Module 45.1 LOS 45.a: Characteristics of Commodity Sectors

Well known commodity sectors are energy, industrial metals, grains, livestock, precious metals and softs. They are all driven by supply and demand factors, but the factors themselves differ by sector.

The energy sector comprises crude oil, natural gas, and refined products.

Crude oil from different regions has different characteristics. Light oil (low viscosity) and sweet oil (low sulfur content) are less costly to refine and, therefore, sell at a premium relative to heavier or higher sulfur crude oils. Crude oil can be stored indefinitely by keeping it in the ground and is also stored in tanks and aboard tanker ships. Many countries store large amounts of crude oil as strategic reserves.

Demand for industrial metals is primarily tied to GDP growth and business cycles because these metals are used extensively in construction and manufacturing. Storage of metals is not costly.

Grains are grown over an annual cycle and stored, although multiple crops in a single year are possible in some areas. The risks to grain supply are the usual: droughts, hail, floods, pests, diseases, changes in climate, and so on. It would be difficult to overstate the importance of grains in feeding the world’s population, especially given the potential for political instability when grain stocks are insufficient.

Precious metals are used in electronics and for jewelry and can be stored indefinitely. Gold has long been used as a store of value and has provided a hedge against the inflation risk of holding currency. Jewelry demand is high where wealth is being accumulated. Industrial demand for precious metals is sensitive to business cycles.

Livestock supply depends on the price of grain, which is the primary input in its production. When increasing grain prices increase the cost of feeding livestock, the rate of slaughter also increases, which leads to a decrease in price. Such a drawdown in population can result in subsequent increases in price over time. Weather can affect the production of some animals. Disease is a source of significant risk to livestock producers, and some diseases have had a large impact on market prices.

Softs refers to cotton, coffee, sugar, and cocoa, which are all grown in the warmer climates of the lower latitudes. Just as with grains, weather is the primary factor in determining production and price, but disease is a significant risk as well. Demand increases with increases in incomes in developing economies but is dependent on consumer tastes as well.

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