Commodity market
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A commodity market is a
A
Derivatives such as futures contracts,
Exchange-traded funds (ETFs) began to feature commodities in 2003. Gold ETFs are based on "electronic gold" that does not entail the ownership of physical bullion, with its added costs of insurance and storage in repositories such as the London bullion market. According to the World Gold Council, ETFs allow investors to be exposed to the gold market without the risk of price volatility associated with gold as a physical commodity.[7][8][notes 1]
History
Commodity-based money and commodity markets in a crude early form are believed to have originated in Sumer between 4500 BC and 4000 BC. Sumerians first used clay tokens sealed in a clay vessel, then clay writing tablets to represent the amount—for example, the number of goats, to be delivered.[9][10] These promises of time and date of delivery resemble futures contract.
Early civilizations variously used pigs, rare seashells, or other items as commodity money. Since that time traders have sought ways to simplify and standardize trade contracts.[11][12]
Gold and silver markets evolved in classical civilizations. At first, the precious metals were valued for their beauty and intrinsic worth and were associated with royalty.[11] In time, they were used for trading and were exchanged for other goods and commodities, or for payments of labor.[13] Gold, measured out, then became money. Gold's scarcity, its unique density and the way it could be easily melted, shaped, and measured made it a natural trading asset.[14]
Beginning in the late 10th century, commodity markets grew as a mechanism for allocating goods, labor, land and capital across Europe. Between the late 11th and the late 13th century, English urbanization, regional specialization, expanded and improved infrastructure, the increased use of coinage and the proliferation of markets and fairs were evidence of commercialization.[15] The spread of markets is illustrated by the 1466 installation of reliable scales in the villages of Sloten and Osdorp so villagers no longer had to travel to Haarlem or Amsterdam to weigh their locally produced cheese and butter.[15]
The
In 1864, in the United States, wheat, corn, cattle, and pigs were widely traded using standard instruments on the Chicago Board of Trade (CBOT), the world's oldest futures and options exchange. Other food commodities were added to the Commodity Exchange Act and traded through CBOT in the 1930s and 1940s, expanding the list from grains to include rice, mill feeds, butter, eggs, Irish potatoes and soybeans.[17] Successful commodity markets require broad consensus on product variations to make each commodity acceptable for trading, such as the purity of gold in bullion.[18] Classical civilizations built complex global markets trading gold or silver for spices, cloth, wood and weapons, most of which had standards of quality and timeliness.[19]
Through the 19th century "the exchanges became effective spokesmen for, and innovators of, improvements in transportation, warehousing, and financing, which paved the way to expanded interstate and international trade."[20]
Reputation and clearing became central concerns, and states that could handle them most effectively developed powerful financial centers.[21]
Commodity price index
In 1934, the U.S. Bureau of Labor Statistics began the computation of a daily Commodity price index that became available to the public in 1940. By 1952, the Bureau of Labor Statistics issued a Spot Market Price Index that measured the price movements of "22 sensitive basic commodities whose markets are presumed to be among the first to be influenced by changes in economic conditions. As such, it serves as one early indication of impending changes in business activity."[22]
Commodity index fund
A
Cash commodity
Cash commodities or "actuals" refer to the physical goods—e.g., wheat, corn, soybeans, crude oil, gold, silver—that someone is buying/selling/trading as distinguished from derivatives.[2]
Electronic commodities trading
In traditional
By 2011, the alternative trading system (ATS) of electronic trading featured computers buying and selling without human dealer intermediation. High-frequency trading (HFT) algorithmic trading, had almost phased out "dinosaur floor-traders".[25][notes 2]
Complexity and interconnectedness of global market
The robust growth of
In 2012, as emerging-market economies slowed down, commodity prices peaked and started to decline. From 2005 through 2013, energy and metals' real prices remained well above their long-term averages. In 2012, real food prices were their highest since 1982.[28]
