Commodity markets are crucial to the global economy because they determine the price of all the raw materials that go into the manufacturing of finished goods, but also their refining and distribution. Every single product you consume, the fuel used to heat and cool your home, and the fuel used to power whatever vehicle you may own, all start out as raw materials traded on the global commodity markets.
Generally speaking, commodities are divided into the two categories of hard and soft:
Hard commodities are the raw materials that are usually mined from the earth, such as oil, gas, precious metals like gold and silver, and industrial metals like iron and copper.
Soft commodities tend to be agricultural products, or other materials that are cultivated. As you can see, there’s not much that you come into contact with throughout your day that doesn’t have a commodity market component. As such, this is an incredibly tradable asset class that provides exposure to all the materials that keep the global economy going.
Thanks to the US dollar’s reserve currency status, commodities are priced in US dollars on the global markets, this means that a strong dollar makes commodities cheaper, and a weak dollar makes commodities more expensive. Perhaps central to all the commodity complex, is energy.
This is because it’s the one commodity that all other commodities require in their production, but also their transportation. So, the cost of oil has direct consequences for every other commodity on the planet. This also goes for food, as energy is required in farming, as well as food production, packaging, and distribution.
Gold, on the other hand, is almost the opposite of oil in that it doesn’t have a massive number of uses in industry, only around 11% of all the gold mined finds its way into industry. As a rare and highly valued element, gold has historically served as a store of value going all the way back to the ancient world.
One upon a time, central bank reserves were backed by gold and silver, but this hasn’t been the case since the Nixon Shock of 1971, when US President Nixon removed the US dollar’s convertibility to gold. Today, gold is traded as a safe haven, investors flock to it at times when confidence is low in the prospects of the global economy, as well as when inflationary fears surface. The fact that the US dollar is also used as a safe haven, sometimes complicates this relationship, so it’s often useful to chart gold against currencies other than the US dollar when wanting to find out how it has truly performed.