Gold, Silver, Crude Oil

Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts.

This article focuses on the history and current debates regarding global commodity markets. It covers physical product (food, metals, electricity) markets but not the ways that services, including those of governments, nor investment, nor debt, can be seen as a commodity. Articles on reinsurance markets, stock markets, bond markets and currency markets cover those concerns separately and in more depth. One focus of this article is the relationship between simple commodity money and the more complex instruments offered in the commodity markets.

The modern commodity markets have their roots in the trading of agricultural products. While wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th century in the United States, other basic foodstuffs such as soybeans were only added quite recently in most markets. For a commodity market to be established, there must be very broad consensus on the variations in the product that make it acceptable for one purpose or another.

The economic impact of the development of commodity markets is hard to overestimate. Through the 19th century “the exchanges became effective spokesmen for, and innovators of, improvements in transportation, warehousing, and financing, which paved the way to expanded interstate and international trade.”

The trading of commodities consists of direct physical trading and derivatives trading.The commodities markets have seen an upturn in the volume of trading in recent years. In the five years up to 2007, the value of global physical exports of commodities increased by 17% while the notional value outstanding of commodity OTC (over the counter) derivatives increased more than 500% and commodity derivative trading on exchanges more than 200%.

The notional value outstanding of banks’ OTC commodities’ derivatives contracts increased 27% in 2007 to $9.0 trillion. OTC trading accounts for the majority of trading in gold and silver. Overall, precious metals accounted for 8% of OTC commodities derivatives trading in 2007, down from their 55% share a decade earlier as trading in energy derivatives rose.

Global physical and derivative trading of commodities on exchanges increased more than a third in 2007 to reach 1,684 million contracts. Agricultural contracts trading grew by 32% in 2007, energy 29% and industrial metals by 30%. Precious metals trading grew by 3%, with higher volume in New York being partially offset by declining volume in Tokyo. Over 40% of commodities trading on exchanges was conducted on US exchanges and a quarter in China. Trading on exchanges in China and India has gained in importance in recent years due to their emergence as significant commodities consumers and producers.

Spot trading is any transaction where delivery either takes place immediately, or with a minimum lag between the trade and delivery due to technical constraints. Spot trading normally involves visual inspection of the commodity or a sample of the commodity, and is carried out in markets such as wholesale markets. Commodity markets, on the other hand, require the existence of agreed standards so that trades can be made without visual inspection.

Generally, commodities’ spot and forward prices are solely dependent on the financial return of the instrument, and do not factor into the price any societal costs, e.g. smog, pollution, water contamination, etc. Nonetheless, new markets and instruments have been created in order to address the external costs of using these commodities such as man-made global warming, deforestation, and general pollution. For instance, many utilities now trade regularly on the emissions markets, buying and selling renewable emissions credits and emissions allowances in order to offset the output of their generation facilities. While many have criticized this as a band-aid solution, others point out that the utility industry is the first to publicly address it’s external costs. Many industries, including the tech industry and auto industry, have done nothing of the sort.