What are commodities and securities?
Commodities are products that can be bought and sold in the market, such as raw materials, agricultural products, or even electricity. Some commodities, like electricity, do not have a specific physical form but are still traded based on supply and demand. What distinguishes commodities is that each unit has equivalent value and is interchangeable. For example, one ton of rice can be substituted for another ton of rice if they have the same quality and value.
Securities are tradable financial assets in the market, including stocks, bonds, investment funds, options, and recently cryptocurrencies (if classified as securities under legal regulations). Securities typically represent ownership rights in a company or organization, providing rights to share profits, voting rights in governance decisions, and risk sharing.
Companies and governments often issue securities to raise capital. However, with the rise of cryptocurrencies, many digital assets are now also viewed as securities, depending on the manner of issuance and other specific factors.
Although existing laws have not fully adapted to digital assets, under U.S. law, securities can be considered 'investment contracts.' This means that investors entering the market expect to profit primarily from the efforts of third parties, such as the issuers of the securities.
The ambiguity in this regulation has led to several lawsuits, such as Ripple with XRP or Telegram with the TON token. As of June 2023, the U.S. Securities and Exchange Commission (SEC) has classified at least 68 types of cryptocurrencies as securities, including well-known tokens like BNB, SOL (Solana), Cardano, MATIC (Polygon), The Sandbox, and several others.
The historical performance of commodities and securities
The distinction between commodities and securities in the legal aspect has developed over many decades, alongside the formation of derivative instruments and financial markets. Key legislation in the 20th century played a crucial role in establishing the regulatory oversight we see today.
For example, the Securities Act of 1933 and the Securities Exchange Act of 1934 established requirements for disclosures, registration processes, and anti-fraud measures in the issuance and trading of securities. These acts laid the foundation for the establishment of the U.S. Securities and Exchange Commission (SEC). Subsequently, the Commodity Futures Trading Commission (CFTC) was established in 1974 through the CFTC Act to regulate commodity derivatives and options markets in the U.S.
As new assets like cryptocurrencies emerge and are not easily classified into previous categories, regulators have expanded their understanding of existing laws to oversee these assets. For example, the SEC has classified some tokens as securities in the form of investment contracts (under the Howey test), while the CFTC has permitted Bitcoin futures products. This flexibility helps apply investor protection principles from the past to modern markets.
The continuous advancement of technology requires agencies like the SEC to constantly adjust reporting regulations, trading standards, custody requirements, and other regulations to maintain market transparency and stability as new products develop. This historical framework plays a crucial role in shaping current oversight methods for both commodities and securities.
The differences between commodities and securities
Despite some similarities in their characteristics, commodities and securities are two broad types of tradable assets with distinct features. Here is a comparison between commodities and securities:
Tangibility
Commodities are raw materials or basic goods that can be bought and sold. Some commodities represent ownership of a physical product, such as a bag of wheat or a barrel of crude oil. The commodities market reacts to changes in supply and demand in the global physical market. However, not all commodities are physical, tangible assets.
Meanwhile, securities represent financial abstractions — one cannot see stocks or bonds in physical form. However, securities provide a set of enforceable rights through legal contracts instead of physical characteristics. Stocks, bonds, and derivatives exist as recorded entries that allow for the transfer of ownership of expected profits, dividends, or asset appreciation.
Investing in commodity futures contracts provides temporary ownership of a certain quantity of commodities, while investing in a company's stock, such as an oil company, grants ownership of equity in that company, with benefits from profit-sharing or the company’s value growth.
Consumption and income flow
Commodities are products that can be used or transformed in industrial or commercial processes. For example, gold and silver can be crafted into jewelry, thereby changing their form and utility value.
In contrast, securities provide owners with periodic benefits such as dividends, coupons, principal payments, and potential profit-sharing. In the cryptocurrency industry, these benefits may come in the form of capital appreciation or airdrops.
Market volatility
The prices of commodities exhibit significant fluctuations and react to supply-demand imbalances, geopolitical risks affecting production, and changes in sentiment about inflation hedges. Unlike securities, commodities do not generate income-producing assets. Therefore, investors can only rely on price appreciation to profit.
Securities, particularly stocks, can also experience significant volatility, influenced by company performance, economic conditions, investor sentiment, and market factors. However, the factors affecting the volatility of securities differ from those of commodities. The value of a stock or fund is related to the performance of the underlying company, and price changes can result from economic developments or shifts in investor sentiment.
