How to trade soft commodities

The term ‘soft commodity’ refers to an agricultural good that is grown, rather than mined or extracted. Some examples include cocoa, coffee, cotton, rice, soybeans, sugar and wheat. These types of goods can also be referred to as tropical or grown commodities, or food and fibre commodities.

These types of products are some of the oldest traded in the world, with commerce roots going back thousands of years. Agricultural goods continue to trade on listed exchanges today and still maintain a significant role in daily trading volume across global markets.

It is important to note that there’s no definitive soft commodities list, and various exchanges where you can trade these products will classify the term ‘soft’ in different ways.

Tropical commodities play a huge part in future markets, where these products can be bought and sold for delivery on a specific date. It’s used by farmers or commercial users who want to lock in future prices of their crop, as well as by speculative investors seeking a profit.

Soft commodity prices tend to fluctuate more or have higher volatility than other assets since production can be impacted by weather uncertainties and other risks that come with farming.

While an agricultural commodity may carry higher risk, owning just a small percentage of these assets is one way to diversify your portfolio​ without exposing yourself to too much risk.

The main grown commodities include cocoa, coffee, cotton and sugar, which we’ll cover in some detail. Since the soft commodity market is huge, these products can also be split into sub-categories, such as cereal grains, oilseeds, meat and dairy products.

Trade in cocoa and cocoa preparations was worth $50.9bn in 2019, making it the 53rd most traded commodity in the world, according to the most recent data from the Observatory of Economic Complexity.

There are three main varieties of cacao beans, which are then processed to become cocoa: Forastero, Criollo, and Trinitario. This is the purest form of chocolate you can eat but is generally processed before consumption.

Cacao derivatives include cocoa butter, which is a natural fat taken from cocoa beans. Cocoa powder is used as an ingredient in food and cocoa liquor is included in chocolate manufacturing.

It is grown in three major production areas across the globe, which have the ideal humid, tropical climate needed for the plant to thrive.

The largest is centred around West Africa, including Cameroon, Côte d'Ivoire and Ghana. Cocoa crops are also cultivated in Ecuador and Brazil, as well as Indonesia and in Papua New Guinea.

Lindt is an example of a stock that trades in cocoa products; see our Lindt share price.

According to the International Coffee Organisation’s most recent Coffee Market Report, 10.86 million 60kg bags of coffee were exported around the world in the month of January 2022. The organisation expects the world’s coffee consumption to grow 3.3% to 170.3 million bags in 2021/22.

This highly popular commodity is grown in subtropical climates. Of the world’s coffee exports, 30% originates from Brazil. The coffee varieties that are most commonly traded are Arabica and Robusta, including green (unroasted) beans. Arabica beans make up most of the world’s coffee production (around 75%) and are farmed in Latin America and eastern Africa. Robusta coffee seeds (which contain more caffeine and have a more bitter flavour) are cultivated in tropical regions of Asia and Africa, typically at lower altitudes.

Learn how to trade coffee​.

Global cotton production is expected to grow by 7.5% in 2021/22 to 120.2 million bales, according to the US Department of Agriculture.

India and China are the two leading cotton producers that contribute approximately 50% of global output. India has only recently surpassed China as the world’s leading producer of cotton. The US is the third-largest producer, followed by Brazil, with the top four countries making up for 75% of global cotton production.

According to sugar producer Ragus, global sugar production is expected to total 189 million tonnes in 2021/22, an increase of 4.7 million tonnes from the previous year.

Sugar comes from two different sources: sugar cane and sugar beet. The former favours the tropical temperatures of China, India and Brazil, while the latter is cultivated in the cooler climates of Europe and Russia.

Brazil is the largest producer of sugar in the world, while India and China are also major importers and producers.

So-called ‘raw sugar’ is the natural product that’s taken from the sugar crop once it’s harvested — the beet or cane is crushed to extract the juice. This is then purified and processed to create white sugar crystals (refined sugar), the type we’re most familiar with.

Commodities are split into two categories: soft and hard. As we’ve mentioned, a soft commodity is an agricultural good that is grown and isn’t mined or extracted. Hard commodities are exactly the opposite. These are natural resources that have been extracted or mined from the earth — think metals such as gold, copper, aluminium or nickel, and energy sources such as oil or natural gas.

In general, tropical commodities have been grown and nurtured to maturity, while hard commodities are waiting in the earth for extraction. Hard commodities can be found in geological deposits in geographical locations around the world. However, tropical commodities will require particular weather conditions to thrive and grow.

Tropical commodities trading can be done on both the spot and future markets.

With spot markets, agricultural goods can be purchased and sold at real-time ‘spot’ prices for immediate delivery. This means that these prices can fluctuate by the second as investors buy and sell these agricultural goods.

Alternatively, these products can be traded on the futures market. This is where investors deal with legally binding contracts to buy and sell tropical commodities for an agreed price at some point in the future. Most tropical commodities futures are offset prior to delivery, meaning that the majority of contracts are speculators trying to profit from price movements.

You should bear in mind that future markets offer standardised contract terms for tropical commodities trading. If you want customisable soft commodity contracts, you could consider forward contracts.

Cocoa beans are traded in dollars per metric tonne. If you have an order for 10 metric tonnes, and cocoa trades at $1,500/t, then this order will have a value totalling $15,000.

If you decide to go long at $15,000/t, which means you’re betting on the cocoa price rising, and the market moves to $1,555/t, you will have banked a profit of $550 (1,500–1,555=55 and 55x10=550).

Alternatively, if the market moves against your expectations, then you will make an equal loss.

Cargill, a producer based in Minneapolis, Minnesota, makes and distributes sugar, cotton, cocoa and salt, among many other things. Founded by William Cargill in 1865, the family still owns nearly 90% of the company today. This makes it one of the largest privately owned firms in the US, with approximately 155,000 employees across 70 countries.

Another leading processor and distributor of tropical commodities is the US-based Archer-Daniels-Midland Company [ADM]. The company was founded in 1902 and is headquartered in Chicago, Illinois. It operates over 270 plants and 420 crop procurement facilities around the world.