What is a Commodity Market?
- A commodity market is a place where raw resources or basic goods can be bought, sold, or traded. Hard and soft commodities are two major categories into which commodities are frequently divided. Soft commodities are agricultural goods or livestock, such as corn, wheat, coffee, sugar, soybeans, and pork, whereas hard commodities are natural resources that must be mined or exploited, such as gold, rubber, and oil.
- Traders and investors buy and sell commodities in the commodity market.
- Two categories of commodities can be distinguished:
- Natural resources such as corn, wheat, sugar, crude oil, and natural gas are all created by nature. These are known as raw commodities. The quantity of raw items, such as maize, soybeans, and orange juice, is often expressed in physical units like bushels or tons.
- The commodity that has been processed includes “soft” commodities like coffee and chocolate as well as energy, metals, and animals.
- Both the spot market and the futures market are available for trading commodities. On the spot market, the buyer immediately pays the item’s current spot price. In futures markets, people buy contracts that guarantee them items at a specified price in the future.
22 separate commodities exchanges have been established in India under the aegis of the Forward Markets Commission. In India, there are 4 widely used commodities exchanges for trading:
- Indian Commodity Exchange (ICEX)
- Indian National Multi Commodity Exchange (NMCE)
- Multi Commodity Exchange of India (MCX)
- NADEX (National Derivative Exchange) (NCDEX)
Commodity market and its meaning
Producers and buyers of commodity goods can access them in a centralized, liquid market thanks to commodities markets. These market participants can insure future demand or output by using commodity derivatives. In these marketplaces, speculators, investors, and arbitrageurs all actively participate. A wide range of commodities can be used as an alternative asset class to diversify a portfolio and some commodities, like precious metals, have been considered to be ideal inflation hedges. Some investors also turn to commodities during times of market turbulence because the prices of commodities frequently move counter to those of stocks.
Trading in commodities used to be primarily the domain of professional traders and needed significant amounts of time, money, and knowledge.
Commodity market definition
- The commodity market has developed over time and is far older than the financial money market. Barter trading, in which farmers and customers would exchange goods like food grains, was the earliest kind of trading that humanity was aware of. Early in the 16th century, a full-fledged commodity market was established in Amsterdam.
- The cost of commodities exchanged on the commodity market is quite complicated and is based on the qualities of the individual. For products like wheat and barley, for instance, there is a storage cost in addition to the forces of supply and demand. The expense of storage is necessary because these goods need suitable storage facilities to protect them from natural disasters or during transportation.
- A commodity must meet a number of requirements in order to be eligible for trade on commodity exchanges. These traits include open supply, price volatility, homogeneity, and durability.
- Although the underlying instrument in the commodity market is different from that in the money markets, the fundamental principles of trading are essentially the same. Spot price, future price, expiry, and strike price all roughly refer to the same thing.
- Though generally speaking, the commodity market deals in generic goods like wheat or coffee, throughout time it has expanded to also contain some specialized products. Although these diversified goods are commonplace commodities, they have certain unusual features.
- Gasoline is a good example of a generic commodity for high-octane fuel.
- Compared to financial assets, commodities are very erratic investments. They are influenced by natural phenomena like floods or tragedies in addition to geopolitical conflicts, economic expansions, and recessions.
- The London Metal Exchange, Dubai Mercantile Exchange, Chicago Board of Trade, and Multi Commodities Exchange are the principal commodity exchanges in the world.
Commodity market concept
- When the cost of a traded good changes, the cost of the related future contracts also does. Take crude oil as an example, whose prices are best determined by supply and demand. The major oil-producing countries in the Middle East tried to control the price of crude oil by limiting supply. In the real world, other factors, such as the main geopolitical element, also have an impact on oil prices.
- For instance, the 2008 financial crisis saw a decline in global growth, which should have caused oil futures prices to sharply decline. That wasn’t really the case, though, as oil futures were trading at a record high of $ 145 a barrel. This was mostly a result of investors pulling money out of equities markets to invest in commodities and futures contracts.
- There are two primary participants in the commodity market, which are speculators and hedgers. Traders that engage in speculation regularly monitor commodity prices in order to forecast future price movements. If they anticipate that the price will rise, they buy a commodity contract and immediately sell them when the price does.
- Similar to this, they sell their commodities contracts when they anticipate a decline in price and then repurchase them later. Every speculator’s main goal is to make a significant profit in any kind of market.
- Hedgers are typically producers and manufacturers who use the commodity futures market to hedge their risks. Suppose a farmer can hedge his position if he anticipates price swings while crop harvesting is taking place. He will sign the futures contract in order to shield himself from the risk.
- If the market price of the crop declines, the farmer can make up all of the lost revenue by forecasting future market earnings. Similar to the last example, if crop prices increase while the crop is being harvested, the farmer may experience a loss in the future market; however, he might make up for it by selling his product for a higher price in the local market.