What are physical commodities?
Physical commodities are a fundamental part of all our lives. Although it might not seem as is, they make up a great proportion of the daily purchases we make. From sunflower oil to lithium, physical commodities are traded and used every day. We depend heavily on them in our day-to-day lives. For the electricity we use, the homes we live in, the food we eat, the clothes we wear, or the transport we rely on. It is estimated that 10 trillion USD worth of commodities is traded annually around the world.
Commodities overall are divided into 2 types in their nature. Primary commodities are extracted or captured directly from natural resources. They come from mines, wells, or farms. Secondary commodities are produced from primary commodities in order to satisfy the global needs of the markets such as the refining process of crude oil to make gasoline. The example below, shows energy-based commodities as primary and secondary;
Aside from that, physical commodities can be divided into 4 broad categories, being;
Agricultural commodities are self-explanatory. They include grains and oilseeds such as corn, wheat, rice and soybean. In addition, the agricultural category includes dairy products (milk, whey, butter), textiles (cotton, wool), lumber, and other soft commodities such as cocoa, coffee, and sugar.
This category includes any and all physical tradable commodities that can be used in order to provide energy. Crude oil, natural gas, and its liquids, coal, and renewables are considered primary energy commodities. They can be processed into different products and fuels which are considered secondary energy commodities. These include bitumen, gasoline biodiesel, and LNG. Energy commodities provide fuels to run motors, appliances, and even space rockets. They take a vital part in our overall functioning world
Metals and Minerals
Metallic commodities are generally processed mined ores. The most common ones are copper, steel, gold, aluminum and silver. Metals are mainly divided into 2 sub-categories which are industrial and precious metals.
Industrial metals’ major uses are industrial and are abundantly available. They have qualities such as high electricity or heat conductivity and are very common in our daily lives. Lead, copper, tin aluminum, and zinc are the most common examples. Precious metals on the other hand are not abundant and hard to extract. Thus, they are priced relatively higher in the markets. They are considered by many investors as a safety net for capital and gains. Below is the global major metal production from the year 2018 and their main industrial uses;
Livestock and Meat
Commodities of this category are for the purpose of slaughter or meat consumption. Cattle is a great example because it can be traded as live cattle or feeder cattle. Live cattle are mature enough to be slaughtered and feeder cattle would have to be fed and grown before it can be slaughtered.
What is physical commodity trading?
Commodity trading, in short, is buying and selling of raw materials. This process is in fact the foundation of our primary global economy. It can be separated into 2 sections, physical trading and paper trading. While physical trading requires a rather long process often plagued by bureaucracy, paper trading focuses on the financials of the trading process, usually through brokerages. Paper trading has a very direct impact on the physical market, and often occurs in the form of futures contracts. This type of trading provides liquidity to the entire commodities market and plays an important role in gauging current commodity prices.
Physical trading of commodities provides the logistics for the commodity to get from point A to point B. However financial commodity trading is based on a settlement in cash depending on the terms of the deal.
The current international trading of commodities such as fuels, minerals, and food is a very significant building block of globalization. Trade has great effects on political relationships all over the world. One recent example that we can give would be the aftermath of the Russia Ukraine dispute. As a deficiency in energy supply arose, The United States is looking for alternative resources. The topics of recognition of the Venezuelan government and lifting the sanctions on Iran after over 40 years are on the table. Many of the current international relations were built on trade and many are sustained with the support of trade.
What is the commodity trade life cycle?
The lifecycle of physical commodity trade is the activity of exchanges and logistics. From the point of the order being placed until the moment of delivery is called the trade lifecycle. Firstly, any commodity needs to be produced or sourced at the very start of a trade. The second step would be the purchase of the goods with a contract where trade financing may come into play. Next comes the logistics, transportation of the goods to the end location is very important because it is perhaps the step with the highest risk of issues coming up. Usually, ships are used for the transportation of commodities in containers, chartering ships is also an option if the quantity is large enough. The next step is storing the goods, if the trader is willing to sell it at a later date as he believes the commodity is underpriced, they must invest in storage costs. If they believe the premium from the future date’s sale will be profitable considering all the expenses, then it is the right way to go. Another option is to process the given commodity. For example, while some traders may choose to process crude oil in a refinery into distillates, others may prefer to sell it in its raw form. Below you can see a supply chain representation of copper;
Throughout the lifecycle of physical commodity trading, there are many factors and aspects to be considered. Trade financing for example can create liquidity and ease the financial tightness of the company making the purchase or hedging risk through financial instruments such as options and futures.
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