Education / Commodities/ History of commodity market

The modern commodity markets have their roots in the trading of agricultural products. The modern futures markets have been traded since rice futures traded in the eighteenth century in Osaka, Japan. 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. To cope with the gluts that occur during harvest times and with the shortages that occur before the harvest, purchasers could now protect themselves from price fluctuations by locking in a specific price for a commodity before they actually needed it. The futures markets with uniform commodity pricing, grading, and delivery, became increasingly important.

Commodity and Futures contracts are based on what's termed "Forward" Contracts. Early on these "forward" contracts (agreements to buy now, pay and deliver later) were used as a way of getting products from producer to the consumer. These typically were only for food and agricultural Products. Forward contracts have evolved and have been standardized into what we know today as futures contracts.

In general the unit of exchange that trades in the exchanges is the futures contract. Each contract deals with the future delivery of goods at a certain date, time, and place. Each particular commodity is bought and sold in standardized contractual units, which makes them completely interchangeable. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. The settlement price, normally, converges towards the futures price on the delivery date.

Futures contracts have finite lives, they are primarily used for hedging, unlike a stock, which represents equity in a company and can be held for a long time. Futures are used for hedging commodity price-fluctuation risks or for taking advantage of price movements, rather than for the buying or selling of the actual cash commodity. The buyer of the futures contract is allowed and obliged to buy on a fixed purchase price the commodity (wheat, gold or T-bills, for example) from the seller at the end of the contract. The seller of the futures contract agrees to sell this commodity to the buyer at the fixed sales price at the end of the contract period. As time passes, the contract's price changes relative to the fixed price at which the trade was initiated. This creates profits or losses for the trader. Nowadays in most cases, commodity delivery doesn't take place at all. The contract is usually liquidated form both long and short positions before it expires; the buyer sells futures and the seller buys futures.