CFA Level II Exam · Introduction to Commodities and Commodity Derivatives
Commodity Sectors and Market Features for CFA Level II
Updated 7 October 2026 · Fact-checked
Commodities are physical goods grouped into sectors: energy, grains, industrial and precious metals, livestock and softs. They produce no cash flows, so value comes from supply and demand, storage and cost of carry, not from discounting. To answer exam questions, identify the sector's traits, then link them to price behaviour.
Understand Commodity Sectors and Market Features
A commodity is a physical good that is largely interchangeable. One barrel of a given grade of crude oil is much like another. Buyers care about grade, quantity and delivery location, not who produced it.
The main sectors are:
- Energy: crude oil, natural gas, refined products, coal. Hard to store for some items (natural gas, electricity), so prices can be volatile and seasonal.
- Grains: wheat, corn, soybeans. Driven by planting and harvest cycles, weather and crop yields. Prices often show seasonal patterns.
- Industrial (base) metals: copper, aluminium, zinc, nickel. Demand follows global industrial activity, so they are cyclical. They are storable.
- Precious metals: gold, silver, platinum. Held as stores of value and for jewellery. Gold is highly storable and has large above-ground stocks, so its price is driven strongly by investor demand, real rates and currency moves.
- Livestock: cattle, hogs. Production takes time and animals cannot be stored cheaply or long, so supply responds slowly to price.
- Softs: coffee, cocoa, sugar, cotton. Weather-sensitive crops, often grown in a few regions, perishable to a degree.
Commodities differ from equities and bonds because they have no earnings, dividends or coupons. A stock or bond is valued as the present value of expected cash flows. A commodity is valued by supply and demand, and the futures price reflects the spot price plus the cost of carrying it (storage, financing, insurance) less any convenience yield. Returns on commodity futures come from price changes, collateral return and roll return, which you study in other topics.
Market features matter. Commodities trade in the spot market (immediate delivery) and the forward and futures markets. Most investors gain exposure through futures or derivatives and rarely take physical delivery. Storability, perishability and seasonal supply or demand explain why futures curves and price volatility differ by sector. Commodities are often seen as a hedge against inflation and may offer diversification, but these relationships are not guaranteed.
Key formulas to remember
- Commodity valuation basis
- Price = f(supply, demand, storage cost, convenience yield); no discounted cash flow
- Commodities have no cash flows, so equity and bond valuation methods do not apply directly.
- Futures price with carry costs (cost-of-carry idea)
- F₀ ≈ S₀ × (1 + r) + storage costs − convenience yield
- Higher storage cost pushes futures above spot; higher convenience yield pushes them down. Treat as a conceptual relationship unless the vignette gives a formula.
- Convenience yield effect
- Higher convenience yield → futures price lower relative to spot
- Strong near-term need for physical supply favours holders of the physical commodity.
How to solve Commodity Sectors and Market Features questions
Use this method for any item-set question about commodity sectors or how commodities differ from other assets.
- 1Identify the commodity and its sector from the vignette.
- 2Note its key traits: storable or not, perishable, seasonal, cyclical, or a store of value.
- 3Find the data given: price moves, inventories, weather, demand drivers, curve shape.
- 4Link the traits to the driver: storage and carry for storable goods, supply shocks for perishables, economic cycle for industrial metals.
- 5Check whether the question compares with stocks or bonds. If so, point to the absence of cash flows and the supply and demand basis.
- 6Choose the option that matches the sector trait. Reject any option that applies discounted cash flow to a commodity.
Quickest way: Sector trait matching
When to use it: Use when you have little time and the question asks which factor drives a commodity or why its price behaves a certain way.
- Name the sector in a few words.
- Recall one trait: energy volatile, grains seasonal, base metals cyclical, gold store of value, livestock slow supply, softs weather.
- Pick the option consistent with that trait.
- Eliminate options that mention earnings, dividends or coupons as drivers.
Common mistakes in Commodity Sectors and Market Features
Valuing a commodity using discounted cash flows.
Equity and bond habits carry over from Level I.
Fix: Remember commodities produce no cash flows. Think supply, demand and cost of carry.
Treating all commodities as equally storable.
Candidates group them as one asset class.
Fix: Check storability by sector. Gold stores easily; electricity, natural gas and livestock do not.
Assuming gold behaves like an industrial metal.
Both are called metals.
Fix: Precious metals respond more to investor demand and monetary factors. Base metals follow the industrial cycle.
Assuming investors usually take physical delivery.
The word 'commodity' suggests holding physical goods.
Fix: Most investors use futures or other derivatives and close positions before delivery.
Stating that commodities always hedge inflation or always diversify.
Overstating a common rule of thumb.
Fix: Say they may offer inflation protection or diversification, depending on the period and sector.
Worked examples
Example 1
Vignette: An analyst compares three assets for a portfolio: a listed equity, a corporate bond and a copper futures position. A colleague says the copper position can be valued by discounting its expected future cash flows, as with the other two. Q1: Is the colleague correct? Q2: Which factor is most likely to drive copper demand? Options for Q2: A) Dividend growth, B) Global industrial activity, C) Coupon rate.
Show the solution
- Q1: Copper is a commodity and produces no dividends, coupons or earnings.
- With no cash flows to discount, valuation rests on supply, demand and cost of carry.
- So the colleague is not correct.
- Q2: Copper is an industrial metal, so demand is cyclical and tied to industrial and construction activity.
- Dividend growth belongs to equities and coupon rate to bonds, so A and C are out.
Answer: Q1: No, commodities have no cash flows to discount. Q2: B, global industrial activity.
Example 2
Vignette: A fund manager holds exposure to gold, natural gas and live cattle. Q1: Which is hardest to store for long periods? Options: A) Gold, B) Natural gas, C) Live cattle. Q2: Which price is driven most by investor demand and real rates rather than physical consumption? Options: A) Gold, B) Natural gas, C) Live cattle.
Show the solution
- Q1: Gold is easy and cheap to store, so A is out.
- Natural gas is storable but needs specialised facilities and is seasonal. Live cattle are living animals that grow, need feed and must be sold at a suitable weight, so they cannot be held long cheaply.
- Live cattle are the most constrained, so C.
- Q2: Gold is a precious metal held as a store of value, with large above-ground stocks, so investor demand and real rates matter most.
- Natural gas and cattle are driven mainly by consumption and production conditions.
Answer: Q1: C, live cattle. Q2: A, gold.
Exam tips
- Read the vignette for storability, seasonality and cyclicality cues, as they usually point to the answer.
- Be ready to contrast commodities with equities and bonds in one line: no cash flows, supply and demand driven.
- Do not overstate diversification or inflation hedging; pick answers that say 'may' or 'can'.
- Link sector traits to futures curve behaviour, since later topics build on this.
- Do not spend long on a question; there is no penalty for a wrong answer, so always select an option.
Commodity Sectors and Market Features in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Commodity Sectors and Market Features: frequently asked questions
What are the main commodity sectors in CFA Level II?
Energy, grains, industrial metals, precious metals, livestock and softs. Each has different storability and demand drivers. Knowing these traits helps you answer vignette questions.
How do commodities differ from stocks and bonds?
Stocks and bonds are claims on future cash flows. Commodities are physical goods with no earnings, dividends or coupons. Their prices come from supply and demand and the cost of carrying the good.
Why are commodity prices so volatile?
Supply is often slow or hard to adjust, and demand can shift with the economy or weather. Where storage is difficult, shocks pass quickly into price. Volatility varies by sector.
Do investors usually take physical delivery of commodities?
No. Most use futures, forwards or other derivatives and close positions before delivery. Physical holding brings storage, insurance and handling costs.