Commodity market

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Chicago Board of Trade Futures market

A commodity market is a market that trades in the primary economic sector rather than manufactured products, such as cocoa, fruit and sugar. Hard commodities are mined, such as gold and oil. [1] Investors access about 50 major commodity markets worldwide with purely financial transactions increasingly outnumbering physical trades in which goods are delivered. Futures contracts are the oldest way of investing in commodities. Futures are secured by physical assets. [2] Commodity markets can include physical trading and derivatives trading using spot prices, forwards, futures, and options on futures. Farmers have used a simple form of derivative trading in the commodity market for centuries for price risk management. [3]

The primary sector of the economy includes any industry involved in the extraction and collection of natural resources; such as farming, forestry, mining and fishing.

Sugar generic name for sweet-tasting, soluble carbohydrates

Sugar is the generic name for sweet-tasting, soluble carbohydrates, many of which are used in food. The various types of sugar are derived from different sources. Simple sugars are called monosaccharides and include glucose, fructose, and galactose. "Table sugar" or "granulated sugar" refers to sucrose, a disaccharide of glucose and fructose. In the body, sucrose is hydrolysed into fructose and glucose.

Gold Chemical element with atomic number 79

Gold is a chemical element with the symbol Au and atomic number 79, making it one of the higher atomic number elements that occur naturally. In its purest form, it is a bright, slightly reddish yellow, dense, soft, malleable, and ductile metal. Chemically, gold is a transition metal and a group 11 element. It is one of the least reactive chemical elements and is solid under standard conditions. Gold often occurs in free elemental (native) form, as nuggets or grains, in rocks, in veins, and in alluvial deposits. It occurs in a solid solution series with the native element silver and also naturally alloyed with copper and palladium. Less commonly, it occurs in minerals as gold compounds, often with tellurium.

Contents

A financial derivative is a financial instrument whose value is derived from a commodity termed an underlier. [2] Derivatives are either exchange-traded or over-the-counter (OTC). An increasing number of derivatives are traded via clearing houses some with central counterparty clearing, which provide clearing and settlement services on a futures exchange, as well as off-exchange in the OTC market. [4]

Derivative (finance) financial instrument whose value is based on one or more underlying assets

In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation or getting access to otherwise hard-to-trade assets or markets. Some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps. Most derivatives are traded over-the-counter (off-exchange) or on an exchange such as the New York Stock Exchange, while most insurance contracts have developed into a separate industry. In the United States, after the financial crisis of 2007–2009, there has been increased pressure to move derivatives to trade on exchanges. Derivatives are one of the three main categories of financial instruments, the other two being stocks and debt. The oldest example of a derivative in history, attested to by Aristotle, is thought to be a contract transaction of olives, entered into by ancient Greek philosopher Thales, who made a profit in the exchange. Bucket shops, outlawed a century ago, are a more recent historical example.

In finance, the underlying of a derivative is an asset, basket of assets, index, or even another derivative, such that the cash flows of the (former) derivative depend on the value of this underlying. There must be an independent way to observe this value to avoid conflicts of interest.

Exchange-traded derivative contracts are standardized derivative contracts such as futures and options contracts that are transacted on an organized futures exchange. They are standardized and require payment of an initial deposit or margin settled through a clearing house. Since the contracts are standardized, accurate pricing models are often available. To understand which derivative is being traded a standardised naming convention has been developed by the exchanges, that shows the expiry month and strike price using special letter codes.

Derivatives such as futures contracts, Swaps (1970s-), Exchange-traded Commodities (ETC) (2003-), forward contracts have become the primary trading instruments in commodity markets. Futures are traded on regulated commodities exchanges. Over-the-counter (OTC) contracts are "privately negotiated bilateral contracts entered into between the contracting parties directly". [5] [6]

Swap (finance) financial derivative product

A swap is a derivative in which two counterparties exchange cash flows of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in question can be the periodic interest (coupon) payments associated with such bonds. Specifically, two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are accrued and calculated. Usually at the time when the contract is initiated, at least one of these series of cash flows is determined by an uncertain variable such as a floating interest rate, foreign exchange rate, equity price, or commodity price.

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]

An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds and generally operates with an arbitrage mechanism designed to keep it trading close to its net asset value, although deviations can occasionally occur. Most ETFs track an index, such as a stock index or bond index. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features.

The London bullion market is a wholesale over-the-counter market for the trading of gold and silver. Trading is conducted amongst members of the London Bullion Market Association (LBMA), loosely overseen by the Bank of England. Most of the members are major international banks or bullion dealers and refiners.

