What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


The Four Major Economic Functions of Futures Commodity Markets

Original post by Walter Johnson of Demand Media

Commodity markets are exchanges that specialize in goods such as agricultural products, livestock, precious metals, industrial metals and petroleum. The market deals with specific amounts of an actual product rather than a chunk of a firm or a loan. Their functions are many, but can be grouped under four specific areas they serve. A commodity exchange tracks prices over time with the purpose of showing how changes in things like demand will translate into changes in price.

Information

The most important economic function of commodities markets is information. Most of all, contemporary markets speed up the connection of prices to both speculation and actual commodity production. Markets such as the Chicago Mercantile Exchange are using the most up-to-date methods of calculating prices given all possible variables such as government aid, weather, international politics, interest rates or anything else that might alter commodity prices. Just as important is the communication of commodity prices. This information provides up to the minute prices on goods. This means that market itself can understand what products need to be increased and what decreased.

Communication

The real point of a commodity exchange is to facilitate communication between buyers and sellers. Buyers can be food chains, refining or processing plants, speculators or governments. Sellers can be farmers, groups of farmers, cooperatives, agri-business or governments. The general point is to keep both sides of the equation up to date on current prices, transportation costs, shocks to the system or anything else that will affect prices in the near or distant future. The market keeps watch over all trends in prices.

Improvement

The growth and sophistication of commodities markets have forced farmers and distributors of these products to improve both their production and distribution methods. Since modern methods can reflect real prices on a second-by-second basis, there is little room for error. The market can act as a watchdog to keep tabs on which commodities are doing well and which ones are failing. This means that errors on the part of distributors or producers are almost immediately reflected in the market price. In turn, this forces all those involved in the commodity production or infrastructure to adopt the most efficient methods.

Regulation

Commodities exchanges help regulate the interaction of buyers and sellers. All major commodity exchanges have strict rules of interaction. Contracts are rigidly enforced, and sanctions cited against producers who will not deliver or buyers who will not pay. They investigate fraudulent practices and unlawful speculation. They make it easy for foreign buyers to deal with domestic sellers in order to lower the risk of international trade in these products.

                   

Resources

References

About the Author

Walter Johnson has more than 20 years experience as a professional writer. After serving in the United Stated Marine Corps for several years, he received his doctorate in history from the University of Nebraska. Focused on economic topics, Johnson reads Russian and has published in journals such as “The Salisbury Review,” "The Constantian" and “The Social Justice Review."

Advertisement