Commodity Prices

Commodity Prices

The financial term commodity is defined as a physical substance, such as food, grains, a and metals, which is interchangeable with other product of the same type, and which investors buy or sell, usually through future contracts. Or more generally, a product which trades on a commodity exchange; this would also include foreign currencies and financial instruments and indexes. When one speaks of a commodity, they can be referring to two types of this aspect of finance. A cash commodity or an actual is an actual physical commodity which is delivered at the completion of a "contract" This is the lesser utilized of commodities.(Investors Glossary) The more predominant type of commodity that is used is the commodity futures contract.

The futures markets are described as continuous auction markets and exchanges providing the latest information about supply and demand with respect to individual commodities, financial instruments, and currencies. Futures exchanges are where buyers and sellers of an expanding list of commodities, financial instruments, and currencies, come together to trade.

The primary purpose of futures markets, is to provide an efficient and effective mechanism to manage price risk. The futures market allows buyers and sellers to stabilize the price of something. Individuals and businesses seek to achieve insurance against adverse price changes. This is done by buying or selling futures contracts, with a price level established now, for items to be delivered later.

A common practice amongst the traders of futures is called hedging. The details of hedging can be somewhat complex but the principle is simple. Hedgers are individuals and firms that make purchases and sales in the futures market solely for the purpose of establishing a known price level-weeks or months in advance-for something they later intend to buy or sell in the cash market (such as at a grain elevator or in the bond market). In this way they attempt to protect themselves against the risk of an unfavorable price change in the interim or hedgers may use futures to lock in an acceptable margin between their purchase cost and their selling price.

A perfect example of how the futures trading works is provided in the agricultural form of commodities. For example, a food manufacturer will need to buy additional corn from his supplier in three months.