Study and Analysis of Commodity Markets Finance Essay

A commodity market is a place in where basic, unprocessed (raw) materials and primary products are traded in exchange of money or other commodities. Our first key term is "commodity" in the definition. There five main categories of commodity that are traded: Grains: corn, wheat soybean, etc. Energy Products: crude oil, heating oil, gasoline, natural gas, etc. Metals: gold, silver, platinum, etc. Softs: food and manucaturing products such as cotton, coffee, etc. Livestock And second key term is "market". Trading activities (buying and selling) occur in regulated markets, that are called "commodity exchanges", via standardized contracts; or in OTC (Over-the-Counter) markets via physical transactions. As it appears from the explanations, commodity markets are like equity markets. However, instead of buying and selling shares, participants buy and sell commodities. There are currently 48 large commodity exchanges trading approximately 100 different types of commodity around world. Another key term, that doesn't exist in the definition, is fungibility that is the best way to understand commodity markets. Fungibility is the property of a good or a commodity whose individual units are capable of mutual substitution. For example, there is no difference between grapes in Buca and in A…žirince. And gold, it is same in China and in Turkey. Other examples of highly fungible commodities may be crude oil, wheat, orange juice, natural gas. How does fungibility help buyers and sellers? By this way: It allows them trade huge quantities of oil, frozen orange juice, cotton, wheat without considering who, where, when produces; as long as quality of the products meet certain guideliness. Agrarian products must be in raw form; for example wheat-not flour or corn-not cornmeal. Also for perishable commodities there are some certain guidelinesses, as well. For example; orange juice must have adequate shelf life in order to be traded in commodity markets.

HISTORY OF COMMODITY MARKETS

According to studies, commodity markets in Sumer were known as the oldest and the primitive form of today's commodity markets. Small baked clay tokens in the shape of sheep or goats were used in trade. Sealed in clay vessels with a certain number of such tokens, with that number written on the outside, they represented a promise to deliver that number of sheep and/or goat. Moreover, a promise included time and date of delivery. So that, the clay vessels were like a modern future contracts. In ancient Greece and Rome, The Agora and The Forum were served as distributions centers for commodities brought from different edges. After the fall of these civilizations, experiences on commerce were transfered to feudal times. Merchants, craftmen, promoters arranged regional fairs at fixed times and places to sell commodities more than food like gold, silver, spices, cloth, wood, etc. With these regional fairs, the immediate predecessors of modern future contracts that "to arrive" contracts started to be used. These were simple agreements to purchase designated goods when they arrived by ship, and they were used for centuries when shipping was the primary mode of international trade. Number of traditional regional fairs was decreasing, as transportation and communication were becoming easier and faster. Specialized market centers; called Fourse, Boerse, Beurs; were developed in Europe, the USA and Japan. In 1700, Japanese merchants stored their rice in warehouses for future use in order to assure continous supply of rice. Warehouse holders sold receipt against the stored rice. They were called as "rice tickets". The tickets were used as forward contracts. In early 1800s, in Chicago, farmers were producing crop, meat, milk, etc. and carrying the products from their villages to city centers. The supply was high and the demand couldn't match enough, so that the prices stayed at low-level. Moreover, there was no enough warehouse to store excess supply. The following years, there were years of crop failure and extreme shortages. Although Chicago was a natural hub for trade, the trading was unefficient and unorganized until a group of businessmen formed Board of Trade of the City of Chicago. The Board offered a centralized location for cash trading of a variety of goods as well as trading of forward contracts. Members served as brokers who facilitated trading in return for commissions. These standardized forwards were essentially the first modern futures contracts.