The World Gold Council is the market development organisation for the gold industry. It works across all parts of the industry, from gold mining to investment, and their aim is to stimulate and sustain demand for gold.

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.

Sumer Ancient civilization and historical region in southern Mesopotamia

Sumer is the earliest known civilization in the historical region of southern Mesopotamia, modern-day southern Iraq, during the Chalcolithic and Early Bronze ages, and one of the first civilizations in the world along with Ancient Egypt and the Indus Valley. Living along the valleys of the Tigris and Euphrates, Sumerian farmers were able to grow an abundance of grain and other crops, the surplus of which enabled them to settle in one place. Prehistoric proto-writing dates back before 3000 BC. The earliest texts, from c. 3300 BC, come from the cities of Uruk and Jemdet Nasr; early cuneiform script emerged around 3000 BC.

Clay A finely-grained natural rock or soil material that combines one or more clay minerals

Clay is a finely-grained natural rock or soil material that combines one or more clay minerals with possible traces of quartz (SiO2), metal oxides (Al2O3, MgO etc.) and organic matter. Geologic clay deposits are mostly composed of phyllosilicate minerals containing variable amounts of water trapped in the mineral structure. Clays are plastic due to particle size and geometry as well as water content, and become hard, brittle and non–plastic upon drying or firing. Depending on the soil's content in which it is found, clay can appear in various colours from white to dull grey or brown to deep orange-red.

Futures contract standardized legal agreement to buy or sell something (usually a commodity or financial instrument) at a predetermined price (“forward price”) at a specified time (“delivery date”) in the future

In finance, a futures contract is a standardized forward contract, a legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. The asset transacted is usually a commodity or financial instrument. The predetermined price the parties agree to buy and sell the asset for is known as the forward price. The specified time in the future—which is when delivery and payment occur—is known as the delivery date. Because it is a function of an underlying asset, a futures contract is a derivative product.

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.[ citation needed ]

Commodity money Money with value derived from composition from a commodity (such as silver or gold coins)

Commodity money is money whose value comes from a commodity of which it is made. Commodity money consists of objects that have value in themselves as well as value in their use as money.

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.[ citation needed ] In time, they were used for trading and were exchanged for other goods and commodities, or for payments of labor. [11] 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. [12]

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. [13] 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. [13]

The Amsterdam Stock Exchange, often cited as the first stock exchange, originated as a market for the exchange of commodities. Early trading on the Amsterdam Stock Exchange often involved the use of very sophisticated contracts, including short sales, forward contracts, and options. "Trading took place at the Amsterdam Bourse, an open aired venue, which was created as a commodity exchange in 1530 and rebuilt in 1608. Commodity exchanges themselves were a relatively recent invention, existing in only a handful of cities." [14]

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. [15] Successful commodity markets require broad consensus on product variations to make each commodity acceptable for trading, such as the purity of gold in bullion. [16] 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.[ citation needed ]

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." [17]

Reputation and clearing became central concerns, and states that could handle them most effectively developed powerful financial centers. [18]

Commodity price index

In 1934, the US 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." [19]

Commodity index fund

A commodity index fund is a fund whose assets are invested in financial instruments based on or linked to a commodity index. In just about every case the index is in fact a Commodity Futures Index. The first such index was the Commodity Research Bureau (CRB) Index, which began in 1958. Its construction made it unuseful as an investment index. The first practically investable commodity futures index was the Goldman Sachs Commodity Index, created in 1991, [20] and known as the "GSCI". The next was the Dow Jones AIG Commodity Index. It differed from the GSCI primarily in the weights allocated to each commodity. The DJ AIG had mechanisms to periodically limit the weight of any one commodity and to remove commodities whose weights became too small. After AIG's financial problems in 2008 the Index rights were sold to UBS and it is now known as the DJUBS index. Other commodity indices include the Reuters / CRB index (which is the old CRB Index as re-structured in 2005) and the Rogers Index.

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. [3]

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. [21]

Electronic commodities trading

In traditional stock market exchanges such as the New York Stock Exchange (NYSE), most trading activity took place in the trading pits in face-to-face interactions between brokers and dealers in open outcry trading. [22] In 1992 the Financial Information eXchange (FIX) protocol was introduced, allowing international real-time exchange of information regarding market transactions. The U.S. Securities and Exchange Commission ordered U.S. stock markets to convert from the fractional system to a decimal system by April 2001. Metrification, conversion from the imperial system of measurement to the metrical, increased throughout the 20th century. [23] Eventually FIX-compliant interfaces were adopted globally by commodity exchanges using the FIX Protocol. [24] In 2001 the Chicago Board of Trade and the Chicago Mercantile Exchange (later merged into the CME group, the world's largest futures exchange company) [23] launched their FIX-compliant interface.

