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A physical commodity is an actual product that is sold or traded as a commodity, either in the futures market or spot market. Commonly, physical commodities are things like oil, grain, and precious metals. These products get a great deal of attention from investors, who often buy them as an investment, and then sell them in the futures market before the contract matures and delivery must be accepted.
In order to be considered a physical commodity, a number of conditions must be met. First, there must be many different producers and the market must be relatively easy to enter. Next, there must be an end market for that physical commodity. Often, the commodity is a raw material that a processor will add value to before it reaches the final user, though this is not always the case.
Many physical commodities do require some additional work in order to be suitable for an end user, but others do not. Typically, as one example, gold must be fashioned into some type of jewelry or other product in order to have consumer value. Grain, such as field corn, may be fed to livestock while in a raw form, or may be processed for human consumption. Those who buy the raw materials are usually bulk buyers who have specialized equipment or needs.
Most people who buy a contract for a physical commodity never intend on taking possession of the actual product. Rather, those individuals buy physical commodities when they are priced low, and try to sell when the market is higher. Often, this type of investment comes with substantial risk. Commodity prices may change higher or lower due to conditions such as the weather, pests and disease, which are sometimes hard to predict.
Businesses who do want to actually use the physical commodity in question also watch the futures market, hoping to protect themselves against wide price fluctuations. For example, heating oil companies may buy heating oil contracts in the summer, when prices are typically lower, but not take delivery until the following winter. Of course, if there is a mild winter or suppliers flood the market, they could discover they bought at the wrong time.
If the person holding a contract on a physical commodity has no use for the product, then eventually that person is forced to sell, or take delivery. Therefore, some investors may be caught in a situation where they must get rid of a contract, take delivery, or pay for storage of a product for which they have no need. If that situation develops, the investor may sell at a loss simply to avoid having to take delivery of the product.