The price of gold bullion fell dramatically on 12 April 2013 and analysts frantically sought explanations. Rumors spread that the European Central Bank (ECB) would force Cyprus to sell its gold reserves in response to its financial crisis. Major banks such as Goldman Sachs began immediately to short gold bullion. Investors scrambled to liquidate their exchange-traded funds (ETFs)[notes 3] and margin call selling accelerated. George Gero, precious metals commodities expert at the Royal Bank of Canada (RBC) Wealth Management section reported that he had not seen selling of gold bullion as panicked as this in his forty years in commodity markets.[30]
The earliest commodity exchange-traded fund (ETFs), such as
Contracts in the commodity market
A
Standardization
This section may be confusing or unclear to readers. (March 2022) |
US soybean futures do not qualify as "standard grade" if they are "GMO or a mixture of GMO and Non-GMO No. 2 yellow soybeans of Indiana, Ohio and Michigan origin produced in the U.S.A. (Non-screened, stored in silo)". They are of "deliverable grade" if they are "GMO or a mixture of GMO and Non-GMO No. 2 yellow soybeans of Iowa, Illinois and Wisconsin origin produced in the U.S.A. (Non-screened, stored in silo)". Note the distinction between states, and the need to clearly mention their status as GMO (genetically modified organism) which makes them unacceptable to most organic food buyers.
Similar specifications apply for cotton, orange juice, cocoa, sugar, wheat, corn, barley, pork bellies, milk, feed stuffs, fruits, vegetables, other grains, other beans, hay, other livestock, meats, poultry, eggs, or any other commodity which is so traded.
Standardization has also occurred technologically, as the use of the FIX Protocol by commodities exchanges has allowed trade messages to be sent, received and processed in the same format as stocks or equities. This process began in 2001 when the Chicago Mercantile Exchange launched a FIX-compliant interface that was adopted by commodity exchanges around the world.[27]
Derivatives
Derivatives evolved from simple commodity future contracts into a diverse group of financial instruments that apply to every kind of asset, including mortgages, insurance and many more. Futures contracts, Swaps (1970s–), Exchange-traded Commodities (ETC) (2003–), forward contracts, etc. are examples. They can be traded through formal exchanges or through Over-the-counter (OTC). Commodity market derivatives unlike credit default derivatives, for example, are secured by the physical assets or commodities.[3]
Forward contracts
A forward contract is an agreement between two parties to exchange at a fixed future date a given quantity of a commodity for a specific price defined when the contract is finalized. The fixed price is also called forward price. Such forward contracts began as a way of reducing pricing risk in food and agricultural product markets. By agreeing in advance on a price for a future delivery, farmers were able protect their output against a possible fall of market prices and in contrast buyers were able to protect themselves against a possible rise of market prices.
Forward contracts, for example, were used for rice in seventeenth century Japan.
Futures contract
Futures contracts are standardized forward contracts that are transacted through an exchange. In futures contracts the buyer and the seller stipulate product, grade, quantity and location and leaving price as the only variable.[32]
Agricultural futures contracts are the oldest, in use in the United States for more than 170 years.
Call options
In a call option counterparties enter into a financial contract option where the buyer purchases the right but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.[35]
Swaps
A swap is a derivative in which counterparties exchange the cash flows of one party's financial instrument for those of the other party's financial instrument. They were introduced in the 1970s.[36][37]
Exchange-traded commodities (ETCs)
Exchange-traded commodity is a term used for commodity exchange-traded funds (which are funds) or commodity exchange-traded notes (which are notes). These track the performance of an underlying commodity index including total return indices based on a single commodity. They are similar to ETFs and traded and settled exactly like stock funds. ETCs have market maker support with guaranteed liquidity, enabling investors to easily invest in commodities.
They were introduced in 2003.
