Commodity prices are the costs associated with the purchase of any type of commodity. Some of the most common types of commodities see price changes throughout the day. Others remain a bit more steady. Pricing models are based on a standard unit of measurement recognized by the reporting agency. The most common pricing models focus on the weight of the commodity. Others focus on the number of items, such as the number of barrels of oil.
Understanding commodity pricing is very important. It tells the investor how much he or she is likely to pay for the purchase of investments in these areas. Moreover, it also provides direct information about supply and demand, risks to the market, and overall market conditions. Investors need to understand not only what the price is, but also what is currently affecting the value of those commodities within the market place. Once this is understood, investors can make better buying and selling decisions.
What Are Commodities?
Commodities can be any number of things. Generally, in order for a stock market or investor to consider a product as commodity, it must fit some general qualifications. In any textbook, you’ll see it defined by having specific properties, such as:
- More than one company must be selling or producing it. Generally, many companies are producing or selling it.
- Even with numerous companies producing the product, the overall quality and features remain the same from one to the next. There is no way to distinguish if the product came from company A or company B by simply looking at it, using it, or investing in it.
Again, there are many types of commodities. Some of the most common include oil, barley, wheat, gold, electricity, and lumber. Even orange juice is a type of commodity.
Traders trade commodities in the stock market on commodity exchanges. There are numerous facilities for this. The largest commodity exchanges include:
- the New York Mercantile Exchange (NYMEX),
- the Winnipeg Commodities Exchange (WCE) and
- the Chicago Mercantile Exchange.
What Is Important to Know About Commodity Prices?
Most commonly, producers sell commodities at a marginal cost of production. This indicates that the price is just slightly higher than the cost of producing the item. While this may be the most common definition of pricing for commodities, it is rarely the total cost. Other factors that affect the price, including the following.
- Supply and demand is the highest influencer of commodity pricing. When supply is low, prices rise. A good example of this is oil. As supply falls and demand continues to increase, the price of oil also increases.
- Economic factors – This often affects the ability of the buyer to make a purchase, which can influence pricing. It’s important to realize that economic conditions affect commodity pricing, even though traders often trade commodities as futures contracts and futures pricing.
- Wars and conflict – This can often affect pricing because any type of political unrest affects the availability of the product. Wars in Iraq, for example, pushed commodities from that region higher because of the risk that supply lines could be cut off.
- Weather – In crop-based commodities, like wheat, poor weather conditions that affect growth of the product impact the availability of the product, sending pricing higher.
As with any type of investment, investors must see the long term change in the commodity prices to know what steps to take. For example, if the buyer expects prices to rise, buying now allows the investor to see a significant increase in value. Making investments based on supply and demand movements is often the most common way to invest. Understanding the commodity markets is also critically important prior to making this type of investment.