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". [22] [notes 2]

Complexity and interconnectedness of global market

The robust growth of emerging market economies (EMEs, such as Brazil, Russia, India, and China), beginning in the 1990s, "propelled commodity markets into a supercycle". The size and diversity of commodity markets expanded internationally, [25] and pension funds and sovereign wealth funds started allocating more capital to commodities, in order to diversify into an asset class with less exposure to currency depreciation. [26]

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. [25]

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. [27]

The earliest commodity exchange-traded fund (ETFs), such as SPDR Gold Shares NYSE Arca :  GLD and iShares Silver Trust NYSE Arca :  SLV, actually owned the physical commodities. Similar to these are NYSE Arca :  PALL (palladium) and NYSE Arca :  PPLT (platinum). However, most Exchange Traded Commodities (ETCs) implement a futures trading strategy. At the time Russian Prime Minister Dmitry Medvedev warned that Russia could sink into recession. He argued that "We live in a dynamic, fast-developing world. It is so global and so complex that we sometimes cannot keep up with the changes". Analysts have claimed that Russia's economy is overly dependent on commodities. [28]

Contracts in the commodity market

A Spot contract is an agreement where delivery and payment either takes place immediately, or with a short lag. Physical trading normally involves a visual inspection and is carried out in physical markets such as a farmers market. Derivatives markets, on the other hand, require the existence of agreed standards so that trades can be made without visual inspection.

Standardization

US soybean futures, for something else, are of not being 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. [24]

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. [2]

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's 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. [29]

Agricultural futures contracts are the oldest, in use in the United States for more than 170 years. [30] Modern futures agreements, began in Chicago in the 1840s, with the appearance of the railroads. Chicago, centrally located, emerged as the hub between Midwestern farmers and east coast consumer population centers.

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. [31] [32]

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. [33]

Prior to the introduction of ETCs, by the 1990s ETFs pioneered by Barclays Global Investors (BGI) revolutionized the mutual funds industry. [33] By the end of December 2009 BGI assets hit an all-time high of $1 trillion. [34]

Gold was the first commodity to be securitised through an Exchange Traded Fund (ETF) in the early 1990s, but it was not available for trade until 2003. [33] The idea of a Gold ETF was first officially conceptualised by Benchmark Asset Management Company Private Ltd in India, when they filed a proposal with the Securities and Exchange Board of India in May 2002. [35] The first gold exchange-traded fund was Gold Bullion Securities launched on the ASX in 2003, and the first silver exchange-traded fund was iShares Silver Trust launched on the NYSE in 2006. As of November 2010 a commodity ETF, namely SPDR Gold Shares, was the second-largest ETF by market capitalization. [36]

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. [37] [38]

The earliest commodity ETFs, such as SPDR Gold Shares NYSE Arca :  GLD and iShares Silver Trust NYSE Arca :  SLV, actually owned the physical commodity (e.g., gold and silver bars). Similar to these are NYSE Arca :  PALL (palladium) and NYSE Arca :  PPLT (platinum). However, most ETCs implement a futures trading strategy, which may produce quite different results from owning the commodity.

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.[ citation needed ]

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. [39]

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. [40]

Contract for Difference (CFD)

A commodity contract for difference (CFD) is a derivative instrument that mirrors the price movements of the commodity underlying the contract.

Commodity CFDs are transacted worldwide (apart from the US) through regulated brokers. CFD investors can speculate on the price of a commodity moving higher (going long the CFD) or lower (going short the CFD). CFD investors do not actually own the commodity. Instead, they enter into a contract with a broker to capture the difference between the price of the commodity at the time that they transact the CFD and the price at the time they choose to exit. CFDs typically require the investor to put up margin of about 3-5% of the price of the underlying commodity contract.

For example; [41] Imagine you’re bullish on oil. You decide to acquire CFDs to capitalize on this. You can acquire a long contract for $60.50.

To buy 20 long CFDs on 3% margin, you would need $3,630 in your account ($60.50 [long price] x 20 [number of contracts] x 100 [number of barrels in a standard contract] x 0.03 [margin percent]). You would then “control” $121,000 worth of oil for your $3,630.

