Education

Commodity Market

History

As the name suggests, commodity market is a global marketplace where commodities are exchanged.

The world’s first commodity exchanges occurred thousands year ago when people first engaged in agricultural practices. Findings from some historical excavation sites suggest evidence that agriculture evolved around 10,000 BC – when people first sustained major shift from hunter-gathering nomadic tribes to building first settlements. Its s generally believed that the first occurrences of commodity exchanges occurred around 8500 BC when agricultural revolution accelerated pace , leading to exchange of agricultural products between settlements. As the foundations were gradually developed, basic concepts of commodity trading started to take shape with notions of supply and demand coming to the surface. As supplies became more plentiful, people started looking for a way to sell their sell the excess produce – leading to the formation of first concepts of commodity futures trading.

The first instance of trading in the commodity futures dates back to the 17th century Japan, though some findings suggest that rice may have been traded as early as 6000 BC. But there is not enough evidence to support the claim.

Types of commodities

Most commodities can be classified into 3 major categories: agriculture, energy and metal commodities.

Agricultural commodities include:

  • Drinkable goods, including coffee, orange juice and palm oil. These belong to so-called soft markets.
  • Grains, such as wheat, soybeans, soybean oil, rice, oats and corn.
  • Animal food like pork and beef
  • Hard commodities, like cotton and lumber

Main Energy commodities include:

  • Crude Oil,
  • Natural gas
  • Heating Oil

Metal and Precious Metals:

  • Gold
  • Silver
  • Copper
  • Platinum
  • Iron Ore

Futures Market

Since the first commodity exchange was established in Japan in the 17th century, the market for trading commodities has grown into global entity of unprecedented scale, with commodity exchanges established in major financial centers across the globe. Biggest exchanges opened in the end of 20th century, with such giants as Chicago and London Mercantile Exchange emerging as key centers.

Most of the commodity trading happening these days takes the form of Commodity Futures Contracts. It is an agreement between two parties (the buyer and the seller) which implies buying and selling a particular quantity of commodity at a particular price in the future. Buyers and sellers use this type of contract to mitigate the risks associated with the inherently volatile nature of the commodity market.

For example, imagine a farmer and Starbucks coffee shop are the parties involved in the deal. The farmer expects to produce 5000 sacks of coffee over the next several months. Assuming the current price of 1 coffee sack is $100/sack, the potential proceeds from selling the expected quantity of coffee would be $500,000. The farmer can either choose to grow the coffee and sell it at whatever the price will be at the time of selling, or alternatively initiate a future contract with the buying party to lock in the current price and avoid possible losses incurred by uncontrolled price fluctuations.  If case of the latter, regardless of what the price of coffee will be at the time of contract maturity – the farmer’s account  will be credited with 500,000$ at the contract expiry date while the counterparty’s account  will be debited with 500,000$.  On the other hand, prices might also rise under favorable conditions, but in any case the farmer will receive only what the contract entitles him to.

For example, if the price were to rise to $120 per sack at time of contract delivery, the farmer would still receive only $100 /sack, losing potential gain of 20$/sack. In this case Starbuck would be the obvious beneficiary party. On the other hand, if price fell to $80/sack – the farmer would still make the delivery at $100/sack, this time him being the one taking advantage of the deal.

Commodity futures trading can be very risky for the inexperienced, and we highly advice to approach it with maximum caution. Commodity exchanges are controlled by regulatory authorities. In the U.S, the market is regulated by the Commodities Futures Trading Commission(CFTC)- an independent agency tasked with preventing fraud and providing safe, transparent environment for all futures market participants.

Other Ways to invest in Commodities

Alternative ways of investing into commodity market include buying shares of the company dealing with commodities or investing in Commodity CFDS (Contracts for Difference) which is much easier and affordable type of commodity investment. Commodity CFD’s do not involve direct ownership of the commodity, but rather track its price as underlying asset.  Also, most brokers that provide commodity CFD trading services allow doing this on margin, meaning traders have to deposit only a very small fraction of the whole trade value in order to take part.

An example CFD trade in soybeans might go like this. The quoted price is $909.75 bid and $912.50 ask per 100 bushels. To buy a contract you would pay the ask price, and the standard size is 200 bushels. This means the value is $912.50 x 2, which is $1,825.00, and the margin cost may be $90(20:1 leverage). The standard lot size for a futures contract is 5,000 bushels, costing significantly more.

If the soybeans go up in value by $10 (per 100), then your profit would be $20. That means a 1% rise in the price just returned more than 20% on your trade. The leveraging power of CFDs multiplies your profit. Many forex brokers offer CFD trading on different commodities, and traders can take advantage pf highly liquid commodity market with minimum exposure and risk.

Conclusions

As such, there is a great number of ways how trades can enter commodity market. And while real commodity futures trading might not be suitable for all individual investors, especially those who don’t have access to big capital, the possibility to invest in commodity CFDs is likely to be a great scenario for smaller players. In our commodity trading educational course, you will learn all you need about commodity markets, grasp specifics of Commodity Futures and CFD trading, and get valuable tips on how to choose a commodity broker geared towards your needs and preferences.