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commodity market is a market that trades in the primary economic sector rather than manufactured products, such as cocoa, fruit and sugar. Hard commodities are mined, such as gold and oil.[1] Investors access about 50 major commodity markets worldwide with purely financial transactions increasingly outnumbering physical trades in which goods are delivered. Futures contracts are the oldest way of investing in commodities. Futures are secured by physical assets.[2]Commodity markets can include physical trading and derivatives trading using spot pricesforwardsfutures, and options on futures. Farmers have used a simple form of derivative trading in the commodity market for centuries for price risk management.[3]

financial derivative is a financial instrument whose value is derived from a commodity termed an underlier.[2] Derivatives are either exchange-traded or over-the-counter (OTC). An increasing number of derivatives are traded via clearing houses some with central counterparty clearing, which provide clearing and settlement services on a futures exchange, as well as off-exchange in the OTC market.[4]

Derivatives such as futures contracts, Swaps (1970s-), Exchange-traded Commodities (ETC) (2003-), forward contracts have become the primary trading instruments in commodity markets. Futures are traded on regulated commodities exchanges. Over-the-counter (OTC) contracts are “privately negotiated bilateral contracts entered into between the contracting parties directly”.[5] [6]

Exchange-traded funds (ETFs) began to feature commodities in 2003. Gold ETFs are based on “electronic gold” that does not entail the ownership of physical bullion, with its added costs of insurance and storage in repositories such as the London bullion market. According to the World Gold Council, ETFs allow investors to be exposed to the gold market without the risk of price volatility associated with gold as a physical commodity.[7][8][notes 1]

History

Commodity-based money and commodity markets in a crude early form are believed to have originated in Sumer between 4500 BC and 4000 BC. Sumerians first used clay tokens sealed in a clay vessel, then clay writing tablets to represent the amount—for example, the number of goats, to be delivered.[9][10] These promises of time and date of delivery resemble futures contract.

Early civilizations variously used pigs, rare seashells, or other items as commodity money. Since that time traders have sought ways to simplify and standardize trade contracts.[citation needed]

Gold and silver markets evolved in classical civilizations. At first the precious metals were valued for their beauty and intrinsic worth and were associated with royalty.[citation needed] In time, they were used for trading and were exchanged for other goods and commodities, or for payments of labor.[11] Gold, measured out, then became money. Gold’s scarcity, its unique density and the way it could be easily melted, shaped, and measured made it a natural trading asset.[12]

Beginning in the late 10th century, commodity markets grew as a mechanism for allocating goods, labor, land and capital across Europe. Between the late 11th and the late 13th century, English urbanization, regional specialization, expanded and improved infrastructure, the increased use of coinage and the proliferation of markets and fairs were evidence of commercialization.[13] The spread of markets is illustrated by the 1466 installation of reliable scales in the villages of Sloten and Osdorp so villagers no longer had to travel to Haarlem or Amsterdam to weigh their locally produced cheese and butter.[13]

The Amsterdam Stock Exchange, often cited as the first stock exchange, originated as a market for the exchange of commodities. Early trading on the Amsterdam Stock Exchange often involved the use of very sophisticated contracts, including short sales, forward contracts, and options. “Trading took place at the Amsterdam Bourse, an open aired venue, which was created as a commodity exchange in 1530 and rebuilt in 1608. Commodity exchanges themselves were a relatively recent invention, existing in only a handful of cities.”[14]

In 1864, in the United States, wheat, corn, cattle, and pigs were widely traded using standard instruments on the Chicago Board of Trade (CBOT), the world’s oldest futures and options exchange. Other food commodities were added to the Commodity Exchange Act and traded through CBOT in the 1930s and 1940s, expanding the list from grains to include rice, mill feeds, butter, eggs, Irish potatoes and soybeans.[15] Successful commodity markets require broad consensus on product variations to make each commodity acceptable for trading, such as the purity of gold in bullion.[16] Classical civilizations built complex global markets trading gold or silver for spices, cloth, wood and weapons, most of which had standards of quality and timeliness.[citation needed]

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.”[17]

Reputation and clearing became central concerns, and states that could handle them most effectively developed powerful financial centers.[18]

