A commodity market is a market that trades in primary economic sector rather than manufactured products. Soft commodities are agricultural products such as wheat , coffee , cocoa and sugar. Hard commodities are mined, such as gold and oil. Futures contracts are the oldest way of investing in commodities. Futures are secured by physical assets. Farmers have used a simple form of derivative trading in the commodity market for centuries for price risk management.
A financial derivative is a financial instrument whose value is derived from a commodity termed an underlier. 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.
Derivatives such as futures contracts, Swaps s- , Exchange-traded Commodities ETC , 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". Exchange-traded funds ETFs began to feature commodities in 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. Commodity-based money and commodity markets in a crude early form are believed to have originated in Sumer between BC and 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. 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. 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.
In time, they were used for trading and were exchanged for other goods and commodities, or for payments of labor. Gold's scarcity, unique density and the way it could be easily melted, shaped, and measured made it a natural trading asset. 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.
Indeed, 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.
Commodity exchanges themselves were a relatively recent invention, existing in only a handful of cities. In , 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 s and s, expanding the list from grains to include rice, mill feeds, butter, eggs, Irish potatoes and soybeans.
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.
Reputation and clearing became central concerns, and states that could handle them most effectively developed powerful financial centers. In , the US Bureau of Labor Statistics began the computation of a daily Commodity price index that became available to the public in By , 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. 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 Its construction made it unuseful as an investment index. The first practically investable commodity futures index was the Goldman Sachs Commodity Index , created in ,  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 the Index rights were sold to UBS and it is now known as the DJUBS index. Cash commodities or "actuals" refer to the physical goods—e.
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. 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. Securities and Exchange Commission ordered U. Metrification , conversion from the imperial system of measurement to the metrical , increased throughout the 20th century.
By , 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". The robust growth of emerging market economies EMEs, such as Brazil, Russia, India, and China , beginning in the s, "propelled commodity markets into a supercycle".
The size and diversity of commodity markets expanded internationally,  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.
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In , as emerging-market economies slowed down, commodity prices peaked and started to decline. From through , energy and metals' real prices remained well above their long-term averages. In , real food prices were their highest since The price of gold bullion fell dramatically on 12 April 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.
SLV , actually owned the physical commodities. 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. 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.
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. Non-screened, stored in silo ". They are of "deliverable grade" if they are "GMO or a mixture of GMO and Non-GMO No. 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 when the Chicago Mercantile Exchange launched a FIX-compliant interface that was adopted by commodity exchanges around the world.
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 s- , Exchange-traded Commodities ETC , forward contracts, etc. 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.
A forward contract is an agreement between two parties to exchange at some fixed future date a given quantity of a commodity for a price defined when the contract is finalized. The fixed price is known as the forward price. 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.
Agricultural futures contracts are the oldest, in use in the United States for more than years. Chicago, centrally located, emerged as the hub between Midwestern farmers and east coast consumer population centers. 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 s. 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. 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 , combined with record low inventories and increasing demand from emerging markets such as China and India.
Prior to the introduction of ETCs, by the s ETFs pioneered by Barclays Global Investors BGI revolutionized the mutual funds industry.
Gold was the first commodity to be securitised through an Exchange Traded Fund ETF in the early s, but it was not available for trade until As of November a commodity ETF, namely SPDR Gold Shares , was the second-largest ETF by market capitalization. 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 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 They may, however, be subject to regulation by the Commodity Futures Trading Commission.
SLV , actually owned the physical commodity e. 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.
ETCs in China and India gained in importance due to those countries' emergence as commodities consumers and producers. 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. The bulk of funds went into precious metals and energy products.
The growth in prices of many commodities in contributed to the increase in the value of commodities funds under management. 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.
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. International Trade Centre . 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.
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.
From April through October , Brent futures contracts exceeded those for WTI, the longest streak since at least 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. Most commodities markets are not so tied to the politics of volatile regions.
Oil and gasoline are traded in units of 1, barrels 42, 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 , via trading symbol PN. Natural gas is traded through NYMEX in units of 10, mmBTU with the trading symbol of NG. Heating oil is traded through NYMEX under trading symbol HO. 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, U. 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. 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 , 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 , other banks quickly followed. Since then the size of the market has more than doubled each year between and Agricultural commodities include grains, food and fiber as well as livestock and meat, various regulatory bodies define agricultural products. On 21 July , 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.
In February , 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.
In , corn acreage was double that of wheat in the United States. But from the s through the s soybean acreage surpassed corn. Early in the s grain and soybean prices, which had been relatively stable, "soared to levels that were unimaginable at the time.
As of , 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 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 Like gold, diamonds are easily authenticated and durable. 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 and is the futures industry's self-regulatory organization.
The NFA's first regulatory operations began in and fall under the Commodity Exchange Act of the Commodity Futures Trading Commission Act. Dodd-Frank was enacted in response to the financial crisis.
It called for "strong measures to limit speculation in agricultural commodities" calling upon the Commodity Futures Trading Commission CFTC to further limit positions and to regulate over-the-counter trades. 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 by the European Parliament EP and the Economic and Financial Affairs Council ECOFIN. The European Securities and Markets Authority Esma , based in Paris and formed in , is an "EU-wide financial markets watchdog".
Esma sets position limits on commodity derivatives as described in Mifid II. The EP voted in favor of stronger regulation of commodity derivative markets in September to "end abusive speculation in commodity markets" that were "driving global food prices increases and price volatility". In July , "food prices globally soared by 10 percent" World Bank 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".
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 , Sol Arc , Open Link and Gibbon. Commodities trading is usually learned on the job.
Typical path of physical commodity trader leads from apprenticeship through traffic department where prospective trader learns on logistics - a key driver in price determination to a trading desk. There are attempts to teach physical commodities trading outside of the job. They are actively supported by the sector lacking candidates prepared to enter the workforce. To the most recognized belong: University of Geneva and Commodities Academy in London.
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Exchange Traded Commodities, sold first by pioneering investors group Barclays Global Investors BGI now owned by BlackRock revolutionized the commodity market. 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 as representatives of IndexIQ Advisors LLC sponsoring the IQ Physical Diamond Trust.
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Archived from the original on 17 September Retrieved 17 April Retrieved 16 March A Trader's First Book on Commodities. Financial derivatives, liberal states, and transformative capacity PDF.
Their Purpose, Their History, Their Growth, Their Successes and Failures". Journal of Futures Markets. The London Bullion Market Association Top 25 ETFs By Market Cap". Retrieved 3 November Barclays Halts Issuance of Natural Gas ETN". Retrieved 26 September Historical Dictionary of the Petroleum Industry. The New York Times. Olsen US 1 Commodity Futures Trading Commission Office of Public Affairs.
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