Difference Between Equity and Commodity

Both equities and commodities are financial investment instruments/asset classes. They both hold real value. Simply put, the major differences between equity and commodity classes are:

• Equity is the company’s stock
• Commodities are tangible items like copper, crude oil, coffee, etc. 

So if you buy equity, you buy a company’s stock. Plus, if you’re reading this article, you probably at least have a gist of why equity/stocks interest people—to grow their wealth.

Conversely, when you are buying commodities, you’re buying a physical commodity; no, not really. In addition, when it comes to commodities, investors are more interested in hedging properties to protect their investments.

If you want a more in-depth take on the subject of equity vs. commodity, consider reading the rest of the article.

What Is Equity?        

If you are an equity holder in a company, you are an owner in that company. That is because a company’s equity or stock represents a share of ownership in the company. It can also be defined as the money the company’s shareholder receives in the event the company has to liquidate its assets after paying off all its obligations.

Companies launch their IPO and list their shares on stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). So, you can invest through the IPO or by purchasing shares on the stock exchange. You can even do so by investing in equity mutual funds or equity derivatives trading on the stock exchanges. Stocks and equity are synonymous terms; when you buy a company’s stock, you’re buying an equity stake in the company.

In other words, equity denotes a share of ownership in the company. Equity can also be defined as the money the company’s shareholders receive if the company liquidates all its assets after paying all its obligations. So, if you buy shares of Reliance Industries or TCS from the NSE, you are an equity investor.

You can invest in equity by investing in a company’s Initial Public Offering (IPO) or by directly purchasing its stock over a regulated exchange like the NSE or BSE. You can also become an equity investor by investing in equity mutual funds or buying through equity derivatives; more on derivatives in the next section. In addition to these traditional methods of investing in equity, you can explore the long-short equity strategy, a distinctive approach that involves taking both long and short positions on stocks to potentially maximise returns while managing risk effectively.

What Is a Commodity? 

On the other hand, a company is a tangible raw material or agricultural product that must be processed before customers can use or consume it. They trade in physical markets as well as regulated exchanges. In India, there are four categories of commodities trading over major exchanges like the Multi Commodity Exchange (MCX). They are:

• Energy: crude oil and natural gas
• Base Metals: aluminium, copper, nickel, etc.
• Bullion: gold and silver
• Agri Products: coffee, sugar, cotton, etc.

However, on the exchanges, you can’t trade the commodity directly; you trade its derivatives. So, in other words, you can’t buy crude on the MCX, but you can trade its futures or options contracts.

Derivatives: To summarise, derivative contracts like futures and options derive their value from underlying assets—commodities in the case of commodity derivatives (stocks in the case of stock derivatives). When you trade a derivatives contract, like the aforementioned one, you agree to transact the underlying assets on a future date based on things like a predetermined price and other stipulations.  

To understand commodity trading, you must understand how derivative trading works.

Equity vs. Commodity | Differences 

Now let’s dive deep and understand the differences between equity and commodity instruments in detail.

Equity vs. Commodity: Form Factor

• A company’s equity shares exist in a dematerialised state; they don’t take a physical form. Conversely, commodities take tangible form, which is why their derivatives are traded through their derivative contracts.
• So, when you buy equity shares, the shares are registered in your name and transferred to your Demat account in T+2 days. However, when you trade commodities—even commodity derivatives—you are not getting the physical commodity at that moment or in the future.

Equity vs. Commodity: Trading Mechanisms  

• If you want to trade equity/stocks, open a trading account and a Demat account with a registered broker. Likewise, commodity trading requires a commodity trading account. 
• Using your trading account, you can buy stocks on the NSE and BSE, and using your commodity trading account, you can buy commodity derivatives on a regulated commodity exchange.
• You buy equity in the cash markets and derivative markets. What this means is you can pay ₹1000 for a stock trading at ₹1000 and get one stock. At the same time, you can buy futures and options contracts of the stock. When it comes to commodities, as retail traders, you only trade in the derivatives market.
• Equity derivatives contracts are settled with the delivery of the stock. On the other hand, commodity derivatives are settled in cash. This means you will get a cash equivalent if you make a profit, or else you will lose the cash equivalent. 

Equity vs. Commodity: Factors Determining Pricing 

• At the core, it’s always demand and supply that determine the market price of stocks and commodities. However, in the case of stocks, it’s more nuanced.
• Demand for a stock is generated because of its performance; investors may see the company improving its profit margins and scaling the business and want to own it. On the other hand, if there is a supply shortage of a crucial commodity, its price may increase.  

Equity vs. Commodity: Why Trade Them? 

• One reason why traders trade both equities and commodities is to speculate in the short term, capitalise on price volatility and make quick profits.
• However, you primarily make equity investments to grow your wealth in the long term. On the other hand, you trade commodity futures to hedge your existing investments. A simple explanation of what this means is:
  • You see the price of crude oil rising. So, the companies that use crude oil to produce their products may take a hit on their profits; since the cost to acquire crude is higher than what it was. So, if you own such a stock, it’s likely to at least temporarily fall in value, so you buy crude futures to compensate for your temporary losses.

Equity vs. Commodity: Which One Should You Invest in? 

• First and foremost, commodity prices are typically more volatile than stock prices.
• Secondly, since commodities trade in the derivative markets, you will need more capital to trade commodities.
• You can hold your stocks for as long as you wish; you hold commodity derivatives until they expire, generally around 1–3 months.            

Conclusion