Liquidity
Commodities are primarily traded through futures contracts on centralized exchanges or through direct transactions between suppliers and commercial consumers. Securities are generally available on multiple exchanges, and pricing is almost continuous.
However, the liquidity of each asset type can vary significantly. Some commodities that are heavily traded, like oil and gold, can have liquidity comparable to blue-chip stocks, while less-traded commodities and small-cap securities may face limitations.
Additionally, commodity contracts often have lower trading volumes compared to blue-chip stocks, except for gold and oil futures. Their specificity means fewer market participants compared to stocks, affecting slippage when placing large buy or sell orders.
History shows that commodities often have a wider price fluctuation range than securities. While the commodity cycle witnesses significant price volatility over 5-10 years due to scarcity or new discoveries, securities exhibit stable growth linked to corporate profits. On the other hand, commodities can serve as crisis hedges, retaining value better when the stock market collapses.
Management outlook
Commodities and securities are overseen by different regulatory agencies. Some commodities are physical assets like agricultural products, metals, and energy, influenced by consumption characteristics and supply-demand factors. However, commodities also include intangible assets like electricity and carbon credits that affect supply and demand.
The primary regulatory agency for the commodity futures market in the U.S. is the Commodity Futures Trading Commission (CFTC). The CFTC oversees contracts such as futures, options, and swaps under the authority granted by the Commodity Exchange Act, focusing on issues like price manipulation, trading standards, and position limit enforcement.
Meanwhile, securities include financial assets such as stocks, bonds, and funds that represent ownership and rights to the underlying entity. However, the distinction between commodities and securities can sometimes blur, especially with the emergence of digital assets and cryptocurrencies. Some cryptocurrencies have been classified as securities by regulators, affecting legal oversight.
The Securities and Exchange Commission (SEC) oversees securities by enforcing extensive corporate financial reporting requirements to support investment decisions, maintaining comprehensive accounting standards, protecting against insider trading abuses, and supervising exchanges, brokerage firms, and agencies like the Financial Industry Regulatory Authority (FINRA).
Despite differences, agencies like the CFTC and SEC have complementary roles, bringing established investor protection principles to both traditional and modern markets under their oversight.
Globally, regulatory oversight of cryptocurrencies is stricter in developed areas, such as certain regions in Asia, Europe, and the U.S. This forces many cryptocurrency exchanges to cease servicing residents in some regions or implement Know Your Customer (KYC) requirements.
Position limits and reporting in the commodities market
To promote fair and orderly commodity trading, regulatory agencies enforce strict position limits and reporting requirements for market participants. Position limits dictate the number of futures contracts that a trader can hold for a specific commodity.
For example, an organization may have a position limit of holding a maximum of 20,000 corn futures contracts at one time. If the company exceeds this limit, it must apply for a waiver. However, such waivers are usually granted only under specific conditions, such as reasonable risk hedging, where futures positions offset risks in the physical market. The waiver application process is very stringent and requires detailed justification.
In relation to this, traders must regularly report their activities if they exceed certain volume thresholds, disclosing important data such as account identities, managed accounts, and buying or selling positions. Overall, strict position limits and trading reporting provide important transparency to detect prices and limit the potential for manipulation of commodity derivatives.
By limiting the power of large traders and requiring data provision, regulatory agencies achieve twofold goals of preventing distortions and monitoring activities with signs of unusual concentration. These protective measures ultimately reinforce trust in standard commodity prices, affecting many downstream consumer products.
Major securities regulations
Similar to position limits for commodities, the stock market also applies volume control mechanisms, disclosure regulations, and trading supervision to ensure fair access and prevent manipulation.
For example, the SEC's Regulation SHO restricts short selling of stocks during significant market downturns, known as 'circuit breakers.' This helps prevent exploitative downward price attacks. Additionally, insider trading regulations prohibit individuals with undisclosed company information from profiting or disclosing information to manipulate stock prices.
Another example is the SEC's Regulation Fair Disclosure, which requires companies to publicly disclose significant company events simultaneously rather than allowing insiders to access information beforehand. Securities issuers must also comply with stringent periodic reporting requirements, including audited financial statements and information about significant business developments, to ensure that all investors have equal information.