That afternoon, you notice the price is up to $62.50 to $62.75, so you exit the trade, which now has a value of $125,500. Your profit would be approximately $4,500 on the deal. Of course, had the market moved against you, the leverage can have the opposite impact and losses can be significant.

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. [3]

Largest commodities exchanges
ExchangeCountryVolume per month $M
CME Group USA$268,000,000 [42]
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-

Traded commodity classes

Top traded commodities
RankCommodityValue in US$ ('000)Date of
information
1Mineral fuels, oils, distillation products, etc.$2,183,079,9412012
2Electrical, electronic equipment$1,833,534,4142012
3Machinery, nuclear reactors, boilers, etc.$1,763,371,8132012
4Vehicles other than railway, tramway$1,076,830,8562012
5Plastics and articles thereof$470,226,6762012
6Optical, photo, technical, medical, etc. apparatus$465,101,5242012
7Pharmaceutical products$443,596,5772012
8Iron and steel$379,113,1472012
9Organic chemicals$377,462,0882012
10Pearls, precious stones, metals, coins, etc.$348,155,3692012

Source: International Trade Centre [43]

Energy

Energy commodities include crude oil particularly West Texas Intermediate (WTI) crude oil and Brent crude oil, natural gas, heating oil, ethanol and purified terephthalic acid. Hedging is a common practice for these commodities.

Crude oil and natural gas

For many years, West Texas Intermediate (WTI) crude oil, a light, sweet crude oil, was the world’s most-traded commodity. WTI is a grade used as a benchmark in oil pricing. It is the underlying commodity of Chicago Mercantile Exchange's oil futures contracts. WTI is often referenced in news reports on oil prices, alongside Brent Crude. WTI is lighter and sweeter than Brent and considerably lighter and sweeter than Dubai or Oman. [44]

From April through October 2012, Brent futures contracts exceeded those for WTI, the longest streak since at least 1995. [45]

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 NYMEX under trading symbol CL and through Intercontinental Exchange (ICE) under trading symbol WTI. Brent crude oil is traded in through Intercontinental Exchange under trading symbol B. Gulf Coast Gasoline is traded through NYMEX with the trading symbol of LR. Gasoline (reformulated gasoline blendstock for oxygen blending or RBOB) is traded through NYMEX via trading symbol RB. Propane is traded through NYMEX, a subsidiary of Intercontinental Exchange since early 2013, via trading symbol PN.

Natural gas is traded through NYMEX in units of 10,000 mmBTU with the trading symbol of NG. Heating oil is traded through NYMEX under trading symbol HO.

Others

Purified terephthalic acid (PTA) is traded through ZCE in units of 5 tons with the trading symbol of TA. Ethanol is traded at CBOT in units of 29,000 U.S. gal under trading symbols AC (Open Auction) and ZE (Electronic).

Metals

Precious metals

Precious metals currently traded on the commodity market include gold, platinum, palladium and silver which are sold by the troy ounce. One of the main exchanges for these precious metals is COMEX.

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. [46]

Industrial metals

Industrial metals are sold by the metric ton through the London Metal Exchange and New York Mercantile Exchange. The London Metal Exchange trades include copper, aluminium, lead, tin, aluminium alloy, nickel, cobalt and molybdenum. In 2007, steel began trading on the London Metal Exchange.

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. [47]

Agriculture

Agricultural commodities include grains, food and fiber as well as livestock and meat, various regulatory bodies define agricultural products. [48]

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. [49]

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. [50] [51]

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 (US inflation reached 11% in 1975)." [52]

Diamonds

As of 2012, diamond was not traded as a commodity. Institutional investors were repelled by campaign against "blood diamonds", the monopoly structure of the diamond market and the lack of uniform standards for diamond pricing. In 2012 the SEC reviewed a proposal to create the "first diamond-backed exchange-traded fund" that would trade on-line in units of one-carat diamonds with a storage vault and delivery point in Antwerp, home of the Antwerp Diamond Bourse. The exchange fund was backed by a company based in New York City called IndexIQ. IndexIQ had already introduced 14 exchange-traded funds since 2008. [46] [53] [notes 4]

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. [46]

Other commodity markets

Rubber trades on the Singapore Commodity Exchange in units of 1 kg priced in US cents. Palm oil is traded on the Malaysian Ringgit (RM), Bursa Malaysia in units of 1 kg priced in US cents. Wool is traded on the AUD in units of 1 kg. Polypropylene and Linear Low Density Polyethylene (LL) did trade on the London Metal Exchange in units of 1,000 kg priced in USD but was dropped in 2011.

