History

The modern commodity markets have their roots in the trading of agricultural products.
While wheat and corn, cattle and pigs, were widely traded using standard instruments in
the 19th century in the United States, other basic foodstuffs such as soybeans were only
added quite recently in most markets.[citation needed] For a commodity market to be
established, there must be very broad consensus on the variations in the product that
make it acceptable for one purpose or another.

The economic impact of the development of commodity markets is hard to overestimate.

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."[citation needed]

[edit] Early history of commodity markets

Historically, dating from ancient Sumerian use of sheep or goats, other peoples using
pigs, rare seashells, or other items as commodity money, people have sought ways to
standardize and trade contracts in the delivery of such items, to render trade itself more
smooth and predictable.[citation needed]

Commodity money and commodity markets in a crude early form are believed to have
originated in Sumer where small baked clay tokens in the shape of sheep or goats were
used in trade. Sealed in clay vessels with a certain number of such tokens, with that
number written on the outside, they represented a promise to deliver that number. This
made them a form of commodity money - more than an I.O.U. but less than a guarantee
by a nation-state or bank. However, they were also known to contain promises of time
and date of delivery - this made them like a modern futures contract. Regardless of the
details, it was only possible to verify the number of tokens inside by shaking the vessel or
by breaking it, at which point the number or terms written on the outside became subject
to doubt. Eventually the tokens disappeared, but the contracts remained on flat tablets.
This represented the first system of commodity accounting.[citation needed]

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.
Considering the many hazards of climate, piracy, theft and abuse of military fiat by rulers
of kingdoms along the trade routes, it was a major focus of these civilizations to keep
markets open and trading in these scarce commodities. Reputation and clearing became
central concerns, and the states which could handle them most effectively became very
powerful empires, trusted by many peoples to manage and mediate trade and commerce.
[citation needed]

[edit] Size of the market

The trading of commodities consists of direct physical trading and derivatives trading.
Exchange traded commodities have seen an upturn in the volume of trading since the start
of the decade. This was largely a result of the growing attraction of commodities as an
asset class and a proliferation of investment options which has made it easier to access
this market.

The global volume of commodities contracts traded on exchanges increased by a fifth in

2010, and a half since 2008, to around 2.5 billion million contracts. During the three
years up to the end of 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 value outstanding in the previous three
years. Trading on exchanges in China and India has gained in importance in recent years
due to their emergence as significant commodities consumers and producers. China
accounted for more than 60% of exchange-traded commodities in 2009, up on its 40%
share in the previous year.

Commodity assets under management more than doubled between 2008 and 2010 to
nearly $380bn. Inflows into the sector totalled over $60bn in 2010, the second highest
year on record, down from the record $72bn allocated to commodities funds in 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.[1]

[edit] Commodities trading

[edit] Spot trading

Spot trading is any transaction where delivery either takes place immediately, or with a
minimum lag between the trade and delivery due to technical constraints. Spot trading
normally involves visual inspection of the commodity or a sample of the commodity, and
is carried out in markets such as wholesale markets. Commodity markets, on the other
hand, require the existence of agreed standards so that trades can be made without visual
inspection.

[edit] Forward contracts

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 today. The fixed price today is
known as the forward price.

[edit] Futures contracts

A futures contract has the same general features as a forward contract but is transacted
through a futures exchange.
Commodity and futures contracts are based on what’s termed forward contracts. Early on
these forward contracts — agreements to buy now, pay and deliver later — were used as
a way of getting products from producer to the consumer. These typically were only for
food and agricultural products. Forward contracts have evolved and have been
standardized into what we know today as futures contracts. Although more complex
today, early forward contracts for example, were used for rice in seventeenth century
Japan. Modern forward, or futures agreements, began in Chicago in the 1840s, with the
appearance of the railroads. Chicago, being centrally located, emerged as the hub
between Midwestern farmers and producers and the east coast consumer population
centers.