Additionally, to maintain orderly trading, stock exchanges implement automatic trading halting mechanisms for stocks whose prices rise or fall beyond specified thresholds within a 5-minute period. These 'limit up, limit down' bands temporarily halt trading for a short duration before resuming, aimed at regulating price volatility.
Through such regulations and overseeing self-regulatory organizations directly managing brokerage firms and securities exchanges, the SEC carries out its mission to build a transparent and fair U.S. securities market. This legal framework aims to facilitate investor access while ensuring a level playing field.
Investing in commodities vs. securities
Both forms of investment in commodities and securities have their own advantages and disadvantages. Each type of asset is suitable for different investment goals and strategies. While commodities are often seen as effective hedges against inflation, securities provide stable returns through the ability to accumulate profits over time.
Advantages of investing in commodities
Protection against inflation. Commodities like gold, oil, or precious metals have intrinsic value and limited supply, making them effective tools for protecting against inflation and currency devaluation. When the economy faces rising inflation or a weakening dollar, commodity prices often increase due to actual demand from industries, helping to preserve investors' asset values.
Portfolio diversification. One of the significant advantages of investing in commodities is the potential for portfolio diversification. Commodities such as metals (gold, silver), grains, and energy have no direct relationship with stock and bond markets, thus helping to mitigate risks during market volatility. Holding commodities in a portfolio allows investors to minimize the impact of declines in other financial assets.
Crisis resilience. During financial crises, commodities are often viewed as defensive assets. These items have physical properties and actual demand, making them more stable than financial assets like stocks. Therefore, during significant sell-offs in the stock market, commodities can be an effective asset preservation choice.
Advantages of investing in securities
Accumulating stable profits. Investing in securities, especially diversified stock indices, allows investors to achieve stable returns through the increasing profits of listed companies, dividends, and share buyback programs. Over time, dividends and stock value appreciation can generate a solid source of passive income. This is particularly beneficial for investors seeking to create regular income in the long term.
Balancing risk and return. Securities offer high-profit opportunities but also come with risks. However, according to studies and market history, securities tend to provide favorable risk-adjusted returns in the long run. While there may be temporary downturns, investing in securities under a long-term strategy typically yields superior returns compared to other assets like bonds or savings accounts.
Easy access. The stock market today is highly liquid and more accessible than ever. Investors can easily participate in the market through brokerage firms, investment funds, or low-cost passive management products. Financial advisory firms and online trading platforms also help investors make decisions and access investment opportunities without needing deep expertise.
Disadvantages of investing in commodities
High volatility. Commodity prices can be highly volatile in the short term due to various influencing factors such as supply disruptions, geopolitical events, changes in consumption demand, and the difficulty of quickly adjusting production. These factors make timing trades more challenging, increasing the risk of losses when trading at the wrong time.
Maintenance costs. When investing in physical commodities, investors incur additional costs such as storage, insurance, and transportation. These costs can significantly reduce the actual profits gained from the investment compared to other financial assets like securities, which do not have such maintenance costs.
Unfavorable tax policies. When investing in commodities, investors face higher tax rates compared to investing in securities. Specifically, profits from commodity investments are taxed at collectible capital gains rates rather than the preferential rates for long-term capital gains from securities. This can increase the tax burden for investors.
Not suitable for a passive investment strategy. Unlike securities, commodities cannot be held indefinitely. The development of substitute materials or changes in market demand can reduce the value of commodities over time. Meanwhile, companies can innovate and generate continuous cash flow, helping to maintain investment value in the long term.
Disadvantages of investing in securities
Market risk and bubbles. Securities are susceptible to market risk, including the potential for financial bubbles to form when the value of securities is driven to unsustainable levels. When a bubble bursts, security prices can plummet dramatically, leading to significant corrections and losses for investors. Thus, investors must always maintain vigilance and have a reasonable risk management strategy.
Bankruptcy risk. One of the major risks when investing in securities is the possibility that the issuing company may go bankrupt. In such cases, investors could lose their entire invested amount. This is a factor that must be carefully considered, especially when investing in companies with unstable financial situations.
Liquidity risk. While stocks of large companies generally have high liquidity, meaning they can be easily bought and sold in large volumes, small-cap companies may struggle with trading. Low trading volume can lead to the inability to sell securities promptly at the desired price or incurring losses when selling at prices lower than their actual value.
