Hard vs Soft Commodities
Learn more about the different types of commodities
What are Hard vs Soft Commodities?
Before we discuss hard vs soft commodities, let us discuss what a commodity is. The term commodity is an umbrella term for economic goods that are fungible, i.e., can be freely brought and sold. The commodities produced by a country include the raw materials and/or primary agricultural products mined, grown, or in any way created within the country. They depend largely on the endowment of the country (natural resources available and the ability to extract the same).
Commodities can be freely brought, sold, and traded on physical or virtual marketplaces known as commodity markets. The price-setting mechanism in commodity markets is controlled by supply and demand factors, which make the commodities particularly vulnerable to volatility due to macroeconomic factors.
Summary
- The term commodity is an umbrella term for economic goods that are fungible, i.e., can be freely brought and sold.
- Commodities can be freely brought, sold, and traded on physical or virtual marketplaces known as commodity markets.
- Examples of hard commodities include natural resources, such as metal ores, oil reserves, etc. Examples of soft commodities include products that must be grown and cared for, such as agricultural produce and livestock.
Hard Commodities
Hard commodities consist of natural resources, such as metal ores, oil reserves, etc. They form the basis of the economic health of a country, and global demand for such resources can be monitored to gauge the future stability of an economy. It is because the supply and demand for the products are largely predictable due to their fixed nature.
For example, Venezuela, a heavy oil export-dependent country, was majorly hit when oil prices slid in September 2015. The global market is largely dominated by oil, natural gas, and gold. The South American country consequently experienced an economic and political crisis, which was marked by hyperinflation and a failed coup.
Gold is extremely valuable, especially during times of a slowdown as it is used by investors as an inflation hedge or a wealth-preservation asset. Other products include silver, steel, copper, iron, aluminum, which also make up for a large part of government revenue.
Soft Commodities
Soft commodities consist of products that must be grown and cared for, such as agricultural produce, livestock, and related primary products. They are more volatile as their price-setting mechanism relies on multiple external factors. The production of such goods depends largely on the environmental conditions of a country. It is one reason why agrarian economies suffer more due to events such as climate change.
Moreover, bumper crops can depress prices be creating a surplus in the market. Owing to such a vulnerability, countries such as India prefer not to be export-dependent with primary agricultural goods. However, it is not the case for countries that trade exclusively in exotic produce, such as avocado-producing Columbia or major cocoa beans exporter Ghana. The goods can only be grown in specific environmental conditions (soil, humidity, temperature), which gives producers a monopoly over the pricing of these products.
Commodity Trading
There are several indirect ways to invest in hard vs soft commodities. One can invest in mutual funds or Exchange Traded Funds (ETFs) that focus primarily on companies involved in commodity production, processing, or distribution. Such funds pool in investors’ money to make huge capital investments.
The most popular way of investing in the commodities market is by purchasing futures contracts. The contracts obligate holders to buy or sell a specified product at a set price and future date. The markets are regulated by commodities exchanges, which are the physical epicenters for trading in such investment vehicles.
More broadly, commodities exchanges are legal entities that enforce rules for trading in the aforementioned securities. The largest commodity exchange in the U.S. is the Chicago Mercantile Exchange (CME) Group, which handled contracts worth trillions of dollars annually. Other prominent exchanges include Intercontinental Exchange (ICE) in Europe, and Shanghai Futures Exchange in Asia.
More Resources
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. Through financial modeling courses, training, and exercises, anyone in the world can become a great analyst. To keep advancing your career, the additional CFI resources below will be useful:
