Commodities For Beginners

For a Wall Street outsider understanding the jargon can be difficult, confusing and intimidating. What is a commodity? What are stocks, bonds? What does P E Ratios mean? And, what do the other terms I see every day in the financial news mean?

Many people when ask, "What is a commodity?" have only a vague idea. They could not give a specific answer. They probably know commodity are trade like stocks and that people can make a lot of money with them. That's about all most people know.

So, what exactly is a commodity?

When talking about a commodity, we are talking about things like oil, electricity and lumber. Agricultural products like grains, meats, fibers (cotton for example) are commodities.

A few other common commodities are wheat, orange juice and pork bellies (the belly-part of a pig that bacon is made from). Recently Internet bandwidth and some computer chips have been traded like commodities.

There are a few characteristics that commodities have in common. Commodities are grown, raised, harvested or mined by more than one entity. The quality of the commodity is, essentially, the same regardless of the source. for example, a gallon of oil from Russia is the same as on from Argentina.

Sound confusing? It's not, really. A product, clothing for example, isn't a commodity because people can recognize clothing company A's clothes from clothing company B's clothes.

The economic term for this is product differentiation. If you can tell two products apart, company A's from company B's, it's not a commodity.

Historically, commodities were priced based on their marginal cost. The cost to take the oil from the ground put it in a barrel and ship its destination.

Today many other things or factored into the price of a commodity. Things like global availability, efficiency of transportation, value of currency and expected demand all affect the price of a commodity.

In the early 1980's there was a movie about a group of men who tried to make big money on the commodities market. I think it was called "Trading Places." It showed how quickly large amounts of money can be made and lost trading commodities.

"Trading Places" is a fun movie with an interesting plot. I suggest that anyone interested in commodities watch i-at least twice. Once to enjoy the story and once to get a feel about how the commodity market works.

Everyone should understanding a little about what goes on in the financial world. With just a little effort, the next time you hear someone mention commodities you'll know exactly what their talking about.