HOW A COMMODITY MARKET WORKS

In this section, two distinct forms of commodity markets and their characteristics, and also trading processes are held in order to explain that how commodity markets work. Moreover, two main type of investors are compared for better understanding of commodity exchanges. The two distinct forms of commodity markets are OTC (Over-the-Counter) Markets and Exchange Based Markets (Standardized Markets). Firstly, an OTC market that is also called spot market has specific, small range of commodities depending on its geographical location; since OTCs are regional markets and participants are usually local people like wholesellers, farmers, processors, etc. Participants; for example, farmers or wholesellers; cannot trade in OTCs by themselves. Instead, broker of a farmer negotiates quantity, quality and price of a commodity with broker of a buyer on behalf of the farmer. When the brokers reach an agreement, physical delivery happens generally at that time or with a minimum lag because of delivery constraints. Thus, it can be said that almost all agreements in OTCs are delivery based. In determination of price of each commodity, the supply-demand principle is valid. If supplies meet demands, prices will be low. So that, buyers gain from the transactions made with sellers. On the other hand; if demands excess supplies, prices will soar. In this circumstance, sellers are expected to enjoy with high-level margin. Although, a participant predicted that prices would decrease or increase before, he/she cannot avoid his/her losses in today, in OTC market. Because the prices have been already determined by the market (based on the principle of supply-demand), not by the participant; and the participant cannot control the prices. Secondly, commodity exchanges that are also called as standardized commodity markets have crucial role in terms of trade volume and risk hedging in the two forms of commodity markets. Majority of derivative trading takes place in commodity exchanges. For that reason, commodity exchanges are supposed to be similar to equity derivative markets in their working. Briefly, a commodity exchange performs three valuable functions. It sets rules and regulations to promote uniform practices between buyers and sellers in the market. It provides the machinery for settlement of business disputes. It instantly circulates valuable price and market information to exchange members, their customers and other interested market participants. But, how does a participant trade in a commodity exchange? There are many types of commodities that are traded in the same commodity exchange, although certain commodies are usually traded in specific markets. Each commodity is traded in its own section by future contracts and, as in OTC markets, transactions and agreements are made by brokers; instead of farmers, processors, investors, wholesellers, etc. When a participant decides to buy/sell a future contract of spefic commodity with certain amount and defined quality&delivery time at a desired price level, the participant let his/her broker know. Then, the broker converts the participant's demand into transaction on behalf of him/her. After all, the participant has a future contract with a specific characteristic. In OTCs, all participants are supposed to make physical delivery at agreed time. However in commodity exchanges, most investors sell their contracts and take cash before delivery time. It has been observed world-over that only 2% of all the trades result in actual delivery. Why do investors use future contracts if they don't will to have the commodity physically? The answer is held below "Impacts of Commodity Markets on Investors" detailed. Lastly, there are two types of participant in commodity exchanges. One is hedger and the other one is speculators. Hedgers are primarily comprised of businesses that actually use the commodities they are trading. The essential aim of hedgers is to fix price of the commodity they are trading until delivery time written on the future contract and to decrease their losses to minimum level because of unforeseen fluctuations in the spot market. Farmers, mining companies, wholesalers are examples of hedgers who use futures contracts as a kind of insurance for their businesses. However, speculators use future contracts only for making profit by using fluctuations of price levels. They are not interested in taking physical delivery of commodity. Speculators watch markets closely and forecast potential decreases or increases in the future in price levels. Then, they take long position (if prices are expected to rise) or short position (if prices are expected to fall) and if their forecasts come true, they gain from transactions they made.

THE LARGEST COMMODITY EXCHANGES IN WORLD

In the world there are lots of commodity exchanges that have some specific features and also have some common features. We can list some commodity markets from all over the world but in this section we will emphasize three largest largests commodity markets in whole world.

New York Mercantile Exchange (USA)

The New York Mercantile Exchange(NYMEX) is the largest commodity futures Exchange and it is located in New York city. It has two different divisions as NYMEX and COMEX. In earlier they have been managed by different companies but in 2008 NYMEX had bougth by same company that have COMEX and now they are managed by the CME Groups. CME Groups also owns Chicago Mercantile Exchange and Chicago Board of Trade. If we look at history, we can realize that commodity exchanges began with narrow perspectives. Some of Manhattan dairy merchants got together for trade of butter and cheese under the Butter and Cheese Exchange of New York. Then they added egg to their trade transactions. In 1882 they modified and add dried fruits,canned goods and poultry in the name of New York Mercantile Exchange. COMEX is younger than NYMEX. In 1933 National Metal Exchange, Rubber Exchange of New York, National Raw Silk Exchange and New York Hide Exchange got together to established COMEX. On August 3, 1994, the NYMEX and COMEX finally merged under the NYMEX name. In NYMEX division the commodities that are sold and bought; coal, crude oil, electricity, gasoline, heating oil, naturel gas, palladium, platinum, propane and uranium. In COMEX division the commodities that are traded; aliminum, copper, gold and silver. The board of directors of CME Groups and NYMEX is same. Because as we mentioned before NYMEX is subsidiary of CME Groups. The Chief Executive Officer is Craig S. Donohue. He has been as member of board since 2004. Terence A. Duffy has served as Executive Chairman since 2006. Mr. Charles P. Carey has served as Vice Chairman for CME Groups. These people are just three members of board of director but there are other chairmans who has significance role in company.

