The term 'commodity' is usually understood to mean futures contracts on physical assets such as metals, energy, grains, livestock, food and fibre. These products are traded on a futures basis with the futures contracts being listed on various exchanges such as the Chicago Board of Trade and Chicago Mercantile Exchange.
A commodity futures contract represents an agreement to buy or sell a specific type and grade of commodity for delivery at a specific time in the future at an agreed upon place at a market-determined price. In reality, commodity futures rarely lead to the delivery of an actual product, because the contract positions are typically closed out before the delivery date.
The futures markets were developed initially to help agricultural producers and consumers manage the price risks they faced harvesting, marketing and processing food crops each year. The modern futures industry still serves those markets.
The world's oldest established futures exchange, the Chicago Board of Trade, was founded in 1848 by 82 Chicago merchants. The first of what were then called "to arrive" contracts were flour, timothy seed and hay, which came into use in 1849. "Forward" contracts on corn came into use in 1851 and gained popularity among merchants and food processors. Meanwhile, what is now the nation's largest futures exchange, the Chicago Mercantile Exchange, was founded as the Chicago Butter and Egg Board in 1898.
Types of Commodity Futures
The main categories of contracts fall under the following headings: metals, energy, grains, livestock, and food and fibre.
The major metals futures contracts include copper, gold, platinum, palladium and silver. Their uses include industrial purposes, in construction, and for jewellry. Geopolitical and economic factors in the dominant producing and consuming countries affect price action, but each also has its own unique fundamental influences. For example, gold has long been used as a hedge against political and economic uncertainties, and many central banks back their currency with gold reserves.
The most popular energy futures contracts are crude oil, gasoline, heating oil and natural gas. These natural resource markets have become one of the most important gauges of world economic and political developments, and are therefore heavily influenced by disruptions in producing nations. The value of the U.S. dollar is significant because much of the world's crude is priced in dollars. U.S. energy prices are also quite sensitive to statistical reports detailing production, imports and especially stocks. These markets are also subject to seasonal fluctuations - mild weather may lessen the need for heating oil, while summer tends to bring greater gasoline demand for driving season.
Grains and soybeans are essential to food and feed supplies, and prices are especially sensitive to weather conditions in growing areas at key times during a crop's development and to economic conditions that affect demand. The major futures contracts in this category are corn, soybeans, soybean oil, soybean meal and wheat. Reports from the U.S. Department of Agriculture are closely watched, and summarise key factors influencing supply and demand including current production and carryover supply from the prior season. Each product has its own unique fundamental factors, depending on their use for human or animal consumption, or for industrial needs.
Futures on live cattle, feeder cattle, lean hogs and pork bellies are all traded at the Chicago Mercantile Exchange. Their prices are affected by consumer demand, competing protein sources, price of feed, and factors that influence the number of animals born and sent to market, such as disease and weather.
Food and Fiber
The food and fiber category includes cocoa, coffee, cotton, frozen concentrated orange juice (FCOJ) and sugar. In addition to global consumer demand, the usual growing factors such as disease, insects and drought affect prices for all of these commodities. FCOJ prices, however, are particularly sensitive to weather conditions. International exchange rates also affect all of these global products, as well as factors like tariffs and geopolitical events in producing nations.
The same principles of fundamental and / or technical analysis are often applied in making decisions in trading commodities, with many traders using a combination of both.
Links Between Financial and Commodity Markets
Economic and geo-political factors do not have effects on one market in isolation. There is usually a highly complex (and sometimes unpredictable) interactive effect on the different markets from a change in a significant factor. For example, if the Federal Reserve Bank puts interest rates up, there might be a movement of a higher proportion of investor funds into Treasury Bonds (typically seen as a safe investment in times of volatility). The resulting increase in the demand for US Dollars might then have the effect of strengthening the US Dollar, thus making prices of goods in the US more expensive, which could then have a negative effect on the US equity markets. Given that commodities such as gold and oil are also typically priced in US Dollars, there are also likely to be price moves in these commodities as a result. Please note that the above is an example only, and it may be that other factors may also affect prices.