In essence, a futures contract is a standardized forward contract in which the buyer and
the seller accept the terms in regards to product, grade, quantity and location and are only
free to negotiate the price.[2]

[edit] Hedging

Hedging, a common (and sometimes mandatory[citation needed]) practice of farming

cooperatives, insures against a poor harvest by purchasing futures contracts in the same
commodity. If the cooperative has significantly less of its product to sell due to weather
or insects, it makes up for that loss with a profit on the markets, since the overall supply
of the crop is short everywhere that suffered the same conditions.

Whole developing nations may be especially vulnerable, and even their currency tends to
be tied to the price of those particular commodity items until it manages to be a fully
developed nation. For example, one could see the nominally fiat money of Cuba as being
tied to sugar prices[citation needed], since a lack of hard currency paying for sugar means less
foreign goods per peso in Cuba itself. In effect, Cuba needs a hedge against a drop in
sugar prices, if it wishes to maintain a stable quality of life for its citizens.[citation needed]

[edit] Delivery and condition guarantees

In addition, delivery day, method of settlement and delivery point must all be specified.
Typically, trading must end two (or more) business days prior to the delivery day, so that
the routing of the shipment can be finalized via ship or rail, and payment can be settled
when the contract arrives at any delivery point.

[edit] Standardization
U.S. soybean futures, for example, are of 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)," and 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, feedstuffs, fruits, vegetables, other grains, other beans, hay, other
livestock, meats, poultry, eggs, or any other commodity which is so traded.

[edit] Regulation of commodity markets

Cotton, kilowatt-hours of electricity, board feet of wood, long distance minutes, royalty
payments due on artists' works, and other products and services have been traded on
markets of varying scale, with varying degrees of success.[citation needed]

Generally, commodities' spot and forward prices are solely dependent on the financial
return of the instrument, and do not factor into the price any societal costs, e.g. smog,
pollution, water contamination, etc. Nonetheless, new markets and instruments have been
created in order to address the external costs of using these commodities such as man-
made global warming, deforestation, and general pollution. For instance, many utilities
now trade regularly on the emissions markets, buying and selling renewable emissions
credits and emissions allowances in order to offset the output of their generation
facilities. While many have criticized this as a band-aid solution, others point out that the
utility industry is the first to publicly address its external costs. Many industries,
including the tech industry and auto industry, have done nothing of the sort.

In the United States, the principal regulator of commodity and futures markets is the
Commodity Futures Trading Commission but it is the National Futures Association that
enforces rules and regulations put forth by the CFTC.

[edit] Oil

Building on the infrastructure and credit and settlement networks established for food and
precious metals, many such markets have proliferated drastically in the late 20th century.
Oil was the first form of energy so widely traded, and the fluctuations in the oil markets
are of particular political interest.

Some commodity market speculation is directly related to the stability of certain states,
e.g. during the Persian Gulf War, speculation on the survival of the regime of Saddam
Hussein in Iraq. Similar political stability concerns have from time to time driven the
price of oil.

The oil market is an exception. Most markets are not so tied to the politics of volatile
regions - even natural gas tends to be more stable, as it is not traded across oceans by
tanker as extensively.

[edit] Commodity markets and protectionism

Developing countries (democratic or not) have been moved to harden their currencies,
accept IMF rules, join the WTO, and submit to a broad regime of reforms that amount to
a hedge against being isolated. China's entry into the WTO signalled the end of truly
isolated nations entirely managing their own currency and affairs. The need for stable
currency and predictable clearing and rules-based handling of trade disputes, has led to a
global trade hegemony - many nations hedging on a global scale against each other's
anticipated protectionism, were they to fail to join the WTO.

There are signs, however, that this regime is far from perfect. U.S. trade sanctions against
Canadian softwood lumber (within NAFTA) and foreign steel (except for NAFTA
partners Canada and Mexico) in 2002 signalled a shift in policy towards a tougher regime
perhaps more driven by political concerns - jobs, industrial policy, even sustainable
forestry and logging practices.