Understanding the Commodity Market
What is Commodity Market?
- Commodity markets are markets where raw or primary products are exchanged.
- It covers physical product (food, metals, and electricity) markets but not the ways that services, including those of governments, nor investment nor debt, can be seen as a commodity.
History of Commodity Market
- Modern Commodity Market has their roots in the trading of agricultural products.
- Wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th century in the United States.
- Historically, in ancient time’s Sumerian use of sheep or goats, or other peoples using pigs, rare seashells, or other items as commodity money, have traded contracts in the delivery of such items, to render trade itself more smooth and predictable.
List of Traded Commodity
- Agricultural products (Grains, and Food and Fiber)
- Livestock & Meat
- Precious metals
- Industrial metals
What are Commodity Futures?
- A Financial Contract
- The underlying commodity is bought or sold at a future date
- A tool used by Investors, Hedgers, Arbitrageurs, Day Traders
- Commodity and Futures contracts are similar as “Forward” Contracts.
- Early days “future” contracts were used as a way of getting products from producer to the consumer.
- These typically were only for food and agricultural Products. Now it is used for every metal.
- Future contract for commodity trading and for share trading is all different from one another.
Why Futures Trading in Commodity?
- Portfolio diversification and risk management
- Additional investment opportunity
- Low cost business
- No Transportation, storage, insurance, security charges
- Low Margins – High leverage
- Intrinsic value of the commodity
- Domain knowledge of industry
- Hedging/ Arbitrage
Purpose of Futures Market
- Meet the needs of three groups of future market users
- Those who wish to discover information about future prices of commodities (suppliers)
- Those who wish to speculate (speculators)
- Those who wish to transfer risk to some other party (hedgers)
- Those who want to take advantage of price difference in different markets (Arbitrageurs)
Commodity Futures Market participants.
- Hedgers, Producers
- Farmers, Consumers
- Refineries, Food processing companies
- Institutional proprietary traders
- Brokerage houses
- Spot Commodity traders
- Arbitrageurs vBrokerage houses vInvestors
All exchanges have both cash and delivery settlement systems. If one wants the contract be delivered in cash, he must indicate this at the time of placing the order. If one opts for delivery of the commodity, he must have the necessary warehouse receipts. Sales tax may applicable on delivery, however it is the seller’s responsibility to collect and pay this tax
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