Tokyo Commodity Exchange (Japan)

The Tokyo Commodity Exchange (TOCOM) has some different features in accordence to other commodity markets. Its basic difference is being non-profit organization. It regulates trading of future contracts and option products of all commodites in Japan. The future contracts include metals (gold, silver, platinum, aluminum, palladium), oil (crude oil, kerosene, gasoline). The option is about just gold. The Tokyo Commodity Exchange was established in 1951. This date is foundation of Tokyo Textile Exchange. This organization is approved of origin of trading commodities in Japan. Tokyo Rubber Exchange , Tokyo Gold Exchange and Tokyo Textile Exchange were merged into Tokyo Commodity Exchange. Tokyo Commodity Exchange's principal business can be defined as opening and operating commodity markets necessary for dealing in futures of the commodities listed (precious metals, rubber, aluminum, oil) on the markets based on the Commodity Exchange Act. Board of directors; CEO of TOCOM is Tadashi Ezaki ,Umetaro Nagao is senior executive managing officer and also it has eight more directors in board of directors. TOCOM is giving service to their members as forum which they can access fair prices and helps them who wants to hedge risk. TOCOM is largest commodity market in Japan. In 2009, 81.2% of all commodity futures were conducted in Japan, were handled by TOCOM. The other commodity exchanges in Japan like Tokyo Grain Exchange, Central Japan Commodity Exchanges and Kansai Commodity Exchange have little impact on market. From geographic view TOCOM has significance role in Asia commodity market. It leads Asia's countries in accordance to trading commodites. They modifies commodities for needs of industries and reforming its market's desing.

NYSE-Euronext (EU)

NYSE Euronext Inc. Euro-American incorporation that operates multiple security exchanges. Generaly as known NYSE, Euronext and NYSE Arca are included NYSE Group. This group also has non-profit organization that Self Regulatery Organization for observing securitiy trade transactions within the NYSE Group. NYSE's origin relies on 1792, in New York city 24 stockbrokers signed Buttonwood Agreement and this agreement consists of base of trade policies between investors and issuers. In 2008 . NYSE Euronext welcomed to historic American Stock Exchange in world's largest and most liquid Exchange groups. Combination of NYSE and Euronext are accepted a milistone for financial market by financier. NYSE completed its acquisition of Archipelago Holdings via a "double dummy" merger in 2006. NYSE Group became a profit organization and its securities are traded publicly under NYX ticker. Merger of NYSE and Euronext occured in 2007 and this event bruoght together Euro marketplace and American marketplace whose histories strected eachother for long time. The purpose of this combination is creating a huge market that combine world's largest two markets. Threre is complex history of NYSE and Euronext. First of all NASDAQ acquired Londan Stock Exchange and then Deutsch Börse. SEC controled and regulated this mergers. Merger process has gone on step by step and nearly all Euopan exhanges market combined to NYSE-Euronext. The major NYSE Euronext locations are ; Euronext Amsterdam(Amsterdam Holland), Euronext Paris(Paris France), Euronext Lisbon(Lisbon Portagul), Euronext.liffe(London England), A NYSE Arca(Chicago,A Illinois,A United States of America), NYSE, Headquarters(New York City,A New York,A United States of America), AMEX(New York City,A New York,A United States of America), NYSE Arca (formerlyA Pacific Exchange), Euronext Brussels(Brussels,A BelgiumA ). Regulation of NYSE Euronext; NYSE Euronext and Financial Industry Regulatory Authority(FINRA) made an agreement on 4 May 2010 about overseeing security exchanges and enforcement fuctions of NYSE Euronext. They announced this regulation standarts for NYSE subsidairies. FINRA controls that the NYSE subsidairies' operations are suitable to NYSE Euronext's regulotary subsidairy of NYSE Regulation. During the 19th century NYSE's board of director are unsalaried persons who are willing to operate NYSE and also kepin a position as insurer or issuer. In 1938 they modified Exchange and brought it to more profesional condition and they conducted a reliable and more professional board of directors. Between 2002 and 2005 the president an co-chief operating officer was Robert G. Britz and between 2006 and 2007 co-chief operating officer was Gerald G. Putnam and finally in 2008 Catherina R.Kinney is responsible for this position. If we look at chief executive officer, we will see two significance person. Once that John A. Thain was Chief executive officer between Jan.2004-Nov 2007. The otherone took over the position and have been going on this position ,Duncan L. Niederauer. NYSE Euronext has large product division. There are lots kinds of cash equites that largest cash equity market in whole world. Also it has futures ,options and bonds.

