Commodity markets

Commodity markets are markets where basic goods and materials are exchanged. Commodity markets can be as small as a local farmers market or as large as the CHICAGO BOARD OF TRADE (CBOT), the first commodity exchange in the United States (established in 1848). Generally commodity markets are located near historic centers of PRODUCTION of major commodities or in major cities like Chicago and New York. In the 19th century, the major commodity markets provided trading opportunities primarily in agricultural PRODUCTS. Initially the CBOT focused on grain trade, allowing farmers and other agricultural industry members to hedge or reduce their risk of price changes by using FUTURES contracts. Similarly, the CHICAGO MERCANTILE EXCHANGE (CME), created in 1898 as the Chicago Butter and Egg Board, allows investors, managers, and broker/dealers to reduce risk in business transactions. As ECONOMIC CONDITIONS changed, commodity markets like the CBOT and the CME expanded their trading to include currency futures, interest-rate futures, and stock-index futures. Most commodity markets determine current market prices, called the cash price, by the interaction of buyers and sellers (DEMAND and SUPPLY). The CBOT and other commodity exchanges have colorful “pits” where traders, using hand signals, execute orders to buy and sell commodities and futures contracts. Within any major commodity market there is a variety of participants, including buyers, sellers, hedgers, floor traders, and speculators. Buyers are representatives of food companies purchasing commodities for use in production. Sellers are representatives of commodity producers. Hedgers are firms and individuals who make purchases and sales in futures markets for the purpose of establishing a known price, weeks or months in advance, for commodities they intend to buy or sell in the cash market. HEDGING allows them to protect themselves against the risk of an unfavorable price change in the time before they are ready to buy or sell in the cash market. To a commodity producer, a decline in prices between the present and when the commodity will be available would be unfavorable. To a cereal company, where grains are input in production, a rise in commodity prices would be unfavorable. Both buyers and sellers of commodities can protect themselves against price changes. For example, a farmer or farm corporation may plant 1,000 acres of winter wheat in the fall. Winter wheat is not harvested until the next year. The farmer knows that historically his/her land yields an average of 60 bushels per acre, so they expect to have 60,000 bushels at harvest time. The farmer can “lock in” the current price for wheat by selling 12 wheat futures contracts at the current price, say $2.90 per bushel. (The standard futures contract for wheat is 5,000 bushels.) If, in the interim, the price of wheat rises, the farmer will buy back the futures contracts at a higher price, losing money in the futures market, but then sell his or her wheat at the higher price in the cash market. If the price of wheat declines, the farmer will buy back the futures contracts at a lower price, profiting in the futures market, but then sell his or her wheat at a lower price in the cash market. In addition to buyers, sellers, and hedgers, many commodity markets include floor traders and speculators. Floor traders are individuals who buy and sell for their own accounts. Like day traders in STOCK MARKETs, they buy and sell rapidly, hoping to earn PROFITS based on small changes in prices. Floor traders also provide liquidity to commodity markets. Speculators seek to profit based on anticipated changes in futures prices. Speculators will “go long,” purchasing futures contracts, or “go short,” selling futures contracts based on expectation that the price will decline, and profit by the difference. As one trading company states, “Commodity trading is risky and is not suitable for everyone.” Historically commodity-markets futures trading was designed to protect producers and manufacturers using commodities from price changes. Today commodity exchanges are used by a variety of nonagricultural buyers and sellers, such as power companies and airlines attempting to lock in their cost of fuel, multinational companies locking in their revenue or costs in other currencies, and investment companies locking in their cost or price of CAPITAL.