The Importance of the Commodities Market

Commodity markets are critical to the economy

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

Commodity Exchanges 

Commodity exchanges actually serve a vital role in the economy and it's unlikely that the U.S. would have experienced as much economic growth in the last 100 years as it has without them.

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 someone like a corn farmer can lock in a price for his 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?

Market Volatility 

Many attribute the volatility in the commodity markets to speculators. Although it's true that speculators make up a large portion of the trading on the exchanges, it's debatable as to whether they cause the volatility or if the markets would be better off without them.

In fact, the commodity exchanges are dependent on speculators to make the markets more efficient.

They provide liquidity, which is the main reason why the exchanges have been able to survive for more than 150 years.

The Role of Speculators—Pros and Cons 

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 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's 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's an efficient marketplace which offers opportunities to commercial hedgers as well as to speculators.

It's up to each individual how he wants 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.

Where Would We Be Without Commodity Exchanges? 

When someone wonders if the commodity exchanges actually serve a useful purpose for the economy or whether they're just an organized sort of casino for investors, you only have to look at what would happen without them. A standardized price for a commodity would be difficult to establish. Producers and users would be dependent 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.