At first, only professional institutional investors had access, but online exchanges opened some ETC markets to almost anyone. ETCs were introduced partly in response to the tight supply of commodities in 2000, combined with record low inventories and increasing demand from emerging markets such as China and India.[38]
Prior to the introduction of ETCs, by the 1990s ETFs pioneered by
Gold was the first commodity to be securitised through an
Generally, commodity ETFs are index funds tracking non-security indices. Because they do not invest in securities, commodity ETFs are not regulated as investment companies under the Investment Company Act of 1940 in the United States, although their public offering is subject to SEC review and they need an SEC no-action letter under the Securities Exchange Act of 1934. They may, however, be subject to regulation by the Commodity Futures Trading Commission.[42][43]
The earliest commodity ETFs, such as
Commodity ETFs trade provide exposure to an increasing range of commodities and commodity indices, including energy, metals, softs and agriculture. Many commodity funds, such as oil roll so-called front-month futures contracts from month to month. This provides exposure to the commodity, but subjects the investor to risks involved in different prices along the term structure, such as a high cost to roll.[7][8]
ETCs in China and India gained in importance due to those countries' emergence as commodities consumers and producers. China accounted for more than 60% of exchange-traded commodities in 2009, up from 40% the previous year. The global volume of ETCs increased by a 20% in 2010, and 50% since 2008, to around 2.5 billion million contracts.{{[44]}}
Over-the-counter (OTC) commodities derivatives
Over-the-counter (OTC) commodities derivatives trading originally involved two parties, without an exchange. Exchange trading offers greater transparency and regulatory protections. In an OTC trade, the price is not generally made public. OTC commodities derivatives are higher risk but may also lead to higher profits.[45]
Between 2007 and 2010, global physical exports of commodities fell by 2%, while the outstanding value of OTC commodities derivatives declined by two-thirds as investors reduced risk following a five-fold increase in the previous three years.
Money under management more than doubled between 2008 and 2010 to nearly $380 billion. Inflows into the sector totaled over $60 billion in 2010, the second-highest year on record, down from $72 billion the previous year. The bulk of funds went into precious metals and energy products. The growth in prices of many commodities in 2010 contributed to the increase in the value of commodities funds under management.[46]
Commodities exchange
A commodities exchange is an exchange where various commodities and derivatives are traded. Most commodity markets across the world trade in agricultural products and other raw materials (like wheat, barley, sugar, maize, cotton, cocoa, coffee, milk products, pork bellies, oil, metals, etc.) and contracts based on them. These contracts can include spot prices, forwards, futures and options on futures. Other sophisticated products may include interest rates, environmental instruments, swaps, or freight contracts.[2]
Exchange | Country | Volume per month $M |
---|---|---|
CME Group | USA | $268,000,000[47] |
Tokyo Commodity Exchange | Japan | - |
Euronext | France, Belgium, Netherlands, Portugal, UK | - |
Dalian Commodity Exchange | China | - |
Multi Commodity Exchange | India | - |
Intercontinental Exchange | USA, Canada, China, UK | - |
Africa Mercantile Exchange | Kenya, Africa | - |
Uzbek Commodity Exchange | Tashkent, Uzbekistan | - |
- Abuja Securities and Commodities Exchange
- Africa Mercantile Exchange
- Bhatinda Om & Oil Exchange Bathinda
- Brazilian Mercantile and Futures Exchange
- Chicago Board of Trade
- Chicago Mercantile Exchange
- Commodity Exchange Bratislava, JSC
- Dalian Commodity Exchange
- Dubai Mercantile Exchange
- Dubai Gold & Commodities Exchange
- Euronext.liffe
- Ethiopia Commodity Exchange
- Hong Kong Mercantile Exchange
- Indian Commodity Exchange
- Intercontinental Exchange
- Iranian Oil Bourse
- Kansas City Board of Trade
- London Metal Exchange
