The Importance of the Commodities Market

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Trading in the commodity markets has been around for more than 150 years in the U.S. and there is evidence the commodity trading began more than a 1,000 years ago in Japan. Commodities are simple goods that make up the basis of our food supply and manufacturing of goods. However, the general public rarely understands why commodities trade on exchanges, as they only see images of a chaotic environment in the commodity trading pits.

Commodity exchanges actually serve a vital role to the economy and it is unlikely we would have had as much economic growth in the last 100 years without the commodity exchanges.

The purpose of commodity exchanges is to provide a centralized marketplace where commodity producers (commercials) can sell their commodities to those who wish to use them for manufacturing or consumption. The beauty of a commodity futures exchange is that someone like a corn farmer can lock in a price for his crops months before they are even harvested. This process increases business survival among farmers and the exchanges always make sure there is 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 is associated with the commodity markets?

Many attribute the volatility in the commodity markets with the speculators. It is true that speculators make up a large portion of the trading on the exchanges, but it is debatable on whether they cause the volatility or the markets would be better off without them. In fact, the commodity exchanges are dependant on speculators to make the markets an efficient place.

The speculators provide liquidity to the markets, which is a main reason why the commodity exchanges have been able to survive for more than a 150 years.

Today, speculators make up the majority of the trading on commodity exchanges, but the exchanges still serve the same purpose as they did a hundred years ago. Actually, they provide many more opportunities for producers and users to hedge their operations. Volatility in the commodity markets, which some blame on speculators, can create better pricing and hedging opportunities for the commercials.

Some commercials might argue that speculators continue to cause commodity prices to rise to unnecessary extremes and that is actually a detriment to the profitability of their operations. In reality, there have always been arguments among speculators, commercials, politicians and the media when it comes to these issues. These conflicts will probably always exist, but the fact remains that the commodity exchanges as a whole benefit everyone.

The small speculator doesn’t really need to be concerned about all the inner workings of the commodity exchanges. The main thing to realize is that there is an efficient marketplace which offers opportunities to commercial hedgers as well as speculators.

It is up to each individual on 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. A commodity exchange has numerous ways in which it can be utilized by a diverse group of investors, producers and anyone with an interest in commodities.

When someone wonders if the commodity exchanges actually serve a useful purpose to the economy or they are just an organized sort of casino for investors, you only have to look at what would happen without the commodity exchanges. A standardized price for a commodity would be difficult to establish. Producers and users would be dependant on individually finding buyers and sellers. More commodity producers would probably go bankrupt without the ability to 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.