Commodity Trading

Commodity Trading

Commodity futures markets provide a means for the organized trading of contracts for the delivery of goods at a later date. Today, these include agricultural products, metals, forest products, petroleum products, interest rates and stocks. The first futures markets were developed to handle the problems created by the seasonal productions of grains. Grain is harvested in a short time period and needs to be stored for use throughout the rest of the year. This creates the potential for oversupply at harvest time and the threat of shortages before the next harvest is produced. At harvest, growers often faced a market glutted with supplies. As a result, prices could be severely depressed. Merchandisers, on the other hand, faced the problem of supplying their customers with a regular flow of grain despite the uncertainty about the amount of grain farmers would be selling and the timing of those sales. Futures markets give growers the ability to establish a price for their crop long before it is actually sold, and give merchandisers and processors assurance of both price and supplies throughout the crop year.

The first futures market was established in 1730 in Osaka, Japan. In the 1860s futures trading began in Chicago to market the expanding production of the American plains, and in 1904 Canada's first futures market was established at what is now the Winnipeg Commodity Exchange. The Toronto Futures Exchange was established in 1980, sharing a trading floor with the Toronto Stock Exchange, and the Montreal Exchange established a futures market for lumber in 1984, but that contract has been dormant since 1986. In Toronto, futures contracts are traded for Canadian government bonds and Treasury bills and for a Canadian stock index. Trading volume in 1997 totalled 317 408 contracts. In Winnipeg, futures contracts are traded for canola, flaxseed and rye for international consumption, and for wheat, oats and barley for the domestic livestock feeding industry. In addition the Winnipeg market also has futures markets for gold and silver. The trading volume in 1992 totalled 2 462 922 contracts.

In the US the world's largest futures markets are located in Chicago and New York, and there are also markets in Kansas City and Minneapolis. Important markets also exist in Europe, Asia, Australia and South America.

Commodity futures markets exist to provide a way to gain protection against the risk that prices will change. Commodity prices are determined by supply and demand. These, in turn, are affected by such unpredictable factors as weather, government policies, transportation and production and consumption decisions throughout the world. As a result, commodities are subject to large and unpredictable price changes. The commodity futures market gives commercial producers, merchandisers and processors the ability to protect themselves against the risk of price change through a process called hedging. Hedging makes it possible for risks to be managed and it reduces the cost of marketing commodities.

These commercial elements are the major users of futures markets. As examples, large borrowers such as corporations, and large lenders such as pension funds face the risk that interest rates will change before they are ready to sell bonds or to invest funds. They can guard against this risk by taking positions in the interest rates futures market. In the same way, farmers pay the cost of seeding a crop at least 4 months, and often as long as 15 months, before they will be able to sell their production. The futures market provides them with an opportunity to protect their selling price against the uncertainties of the international grain market.

In addition to the commercial producers and users of commodities, futures markets are also attractive to speculators, who attempt to profit by predicting the direction of commodity price movements. In the process they provide the essential function of taking on the risk that commercial hedgers are trying to avoid.