- Minneapolis Grain Exchange
- Multi Commodity Exchange
- National Commodity and Derivatives Exchange
- National Multi-Commodity Exchange of India Ltd
- National Food Exchange
- National Spot Exchange
- New York Mercantile Exchange
- Rochel International
- Rosario Board of Trade
- Sioux City Grain Exchange
- Tokyo Commodity Exchange
- Winnipeg Commodity Exchange
Traded commodity classes
Rank | Commodity | Value in US$ ('000) | Date of information |
---|---|---|---|
1 | Mineral fuels, oils, distillation products, etc. | $2,183,079,941 | 2012 |
2 | Electrical, electronic equipment | $1,833,534,414 | 2012 |
3 | Machinery, nuclear reactors, boilers, etc. | $1,763,371,813 | 2012 |
4 | Vehicles other than railway, tramway | $1,076,830,856 | 2012 |
5 | Plastics and articles thereof | $470,226,676 | 2012 |
6 | Optical, photo, technical, medical, etc. apparatus | $465,101,524 | 2012 |
7 | Pharmaceutical products | $443,596,577 | 2012 |
8 | Iron and steel | $379,113,147 | 2012 |
9 | Organic chemicals | $377,462,088 | 2012 |
10 | Pearls, precious stones, metals, coins, etc. | $348,155,369 | 2012 |
Source: International Trade Centre[48]
Energy
Energy commodities include
Crude oil and natural gas
For many years,
From April through October 2012, Brent futures contracts exceeded those for WTI, the longest streak since at least 1995.[50]
Crude oil can be light or heavy. Oil was the first form of energy to be widely traded. Some commodity market speculation is directly related to the stability of certain states, e.g., Iraq, Bahrain, Iran, Venezuela and many others. Most commodities markets are not so tied to the politics of volatile regions.
Oil and gasoline are traded in units of 1,000 barrels (42,000 US gallons). WTI crude oil is traded through
Natural gas is traded through NYMEX in units of 10,000 million BTU with the trading symbol of NG. Heating oil is traded through NYMEX under trading symbol HO.
Others
Metals
Precious metals
According to the World Gold Council, investments in gold are the primary driver of industry growth. Gold prices are highly volatile, driven by large flows of speculative money.[51]
Industrial metals
Industrial metals are sold by the
Iron ore has been the latest addition to industrial metal derivatives. Deutsche Bank first began offering iron ore swaps in 2008, other banks quickly followed. Since then the size of the market has more than doubled each year between 2008 and 2012.[52]
Agriculture
Agricultural commodities include grains, food and fiber as well as livestock and meat, various regulatory bodies define agricultural products.[53]
In 1900, corn acreage was double that of wheat in the United States. But from the 1930s through the 1970s soybean acreage surpassed corn. Early in the 1970s grain and soybean prices, which had been relatively stable, "soared to levels that were unimaginable at the time". There were a number of factors affecting prices including the "surge in crude oil prices caused by the Arab Oil Embargo in October 1973 (U.S. inflation reached 11% in 1975)".[54]
On 21 July 2010, United States Congress passed the Dodd–Frank Wall Street Reform and Consumer Protection Act with changes to the definition of agricultural commodity. The operational definition used by Dodd-Frank includes "[a]ll other commodities that are, or once were, or are derived from, living organisms, including plant, animal and aquatic life, which are generally fungible, within their respective classes, and are used primarily for human food, shelter, animal feed, or natural fiber". Three other categories were explained and listed.[55]
In February 2013, Cornell Law School included lumber, soybeans, oilseeds, livestock (live cattle and hogs), dairy products. Agricultural commodities can include lumber (timber and forests), grains excluding stored grain (wheat, oats, barley, rye, grain sorghum, cotton, flax, forage, tame hay, native grass), vegetables (potatoes, tomatoes, sweet corn, dry beans, dry peas, freezing and canning peas), fruit (citrus such as oranges, apples, grapes) corn, tobacco, rice, peanuts, sugar beets, sugar cane, sunflowers, raisins, nursery crops, nuts, soybean complex, aquacultural fish farm species such as finfish, mollusk, crustacean, aquatic invertebrate, amphibian, reptile, or plant life cultivated in aquatic plant farms.[56][57]
