Modern commodity exchanges have humble origins in the agricultural community. The first commodity market in the United States began when the Chicago Board of Trade opened in 1848. It gave buyers and sellers a convenient and supervised trading arena. Soon contracts for future sales replaced cash deals for actual goods. In recent years — as of the date of publication — rising demand for raw materials in developing nations has increased prices and spurred interest in commodities as investments.
Goods and Markets
Commodities markets include all types of raw materials. In addition to traditional products such as grain and cattle, commodity exchanges deal in metals, coffee, sugar, gasoline and oil. A number of markets worldwide facilitate the buying and selling of these materials. They include the London Metals Exchange, the Chicago Board of Trade, the Chicago Mercantile Exchange, the New York Mercantile Exchange and the Bolsa de Mercadorias & Futuros in Brazil.
In modern commodities markets, the farmer or producer agrees in a contract to sell his product for a particular price at a set time in the future. This agreement, called a futures contract, helps protect against price changes. For example, if a farmer locks in the price of his wheat six months ahead, he is guaranteed that price even if a bumper harvest causes prices to go down by that time. Similarly, if a bread maker buys a six-month futures contract for wheat, he locks in the price. If the price goes up after six months, the bread maker stills gets the wheat for the lower price.
Speculators or traders often buy futures contracts hoping to resell them for a profit before the delivery date.They act as middlemen between farmers and end users. For example, a trader buys a six-month contract for wheat. If wheat goes up during that period, she resells the contract to a bread maker at a profit. If wheat prices goes down, she sells to a bread maker at a loss. She buys and sells only the contracts since she has no use for bushels of wheat.
Commodities as Investments
Commodities are volatile, meaning their prices often experience wide swings. For this reason, commodity futures are considered high-risk investments. Although commodity investors sometimes earn huge returns, they also can suffer great losses. Commodities help hedge against inflation and against wars and other crises. They also hedge against stock and bond losses because they usually move opposite to such investments. Investors do not have to speculate directly in commodities by trading in the actual futures. They may also choose indirect alternatives, such as commodity funds. Broad commodity index funds, for example, strive to minimize the risks of investing in any one commodity.
- Comstock/Comstock/Getty Images