe the markets used to trade some of the world's most important goods. But there's much more to know about this market that's worth hundreds of trillions of dollars. In this look at the topic, we'll go over the definition of commodities, what you should understand about commodities, and why they matter to you as an investor and as a consumer.
What does "commodities" mean?
Commodities are undifferentiated products, distinct from branded goods like cars or smartphones that are identified by the company that makes them. They tend to be naturally occurring materials like oil and silver or crops like corn, soybeans, and cotton.
Like stocks, commodities trade on exchanges with prices determined by the open market. Prices can be affected by weather, war, politics, trade regulations, demand, the strength of the global economy, or disruptive events like the COVID-19 pandemic.
Why do commodities matter?
Whether you're an investor or a consumer, commodities have a direct impact on your pocketbook.
Even if you don't drive, the price of oil is absorbed into most goods you purchase because the trucks and freight liners that carry them run on diesel and other oil-based fuels. Commodities also play a major role at the supermarket. Almost every kind of food, whether corn, beef, dairy, or fruit, starts out as a commodity before being processed into a branded product for grocery store shelves.
The global rise in consumer prices that began in 2021 highlighted just how sensitive everyday costs are to commodity prices. Both food and energy rose sharply due to the war in Ukraine, the expansion of the global money supply during the pandemic, and a rebound in consumer demand as the pandemic receded.
How do commodities affect investors?
Commodities are distinct from stocks in one critical way: there is no competitive advantage a commodity can occupy, since they aren't products or businesses controlled by a single entity. Successful investing in commodities like crude oil comes down largely to market timing or forecasting price spikes driven by events like geopolitical crises or major weather disruptions.
If you invest in stocks, you may be better off favoring companies that avoid commoditization. Most successful branded businesses use marketing and product differentiation to convince consumers their products are unique, which protects their margins regardless of commodity price swings.
Coca-Cola (KO +0.90%) is a good example. It competes with many other beverages, but a large part of its success comes from distinguishing itself through brand, packaging, flavor, and a global distribution network. Apple faces competition in smartphones and laptops but generates strong profits by differentiating through its brand, operating system, chip design, and ecosystem. Neither company's fate is tied to the price of a raw material.
Commodity companies like oil producers, by contrast, don't control the prices they receive. That makes them subject to the uncertainties of the commodity market and recurring boom-and-bust cycles.
What's a good example of a commodity?
The banana is a useful illustration of how hard it is to brand a commodity. The industry is dominated by a handful of companies including Chiquita, Dole, and Del Monte, all of which put branded stickers on their fruit. But consumers largely ignore the branding and treat the banana as interchangeable regardless of who grew it.
Commodity prices tend to rise in bull markets and fall in bear markets, since many are sensitive to the overall economy. If you're interested in investing in commodities, keep an eye on the global economy and factors like geopolitics that can affect supply and demand.
Related investing topics
About the Author