Diamonds
As of 2012, diamond was not traded as a commodity. Institutional investors were repelled by campaign against "
According to Citigroup analysts, the annual production of polished diamonds is about $18 billion. Like gold, diamonds are easily authenticated and durable. Diamond prices have been more stable than the metals, as the global diamond monopoly De Beers once held almost 90% (by 2013 reduced to 40%) of the new diamond market.[51]
Other commodity markets
Rubber trades on the
Regulatory bodies and policies
United States
In the United States, the principal regulator of commodity and futures markets is the Commodity Futures Trading Commission (CFTC). The National Futures Association (NFA) was formed in 1976 and is the futures industry's self-regulatory organization. The NFA's first regulatory operations began in 1982 and fall under the Commodity Exchange Act of the Commodity Futures Trading Commission Act.[59]
Dodd–Frank was enacted in response to the 2008 financial crisis. It called for "strong measures to limit speculation in agricultural commodities" calling upon the CFTC to further limit positions and to regulate over-the-counter trades.[60]
European Union
The European Securities and Markets Authority (Esma), based in Paris and formed in 2011, is an "EU-wide financial markets watchdog". Esma sets position limits on commodity derivatives as described in Mifid II.[62]
The EP voted in favor of stronger regulation of commodity derivative markets in September 2012 to "end abusive speculation in commodity markets" that were "driving global food prices increases and price volatility". In July 2012, "food prices globally soared by 10 percent" (World Bank 2012). Senior British MEP Arlene McCarthy called for "putting a brake on excessive food speculation and speculating giants profiting from hunger" ending immoral practices that "only serve the interests of profiteers".[63] In March 2012, EP Member Markus Ferber suggested amendments to the European Commission's proposals, intended to strengthen restrictions on high-frequency trading and commodity price manipulation.[64]
See also
Notes
- currency marketscover those concerns separately and in more depth.
- ^ In July 2009, when a high-frequency trading platform with proprietary algorithmic trading code used by Goldman Sachs to allegedly generate massive profits in the commodity market was stolen by Sergey Aleynikov there was widespread concern about the unintended economic consequences of HFT.
- ^ Exchange Traded Funds revolutionized the mutual funds industry when they were introduced. Exchange Traded Commodities, sold first by pioneering investors group Barclays Global Investors (BGI) (now owned by BlackRock) revolutionized the commodity market. By the end of December 2009 Barclays Global Investors (BGI) assets hit an all-time high of $1 trillion ($1,032 billion).
- ^ IndexIQ registered Adam S. Patti as Chief Executive Officer (CEO) and David Fogel as Chief Financial Officer and Executive Vice President in the City of Rye Brook, New York, on 31 January 2013 as representatives of IndexIQ Advisors LLC sponsoring the IQ Physical Diamond Trust.
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- ^ Banks, Martin (27 September 2012). "EU parliament approves moves to end 'abusive' speculation in commodity markets". European Parliament.
- ^ Reeve, Nick (29 March 2012). "Mifid amendment calls for commission ban to be scrapped". Financial Times. Archived from the original on 21 May 2012.
Further reading
- Blas, Javier; Farchy, Jack (2022). The World for Sale: Money, Power and the Traders Who Barter the Earth's Resources. London: Cornerstone. ISBN 9781847942654.
- Longstreth, Andrew (26 May 2011). Alden Bentley (ed.). "CFTC faces high hurdles in oil manipulation case". Reuters.
- ISBN 9780275923136.
- Understanding Derivatives: Markets and Infrastructure Federal Reserve Bank of Chicago, Financial Markets Group
- "Opportunities and Risk: an Educational Guide to Trading Futures and Options on Futures" (PDF). Chicago, Illinois: National Futures Association. 2006. p. 48.
External links
- Media related to Commodity markets at Wikimedia Commons
- Open Historical Commodity Price Data