Securities vs. Commodities
You likely know what securities and commodities are, even if you use different names for them. Investors purchase stocks, bonds, debt, and other interests in companies, governments, or private businesses. These kinds of investments are securities. At the same time, businesses purchase natural resources like oil, gas, and coal as well as agricultural products like coffee, corn, sugar, and wheat well in advance of delivery. These are examples of commodities. This article provides an overview of the difference between securities and commodities.
Securities: Stocks and Bonds
Most people who buy securities buy them as investments. Stock in a publicly traded company can increase or decrease in value. Buying bonds can ensure a steady rate of return without much risk of loss. Most holders of securities keep them to fund tuition, major purchases, and retirement. Other investors simply use them to maintain and grow their overall wealth. Securities play an important role in the financial system, providing companies and government with capital and investors with the potential for returns.
Stocks, bonds, and credit default swaps are common securities. There can be many other types of securities though. In 1946, the U.S. Supreme Court formulated a functional definition for a security in SEC v. W.J. Howey Co. The Court held that a security regulated by federal law existed when "a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party."
This definition can cover a lot of ground. More commonly, an investor buying stock in a corporation expects to profit from the company's success. That's a typical security. The Howey case, however, involved an atypical security. A company sold plots of citrus acres while a related company contracted to work and maintain the fields on behalf of the owners. The Court determined this arrangement to be a security as well. Securities are broadly defined in part to prevent efforts to evade federal securities regulation.
Commodities: Metals, Grains, and Oil
The major difference between buying and selling securities and commodities lies in what is being sold. Purchasing stock buys a share in a corporation's ownership and control. Purchasing commodities, on the other hand, is to buy goods themselves before they actually exist. The buyer agrees to purchase so many units of a good at a set price to be delivered much later.
Purchasing commodities are a form of investment. Buyers hope to lock in a good price in advance in order to avoid any rise in prices later on. The opposite is true of sellers: they want to sell at a good price in advance in case the price goes down in the future. These are examples of hedging. Buying oil in advance at $50 will be a bargain if the price of oil later on rises to $100. You can also see the potential profit here, and commodity speculation is common. There's profit to be made in buying low and selling high even when the item is corn.
A commodity's defining feature is its interchangeability. One unit is essentially the same as another unit. To an orange juice company oranges are oranges, to an apple juice company apples are apples, and to an oil refinery one barrel of oil is a lot like any other barrel of oil. Commodities must meet certain minimum quality standards and markets do distinguish between different types of the same commodity. But for the most part it's about quantity.
Similarities and Differences: Securities vs. Commodities
Securities and commodities are both traded on markets. They're also liquid, meaning they can be easily exchanged. These features invite buying and selling for whatever reason. An investor buys stock hoping for its value to rise and make a profit. An apple juice company might buy next year's apples in advance to avoid a rising apple prices should there be a bad crop. Both situations involve an opportunity for profit and some degree of risk. It's more and more common for financial planners to diversify portfolios by including commodities.
There's another major difference between the two. Securities and commodities operate under different laws and are regulated by different agencies. The U.S. Securities and Exchange Commission (SEC) regulates securities under the Securities Act of 1933. The Commodity Futures Trading Commission regulates commodity markets under the Commodity Exchange Act of 1936. Securities and commodities are governed by different statutes, regulated by different agencies, and operate in different markets. This difference affects buyers, sellers, and investors. It can also make a difference should you need an attorney.
If you believe you've been the victim of securities fraud, you should consult with an experienced securities attorney.
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