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. [54]

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. [55]

European Union

Markets in Financial Instruments Directive (MiFID) is the cornerstone of the European Commission's Financial Services Action Plan that regulate operations of the EU financial service markets. It was reviewed in 2012 by the European Parliament (EP) and the Economic and Financial Affairs Council (ECOFIN). [56] The European Parliament adopted a revised version of Mifid II on 26 October 2012 which include "provisions for position limits on commodity derivatives", aimed at "preventing market abuse" and supporting "orderly pricing and settlement conditions". [57]

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. [57]

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". [58] 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. [59]

Trading systems

Software for managing trading systems has been available for several decades in various configurations. This includes software as a service. So-called Energy Trading Risk Management (ETRM) includes software such as Triple Point Technology, Pioneer Solutions, Sol Arc, and Open Link. [60] One of the more popular soft commodity solutions is called Just Commodity, based in Singapore this application caters to a large number of palm oil, edible oil, sugar and wheat trading businesses.[ citation needed ]

See also

Notes

  1. This article covers physical product (food, metals, energy) markets but not the ways that services, including those of governments, nor investment, nor debt, can be seen as a commodity. Articles on reinsurance markets, stock markets, bond markets, and currency markets cover those concerns separately and in more depth.
  2. 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.
  3. 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).
  4. 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.

Related Research Articles

Contango

Contango, also sometimes called forwardation, is a situation where the futures price of a commodity is higher than the anticipated spot price at maturity of the futures contract. In a contango situation, arbitrageurs/speculators, are "willing to pay more [now] for a commodity [to be received] at some point in the future than the actual expected price of the commodity [at that future point]. This may be due to people's desire to pay a premium to have the commodity in the future rather than paying the costs of storage and carry costs of buying the commodity today." On the other side of the trade, hedgers are happy to sell futures contracts and accept the higher-than-expected returns. A contango market is also known as a normal market, or carrying-cost market.

Futures exchange central financial exchange where people can trade standardized futures contracts

A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. These types of contracts fall into the category of derivatives. The opposite of the futures market is the spots market, where trades will occur immediately after a transaction agreement has been made, rather than at a predetermined time in the future. Futures instruments are priced according to the movement of the underlying asset. The aforementioned category is named "derivatives" because the value of these instruments are derived from another asset class.

New York Mercantile Exchange Commodity and futures exchange located in New York City, New York, United States

The New York Mercantile Exchange (NYMEX) is a commodity futures exchange owned and operated by CME Group of Chicago. NYMEX is located at One North End Avenue in Brookfield Place in the Battery Park City section of Manhattan, New York City. Additional offices are located in Boston, Washington, Atlanta, San Francisco, Dubai, London, and Tokyo.

A commodity price index is a fixed-weight index or (weighted) average of selected commodity prices, which may be based on spot or futures prices. It is designed to be representative of the broad commodity asset class or a specific subset of commodities, such as energy or metals. It is an index that tracks a basket of commodities to measure their performance. These indexes are often traded on exchanges, allowing investors to gain easier access to commodities without having to enter the futures market. The value of these indexes fluctuates based on their underlying commodities, and this value can be traded on an exchange in much the same way as stock index futures.

Gold as an investment

Of all the precious metals, gold is the most popular as an investment. Investors generally buy gold as a way of diversifying risk, especially through the use of futures contracts and derivatives. The gold market is subject to speculation and volatility as are other markets. Compared to other precious metals used for investment, gold has the most effective safe haven and hedging properties across a number of countries.

The Dalian Commodity Exchange (DCE) is a Chinese futures exchange based in Dalian, Liaoning province, China. It is a non-profit, self-regulating and membership legal entity established on February 28, 1993.

ETF Securities British asset management firm

ETF Securities is an asset management firm focused on exchange-traded funds (ETFs), exchange-traded commodities and exchange-traded currencies with offices in Jersey, London, New York, Sydney and Melbourne. The Company currently offers exchange-traded products listed or quoted on exchanges in Europe: London Stock Exchange, Deutsche Börse, Euronext, Swiss Exchange, Borsa Italiana and Euronext, in the Americas: NYSE and Bolsa Mexicana and Asia Pacific: ASX.

