U.S. investors have been trading in the commodity markets for more than 150 years, and there's evidence that commodity trading began in 18th century Japan. The commodities industry includes simple goods and the manufacturing of goods that make up the basis of our food supply. Most commodities come from agricultural, energy, or metals producers. Common examples of U.S. commodities include corn, soybeans, gold, and natural gas.
Commodity exchanges serve a vital role in the economy, and without them, it's unlikely that the U.S. would have experienced as much economic growth throughout the 20th century. The purpose of exchanges is to provide a centralized marketplace where commodity producers—the commercials—can sell their commodities to those who want to use them for manufacturing or consumption.
The beauty of a commodity futures exchange is that it makes it easy to connect buyers and sellers. For example, someone like a corn farmer can lock in a price for their crops months before they're even harvested. This process increases business survival among farmers, and the exchanges always make sure there's a buyer for every seller (provided their prices meet).
Commodity exchanges certainly make the economy much more efficient, but is it necessary to have such active trading in the markets? And what about the extreme volatility that's associated with the commodity markets?
Many attribute the volatility in the commodity markets to speculators. Although speculators are indeed responsible for a large portion of the trading activity on the exchanges, it's debatable as to whether they cause price volatility, or if the markets would be better off without them.
Whether or not they cause volatility, speculators do help make the commodity exchanges more efficient. They provide liquidity, which has helped the exchanges survive for more than 150 years.
The Role of Speculators: Pros and Cons
While speculators now make up more of the trading activity on commodity exchanges, the exchanges still serve the same purpose as they did a hundred years ago. The extra trading from speculators can provide more opportunities for producers and users to hedge their operations. Volatility in the commodity markets can create better pricing and hedging opportunities for the commercials.
However, some commercials might argue that speculators cause commodity prices to rise to unnecessary extremes. Those high prices can negatively impact the profitability of their operations.
Whether the impact of speculators is a net benefit or drawback to the markets has been an ongoing argument among the parties involved. These conflicts will probably always exist, but the fact remains that the commodity exchanges, as a whole, benefit everyone.
Small-scale speculators don't need to be concerned about all the inner workings of the commodity exchanges. The main thing to realize is that there's an efficient marketplace that offers opportunities to commercial hedgers as well as to speculators. It's up to each individual to determine how they want to utilize the exchange. A speculator can bet on the price of a commodity moving up or down. A hedger can lock in the price of a commodity to help ensure profitability.
Where Would We Be Without Commodity Exchanges?
Without commodity exchanges, it would be difficult—if not impossible—to establish a standardized price for a commodity. Those in the commodity industry would be personally responsible for finding individual buyers and sellers. Prices would be determined by those who they could manage to contact. There would be a higher possibility of commodity producers going bankrupt if they couldn't hedge their operations with the use of a commodity exchange. That, in turn, would likely lead to higher prices for commodities and higher operational costs around the globe.