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Commodities and raw materials

Commodities are fungible goods such as energy products, metals and agricultural products. Physical ownership, spot prices, futures, options and ETPs provide different exposures and do not produce the same return.

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In plain language — “Getting exposure to oil” may mean buying a future, an ETP share, a CFD or shares in a producer. None of these automatically amounts to owning barrels of oil.

Commodities are relatively fungible goods traded according to defined quality, quantity, location and timing. In financial language, they normally include:

  • energy;
  • precious and industrial metals;
  • agricultural products;
  • livestock and livestock products;
  • other categories defined by markets or regulation.

The legal definition may be broader than the ordinary meaning of “raw material.” Before analysing price, specify which good, which grade, which location, which expiry and which instrument.

Seven exposures that are not equivalent

Exposure What you hold Distinctive issues
Physical good ownership and custody of the material quality, insurance, storage, transport
Spot
 prompt transaction under a market specification delivery, location, availability
Future
 standardized contract for a quantity and expiry margin, expiry, delivery or cash settlement
Option
 conditional right/obligation linked to the underlying premium, strike, time, volatility
ETP/ETC/fund share or security implementing an exposure strategy structure, futures used, collateral, costs
CFD
 OTC contract with the provider counterparty, financing, pricing rules
Producer's stock ownership interest in a company management, costs, debt, jurisdiction, reserves

A mining company remains a stock: the metal price is only one of its drivers. An ETP may hold physical commodities, futures or other assets. The product name is no substitute for the prospectus.

Spot, futures and specifications

A spot price must refer to a particular quality and location. For physical commodities, transport, storage and insurance costs, as well as availability, can produce different prices at the same time.

A future specifies:

  • the underlying and quality standard;
  • quantity per contract;
  • delivery months;
  • location and delivery procedure or cash settlement;
  • tick, limits and margin rules.

Many financial positions are closed or transferred before delivery, but the contractual possibility of delivery remains part of price formation. Anyone holding a contract towards expiry must know the rules and must not assume that the broker will always close it without consequences.

Futures curve, basis and roll

Different expiries exist simultaneously for the same commodity. Their sequence forms the futures curve.

  • contango: more distant expiries trade above nearby expiries under the specified comparison;
  • backwardation: distant expiries trade below nearby expiries;
  • basis: the difference between a futures price and a defined spot or cash reference, under a stated sign convention.

These relationships reflect availability, demand, carrying costs, storage, financing, convenience yield and specific conditions. They are not universal signals that prices will rise or fall.

A fund that maintains exposure through futures must replace expiring contracts through a roll. Roll yield depends on the stated definition and is not automatically the observed differential between two contracts. A futures-based ETP can therefore diverge substantially from the cash price even when there is no operational error.

Hedger and speculator

Derivative markets enable risk transfer:

  • producers and consumers can hedge future prices;
  • processors and distributors can manage margins and inventories;
  • investors and traders can assume risk in pursuit of a return;
  • arbitrageurs can connect expiries, locations and instruments.

The same transaction does not have the same meaning for everyone. A producer short futures may reduce the economic risk of a commodity it owns; a trader who is short without physical exposure instead assumes directional risk.

What moves prices

  • production, harvests and extraction capacity;
  • inventories and availability at delivery locations;
  • industrial and consumer demand;
  • weather, seasonality and biological shocks;
  • transport, infrastructure and storage;
  • geopolitics, sanctions and trade policy;
  • rates, quote currency and financial conditions;
  • technological substitution and regulation;
  • position along the curve and delivery constraints.

The IMF Primary Commodity Prices database provides monthly series and indices for analytical purposes. It is not a real-time executable feed and does not represent every local grade.

Main risks

  • price — demand and supply shocks can be rapid;
  • leverage — futures margin does not cap the loss;
  • basis — the hedge and its reference may not move together;
  • roll — the curve changes the return of continuous strategies;
  • delivery — obligations, windows and costs can become material;
  • liquidity — it varies across commodities and expiries;
  • limits and suspensions — market rules may constrain execution;
  • ETP structure — credit, collateral, derivatives and costs;
  • currency — many benchmarks are quoted in dollars;
  • concentration — a single commodity does not guarantee an inflation hedge or diversification in every regime.

Common mistake — Comparing the return of a futures-based ETP with the spot chart and calling the entire difference “tracking error.” The curve, roll, collateral, costs and trading hours are part of the vehicle.

Checklist

  1. Which commodity, grade, unit and location?
  2. Physical, spot, future, option, ETP, stock or CFD?
  3. Which expiry and which settlement procedure?
  4. What are the multiplier and notional amount?
  5. What does the curve look like and how does the roll work?
  6. Which prices does the product use as its benchmark?
  7. Are there issuer, collateral or securities-lending risks?
  8. What are the spreads, limits, costs and liquidation conditions?

Sources

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