A benchmark crude or marker crude is a crude oil that serves as a reference price for buyers and sellers of crude oil. There are three primary benchmarks, West Texas Intermediate (WTI), Brent Blend, and Dubai Crude. Other well-known blends include the OPEC Reference Basket used by OPEC, Tapis Crude which is traded in Singapore, Bonny Light used in Nigeria, Urals oil used in Russia and Mexico's Isthmus. Energy Intelligence Group publishes a handbook which identified 195 major crude streams or blends in its 2011 edition.

A commodity broker is a firm or an individual who executes orders to buy or sell commodity contracts on behalf of the clients and charges them a commission. A firm or individual who trades for his own account is called a trader. Commodity contracts include futures, options, and similar financial derivatives. Clients who trade commodity contracts are either hedgers using the derivatives markets to manage risk, or speculators who are willing to assume that risk from hedgers in hopes of a profit.

The Dubai Mercantile Exchange (DME) is a commodity exchange based in Dubai currently listing its flagship futures contract, DME Oman Crude Oil Futures Contract (OQD). Launched in 2007, the DME aims to become the crude oil pricing benchmark for the Asian market with its Oman Crude Oil contract, like the Intercontinental Exchange’s (ICE) North Sea Brent is to Europe and the New York Mercantile Exchange’s (NYMEX) West Texas Intermediate is to North America.

Multi Commodity Exchange Commodity exchange located in Mumbai, India

Multi Commodity Exchange of India Ltd (MCX) is an independent commodity exchange based in India. It was established in 2003 and is based in Mumbai. It is India's largest commodity derivatives exchange where the clearance and settlements of the exchange happens and the turnover of the exchange for quarter ended September 2018 was 1.78 billion rupees. MCX offers options trading in gold and futures trading in non-ferrous metals, bullion, energy, and a number of agricultural commodities.

An inverse exchange-traded fund is an exchange-traded fund (ETF), traded on a public stock market, which is designed to perform as the inverse of whatever index or benchmark it is designed to track. These funds work by using short selling, trading derivatives such as futures contracts, and other leveraged investment techniques.

In May 2006, Deutsche Bank launched a new set of commodity index products called the Deutsche Bank Liquid Commodities Indices Optimum Yield, or DBLCI-OY. The DBLCI-OY indices are available for 24 commodities drawn from the energy, precious metals, industrial metals, agricultural and livestock sectors. A DBLCI-OY index based on the DBLCI benchmark weights is also available and the optimum yield technology has also been applied to the energy, precious metals, industrial metals and agricultural sector indices. Like the DBLCI, the DBLCI-OY is available in USD, EUR, GBP and JPY on a hedged and un-hedge basis. The DBLCI-OY is rebalanced on the fifth index business day of November when each commodity is adjusted to its base weight. The DBLCI-OY is also listed as an exchange-traded fund (ETF) on the American Stock Exchange.

LCH is a British clearing house that serves major international exchanges, as well as a range of OTC markets. Based on 2012 figures LCH cleared approximately 50% of the global interest rate swap market, and is the second largest clearer of bonds and repos in the world, providing services across 13 government debt markets. In addition, LCH clears a broad range of asset classes including: commodities, securities, exchange traded derivatives, credit default swaps, energy contracts, freight derivatives, interest rate swaps, foreign exchange and Euro and Sterling denominated bonds and repos.

Silver exchange-traded products are exchange-traded funds (ETFs), exchange-traded notes (ETNs) and closed-end funds (CEFs) that aim to track the price of silver. Silver exchange-traded products are traded on the major stock exchanges including the London and New York Stock Exchanges. The U.S Geological Survey cites the emergence of silver ETFs as a significant factor in the 2007-2011 price rise of silver. As of September 2011, the largest of these funds holds the equivalent of over one third of the world's total annual silver production.

Iran Mercantile Exchange (IME) is a commodities exchange located in Tehran, Iran. It was founded in 2006. IME trades in agricultural, industrial and petrochemical products in the spot and futures markets. It is mainly a domestic or regional market with the ambition to become more international in the future. As of 2014, about one fourth of IME's commodities were exported. IME offers a variety of services, including providing access to the initial offering of commodities, pricing for Iran’s Over-the-Counter (OTC), secondary markets and end users, providing a venue for government sales and procurement purchases, facilitating a trading platform and user interface, providing clearing & settlement services, risk management, technology services, and training of market participants.

The Canadian Crude Oil Index (CCI) serves as a benchmark for oil produced in Canada. It allows investors to track the price, risk and volatility of the Canadian commodity.

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Further reading