Commodity price index

In 1934, the US Bureau of Labor Statistics began the computation of a daily Commodity price index that became available to the public in 1940. By 1952, the Bureau of Labor Statistics issued a Spot Market Price Index that measured the price movements of “22 sensitive basic commodities whose markets are presumed to be among the first to be influenced by changes in economic conditions. As such, it serves as one early indication of impending changes in business activity.”[19]

Commodity index fund

commodity index fund is a fund whose assets are invested in financial instruments based on or linked to a commodity index. In just about every case the index is in fact a Commodity Futures Index. The first such index was the Commodity Research Bureau (CRB) Index, which began in 1958. Its construction made it unuseful as an investment index. The first practically investable commodity futures index was the Goldman Sachs Commodity Index, created in 1991,[20] and known as the “GSCI”. The next was the Dow Jones AIG Commodity Index. It differed from the GSCI primarily in the weights allocated to each commodity. The DJ AIG had mechanisms to periodically limit the weight of any one commodity and to remove commodities whose weights became too small. After AIG‘s financial problems in 2008 the Index rights were sold to UBS and it is now known as the DJUBS index. Other commodity indices include the Reuters / CRB index (which is the old CRB Index as re-structured in 2005) and the Rogers Index.

Cash commodity

Cash commodities or “actuals” refer to the physical goods—e.g., wheat, corn, soybeans, crude oil, gold, silver—that someone is buying/selling/trading as distinguished from derivatives.[3]

Call options

In a call option counterparties enter into a financial contract option where the buyer purchases the right but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or “writer”) is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.[21]

Electronic commodities trading

In traditional stock market exchanges such as the New York Stock Exchange (NYSE), most trading activity took place in the trading pits in face-to-face interactions between brokers and dealers in open outcry trading.[22] In 1992 the Financial Information eXchange (FIX) protocol was introduced, allowing international real-time exchange of information regarding market transactions. The U.S. Securities and Exchange Commission ordered U.S. stock markets to convert from the fractional system to a decimal system by April 2001. Metrification, conversion from the imperial system of measurement to the metrical, increased throughout the 20th century.[23] Eventually FIX-compliant interfaces were adopted globally by commodity exchanges using the FIX Protocol.[24] In 2001 the Chicago Board of Trade and the Chicago Mercantile Exchange (later merged into the CME group, the world’s largest futures exchange company)[23] launched their FIX-compliant interface.

By 2011, the alternative trading system (ATS) of electronic trading featured computers buying and selling without human dealer intermediation. High-frequency trading (HFT) algorithmic trading, had almost phased out “dinosaur floor-traders”.[22][notes 2]

Complexity and interconnectedness of global market

The robust growth of emerging market economies (EMEs, such as Brazil, Russia, India, and China), beginning in the 1990s, “propelled commodity markets into a supercycle”. The size and diversity of commodity markets expanded internationally,[25] and pension funds and sovereign wealth funds started allocating more capital to commodities, in order to diversify into an asset class with less exposure to currency depreciation.[26]

In 2012, as emerging-market economies slowed down, commodity prices peaked and started to decline. From 2005 through 2013, energy and metals’ real prices remained well above their long-term averages. In 2012, real food prices were their highest since 1982.[25]

The price of gold bullion fell dramatically on 12 April 2013 and analysts frantically sought explanations. Rumors spread that the European Central Bank (ECB) would force Cyprus to sell its gold reserves in response to its financial crisis. Major banks such as Goldman Sachs began immediately to short gold bullion. Investors scrambled to liquidate their exchange-traded funds (ETFs)[notes 3] and margin call sellingaccelerated. George Gero, precious metals commodities expert at the Royal Bank of Canada (RBC) Wealth Management section reported that he had not seen selling of gold bullion as panicked as this in his forty years in commodity markets.[27]

The earliest commodity exchange-traded fund (ETFs), such as SPDR Gold Shares NYSE ArcaGLD and iShares Silver Trust NYSE ArcaSLV, actually owned the physical commodities. Similar to these are NYSE ArcaPALL (palladium) and NYSE ArcaPPLT (platinum). However, most Exchange Traded Commodities (ETCs) implement a futures trading strategy. At the time Russian Prime Minister Dmitry Medvedev warned that Russia could sink into recession. He argued that “We live in a dynamic, fast-developing world. It is so global and so complex that we sometimes cannot keep up with the changes”. Analysts have claimed that Russia’s economy is overly dependent on commodities.[28]

 

https://en.wikipedia.org/wiki/Commodity_market

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