Commodities – what are they and how to trade them

What are commodities?

At their core, commodities are basic goods used in commerce that are interchangeable with other goods of the same type. Whether it's a barrel of crude oil, a bushel of corn, or an ounce of gold, each unit is essentially identical, regardless of who produces it. That makes them easy to trade on a global scale.

Commodities fall into two main categories: hard commodities and soft commodities.

Types of commodities

Hard commodities

Hard commodities are natural resources that are mined or extracted. These include:

• Energy: Crude oil, natural gas, heating oil, and gasoline
• Metals: Gold, silver, platinum, copper, and aluminum

Hard commodities tend to be highly sensitive to geopolitical events, supply chain disruptions, and economic cycles. For example, oil prices often surge during global tensions that affect oil-producing nations.

Soft commodities

Soft commodities are agricultural products or livestock that are grown or raised rather than mined. Examples include:

• Grains: Corn, wheat, soybeans
• Food and fiber: Coffee, sugar, cocoa, cotton
• Livestock: Cattle and hogs

Because soft commodities are affected by seasonal cycles, weather, and disease, their prices can be especially volatile.

How to trade commodities

There are several ways to trade commodities, depending on your goals, experience, and risk tolerance. The most common methods are through futures, spot markets, and options.

Trading commodity futures

A futures contract is a legal agreement to buy or sell a specific quantity of a commodity at a predetermined price on a set future date. These contracts are traded on regulated exchanges like the Chicago Mercantile Exchange (CME).

Benefits:

• High liquidity and transparency
• Potential for leverage
• Standardised contracts

Risks:

• High volatility
• Requires margin and can lead to losses exceeding initial investment
• Not ideal for passive investors
• Leveraged products can be risky and are not suitable for all investors, increased leverage increases risk.

Trading commodity spot prices

The spot market involves buying or selling commodities for immediate delivery at current prices. Spot trading is more common in physical markets, but some online brokers offer instruments that mimic spot price movements.

Benefits:

• Simple to understand
• Closely reflects current market prices

Risks:

• No leverage or hedging features
• Typically involves higher transaction costs

Trading commodity options

Options give the buyer the right, but not the obligation, to buy or sell a commodity at a specific price before a certain date. They’re often used as a risk management tool in futures trading.

Benefits:

• Can cap potential losses
• Useful for hedging or speculation

Risks:

• Time decay can erode value quickly
• More complex than futures or spot trading
• Can lose total premium paid

Investing in commodities

You don’t have to trade actively to get exposure to commodities. There are several investment strategies that range from owning the actual asset to investing through financial instruments.

Physical ownership

This means buying and storing the actual commodity, like gold bars, silver coins, or oil barrels.

Benefits:

• Tangible asset with intrinsic value
• Not tied to financial markets

Risks:

• Storage and insurance costs
• Illiquidity

Futures contracts

Investors can also buy futures contracts purely as an investment, rather than for physical delivery.

Benefits:

• Access to major commodities markets
• Potential for large returns

Risks:

• High risk and complexity
• Requires margin trading knowledge
• increased leverage increases risk

Individual securities

You can invest in commodity-related stocks – in other words, companies involved in mining, drilling, farming, or transporting commodities.

Examples:

• Oil majors (e.g., ExxonMobil)
• Agricultural firms (e.g., Archer Daniels Midland)
• Precious metals miners (e.g., Newmont Corporation)

Benefits:

• Easier to access via stock exchanges
• May pay dividends

Risks:

• Subject to company-specific risk
• Not a direct play on commodity prices

Mutual funds, ETFs, and ETNs

These pooled investment vehicles offer diversified exposure to commodities or commodity-producing sectors.

Benefits:

• Diversification
• Lower cost and easier access
• Some ETFs track specific commodities or commodity indexes

Risks:

• Management fees
• Indirect exposure (not always backed by physical commodities)

Alternative investments

Some investors access commodities via commodity pools, managed futures, or structured products.

Benefits:

• Professional management
• Tailored strategies

Risks:

• Higher fees
• Complexity and less transparency

Why invest in commodities?

Minimise portfolio volatility

Commodities often move independently from stocks and bonds, making them useful for diversification. When equities fall, commodities like gold or oil can sometimes rise.

Hedge against inflation

Commodities tend to perform well during inflationary periods, since their prices usually increase as the cost of goods rises.

Physical assets

Unlike stocks or bonds, many commodities are physical goods with real-world use and scarcity, adding a level of intrinsic value to your investment.

Common commodities terminology

• Spot price: The current market price for immediate delivery
• Futures contract: A standardised agreement to buy/sell a commodity at a future date
• Options: Contracts giving the right, but not obligation, to buy/sell a commodity
• Margin: The collateral required to open a leveraged trade
• Roll yield: The return generated when a futures contract is rolled forward
• Backwardation: When futures prices are lower than the spot price
• Contango: When futures prices are higher than the spot price

The role of commodities in your portfolio

Commodities can be a powerful tool in a diversified investment strategy. While they may not produce income like dividend-paying stocks or bonds, they provide exposure to global demand, supply constraints, and inflation trends, making them especially useful during uncertain economic times.

Disclaimer: FOREX.com Australia is a Contracts for Difference (CFD) issuer and our products are traded off exchange. We do not offer direct ownership of the product and exposure to commodities is available solely via Contracts for Difference (CFDs). This material relates to the underlying asset and does not constitute a recommendation or offer to trade.