A commodity is basically any good available naturally in large volumes and doesn’t have a unique selling proposition. It has constant demand throughout the year and can be easily sold and traded worldwide at a relatively uniform price. The term “commodity” encompasses a wide array of goods, including coffee beans, gold, rubber, water and fuel. Ice cream, fruit juices, mobile phones, etc., are not commodities. Though natural, diamonds are not considered commodities for their varying quality.
Same-grade commodities are fungible, meaning they can be replaced by another identical good. Regardless of who sells gold, water or copper, there won’t be significant differences in the good’s basic composition and quality. In other words, there is very minimal scope for product differentiation with commodities. That said, quite a few sellers try to differentiate certain commodities such as gold by branding and heavily advertising them.
Commodities can be sold individually or used as raw materials to manufacture allied goods. For instance, gold can be sold as jewelry, gold coins, etc. or utilized in watches, electronic items, etc. The purchase and sale of commodities is called commodity trading. Such trading could be carried out in the cash or spot market where commodities are sold and bought for immediate delivery, or in futures market where commodities-based financial instruments are traded.
Investment and Pricing
Like stocks, real estate and bonds, a commodity is also an asset class and traded in the futures market. To be deemed fit for futures trading, a commodity should meet certain standards, referred to as basis grade. Futures trading commodities are typically categorized as soft commodities (coffee, wheat, sugar, cocoa); and hard commodities (rubber, gold and oil).
Commodities do not have set prices and their market value varies with fluctuating demand and supply. A futures market helps lock-in prices of certain commodities or indulge in speculative trading for a profit. People usually buy a commodity based on its price, which explains why commodity selling is predominantly a low-margin business, with a few exceptions such as gold and oil. If a seller tries to sell a commodity at a price above market value, its sales would fall drastically.
A Commodity is Not Forever
Newer items are added to the “commodity” list as and when needed. Similarly, some natural goods could lose their “commodity” status for specific reasons. If a natural product varies in quality across regions, isn’t available in sufficiently high volumes, or is not traded uniformly throughout the world, it is not a commodity. Since trading status and volumes could change with time, some commodities may not be considered a “commodity” anymore.
Similarly, an item could get commoditized with time if its market expands, price goes down and the masses embrace it. For instance, the market for solar and wind power is developing and when the respective energy forms grow beyond being an alternative source, they may get recognized as commodities. With smartphones becoming ubiquitous and their features and capabilities increasingly getting common across manufacturers and carriers, they could also become commodities (in the not-so-distant future).