A soft commodity is any type of commodity that is grown rather than mined. A few examples of soft commodities include sugar, soybeans, coffee, wheat, or fruit. This is in contrast to hard commodities, which are typically products like coal or precious metals that are extracted from the earth rather than cultivated. Soft commodity trading makes up a sizable portion of the commodities market, especially in terms of the creation and issuance of futures contracts.
Unlike other types of commodities, a soft commodity is typically something that is totally consumed, rather than renewed in some manner. For example, gold and other metals can be recycled over time into new forms. In contrast, once wheat is grown, sold, and consumed, it no longer exists and cannot be used to generate continuing returns. An investor must purchase more wheat in order to repeat the cycle and earn more profits from his or her activity.
Futures trading is very common with a soft commodity. Typically, growers of corn, soybeans, or some other similar commodity contract to sell their crops before they are actually ready for harvest. This allows the growers to lock in the prices they can command for their crops, making it possible to project the amount of profit they will receive once the crops are harvested and transferred to the buyer. At the same time, investors who suspect that the soft commodity in question will be worth more by the time of harvest than at the present date can benefit from the futures contract. Buying at the lower price offered today, holding the contract until the crops are harvested, and then selling the crops at the higher market price can earn a significant return, assuming the market does perform according to expectations.
Investors do assume some degree of risk when investing in a soft commodity via a futures contract. Should the demand for the commodity shift in a direction that is not foreseen by the investor, there is the chance of losing money rather than making a profit. For this reason, commodities investors tend to look closely at any factors that could have a negative effect on the pricing of a given commodity at or near the date specified in the contract. This includes allowing for shifts in consumer demand, adverse weather conditions that cause crops to fail, technology changes that affect the use of the crop in different types of packaged products, or a glut of the commodity on the market that effectively drives down prices.