IMPACTS OF COMMODITY MARKETS ON ECONOMIES & INVESTORS

Impacts on Economies

Commodity markets is highly active and central to the global marketplace. Due to its highly competitive nature, the future market has become an important tool to determine commodity future prices and current prices with considering estimated amount of supply and demand. Prices are effected by information flow about commodities such as weather conditions or another conditions which effect the supply and demand from around the world. This kind of information and the way people absorb it constantly changes the price of a commodity. This process is known as price discovery. There is no doubt that commodity exchange is a necessity for developing and still underdeveloped countries which economy based on agriculture, species, metals, crude oil and natural gas. Countries have a chance to market our commodity this markets easily so that Financial and Capital markets will be vitality and fullness than before. Also using commodity markets provide that foreign trade will increase, development of economy pick up speed. Using Commodity Exchange ensures that as follow; Contributes to economy more efficient use and distribution of sources. So provides standardization of commodities. Increases level of development of financial markets. Takes part in advanced markets and provides the integration of these markets. Increases efficiency of market and derivatives markets increase the rate of circulation of money by offering alternative investment opportunities for the money circulating in financial markets so increase liquidity of economy. Provides a realistic prices in international market conditions. Markets spread wide bases and prevented shallowness and easy manipulation affected by price movements. And this way markets operate in stability and confidence.

Impacts on Investors

Existing and doing business on commodity exchange, together with use of different financial derivatives bring benefits to all participants. Future contracts can be used as a means of protection. It provides protection of future price uncertainity. It largely reduce price risk when making purchases, increases liquidity of market and open a lot of space to increase and secure profit. Purpose of futures is transfer the risk from one party to another and to protect against price fluctuations. Speculation has become an important factor in these market. Consumer use futures to protect themselves against a rise in the price of commodities. On the other hand investors use future to speculate on future price changes. Theoretically the speculator assumes the price risk that the hedger is seeking to minimize. Consumer of commodity gets information about prices from the exchange, After the evaluation of price and commodity to ensure commodity over the stability price so account the costs and selling prices with less risk there is less chance of producers hiking up prices to make up for profit losses in the cash market. If produce more cheaper than foreign competitors, they can export to the world and provide foreign exchange return to the own economy. In the commodity markets it is possible to get a position with less capital. Someone who knows the market but can not get a position because of less capital take a futures and obtain high returns. And should be noted that gain can be less than losses even more than entry of contract price.

RECENT TRENDS IN GLOBAL COMMODITY MARKETS

In the middle of 20th century commodity market's importance have been noticed by people. Nowadays the investors,issuers and finance specialists realizes that commodity markets should be investigated and considered on it because of high expected returns. Commodity markets are very huge contents. Lots of products are trading in commodity markerts. For example as agriculture and food rice ,coffee, dried food, wheat, fruits we can increase the number of product.Industry products are cotton, crude oil or as metals copper, aliminuim. At below we select and mention two important commodities market because of hugeness of commodities markets. Agriculture&Food: World market prices of major agriculture and food have increased sharply that more than %60 in last two years. Also retail food prices are increasing all over the world. This increment depends on some circumstances like weather, transportation, demand and supply. Some factors reflect underlying trend for supply and demand for agriculture products. Also we can say that increments of agriculture products are related to other commodity products like oil. We listed some supply factors and demand factors that result in increment of agriculture produt prices: Demand factors; increasing population ,rapid economic growth, declining demand for stocks of food commodities, rapid expansion biofuels production, aggressive purchases by importers and importer policies. Supply factors; slowing growth in agriculture products ,ascalating crude oil product, rising farm production cost, adverse weather and exporter policies. Note: Each year small percentage of agriculture land has been converted non-agriculture land. Oil commodities: Oil commodities are first formly traded and most widely energy commodities. Fluctuations in the oil markets are particular political interests. Some commodity market speculation is directly related to the stability of certain states, e.g. during Persian Gulf War, speculation on the survival of the regime ofA Saddam HussainA in Iraq. Similar political stability concerns have from time to time driven the price ofA oil. In oil market political conditions of oil countries is very important for stability and prices of oil. Middle East countries(who has huge amount of world oil) are playing a key role for prices. In oil crisis times prices are rapidly increasing as result of countries politics. Nowadays prices are increasing in all countries but with different amounts. Specialists have made some investigation about resources of oil that they assume that oil resources have life of 40-50 year. The world should find out new resources instead of oil. Accourding to this assumption we can think that when supply of commodity decrase , the price of commodity is increase.

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