Soft Commodities

Soft commodities are typically grown, while hard commodities are typically mined or extracted. Orange juice, corn, wheat, lean hogs, coffee, sugar and cocoa beans are all examples of "soft" commodities.

Many soft commodities are subject to spoilage, which can create huge volatility in the short term; if you're sitting on 30,000 pounds of cocoa beans and the price drops, you might have to dump them onto the market whether you want to or not. On the flip side, a well-timed, narrow investment in a soft commodity can yield phenomenal gains if you buy in at just the right time.

Producers are often large players in the "softs" market. Farmers, for instance, regularly hedge their crops by selling futures contracts and locking in prices. This demand ... combined with the natural growing cycle of many of these commodities ... can create a natural seasonality in prices, which investors must consider as they're looking into the space.

Weather plays a huge role in the softs market, which makes predicting supply especially difficult.

Hard Commodities

"Hard" commodities are typically mined from the ground or taken from other natural resources: gold, oil, rubber, aluminum. In many cases, initial products are refined into further commodities, as oil is refined into gasoline.

Literally trillions of dollars of oil futures trade hands each year.

Because "hard" commodities are easier to handle than "softs," and because they are more integrated into the industrial process, most investors focus on these products. That's changing to an extent as former "softs" like corn and sugar are transformed into ethanol-based energy products, but still, hard commodities dominate the marketplace. For instance, literally trillions of dollars of oil futures trade hands each year.

Emerging Commodities

Beyond these, there is a whole class of goods that most of us consider commodities, but for whatever reason, have no liquid futures market. These include things like coal, timber and iron.

There are also "emerging commodities" like water (and water rights), pollution rights and ethanol, which many expect to develop into booming markets in 5-10 years. There are serious investors who believe that these function in a similar fashion to other commodities, and that they deserve a place in a commodities portfolio. For now, investors can only access these commodities by buying stock in companies that operate in these fields.

We cover some of these emerging commodities in depth in Hard Assets University 202.

Next Up? Why Invest In Commodities

Now let's get down to the nitty-gritty: Why should you invest in commodities and hard assets?