Commodity market facts for kids

The Chicago Board of Trade Building, where futures are traded.

Commodity markets are special places where raw materials are bought and sold. Think of things like food, metals, or energy. These raw materials are called commodities. They are traded on organized exchanges, like a stock market, but for physical goods.

People buy and sell these goods using special agreements called contracts. These contracts make sure everyone agrees on the quality, amount, and delivery time of the commodity. This article will tell you about how these markets started and how they work today.

You can find a list of many different commodities that are traded, along with their units and trading places, at List of traded commodities.

History of Commodity Markets
New Kinds of Commodities
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History of Commodity Markets

Modern commodity markets grew from trading farm products. In the 1800s, things like wheat, corn, cattle, and pigs were widely traded in the United States. Other foods, like soybeans, were added later. For a commodity market to work, everyone must agree on what makes a product good enough to trade.

These markets had a huge impact on the economy. They helped improve transportation, storage, and money systems. This made it easier to trade goods across states and even between countries.

Early Trading Ideas

For thousands of years, people have looked for ways to trade goods smoothly. In ancient Sumer, people used small clay tokens shaped like sheep or goats as a kind of money. These tokens were placed in clay pots. The number of tokens was written on the outside. This was a promise to deliver that many animals.

These early tokens were like a simple form of commodity money. They even included promises about when the animals would be delivered. This was similar to a modern futures contract. Later, the tokens were replaced by writing the contracts on flat clay tablets. This was one of the first ways to keep track of commodity trades.

However, trading living animals was tricky. It was hard to know if the sheep or goats were healthy. Sometimes, sellers would make excuses for not delivering good animals. People learned that trust was very important in trading.

Ancient civilizations built big markets. They traded gold and silver for spices, cloth, wood, and weapons. These goods often had standards for quality and delivery time. It was a big challenge to keep these markets open and safe from dangers like pirates or theft. Empires that could manage trade well became very powerful.

Forward Contracts

Today's commodity and futures contracts come from something called "forward contracts." These were early agreements to buy something now but pay for it and get it delivered later. At first, these were mostly used for food and farm products.

For example, in Japan in the 1600s, people used forward contracts for rice. Modern forward agreements, also known as futures, started in Chicago in the 1840s. This happened when railroads made it easier to move goods. Chicago became a central place for farmers in the Midwest to send their products to people on the East Coast.

Hedging: Protecting Against Risk

Hedging is a common way to protect against future problems. Imagine a farming group that grows crops. They can buy futures contracts for the same crop they grow. If their harvest is bad because of weather or bugs, they will have less product to sell. But the price of that crop will likely go up everywhere. The profit they make from their futures contracts helps make up for the loss from their poor harvest.

Some developing countries rely heavily on one or two commodities. Their money might even be tied to the price of these goods. For example, if a country relies on sugar, a drop in sugar prices could mean they can't buy as many foreign goods. Hedging can help these countries keep their economy stable.

Delivery and Quality Rules

When you trade commodities, the contract must clearly state the delivery day, how payment will be made, and where the product will be delivered. Trading usually stops a few days before delivery. This gives time to arrange shipping, like by ship or train, and to finalize payments.

Commodities also have strict quality standards. For example, U.S. soybean futures have rules about their type, where they come from, and how they are stored. They even specify if they are GMO or non-GMO. This is important because some buyers, like those who sell organic food, do not accept GMO products.

Similar rules apply to many other commodities, such as orange juice, cocoa, sugar, wheat, corn, and even pork bellies. These rules ensure that buyers know exactly what they are getting.

Regulating Commodity Markets

Governments often help set rules for commodity markets. This is important to make sure products are safe and traded fairly. For example, electricity must be traded without problems related to pollution from power plants. Wood must not come from protected forests.

Governments often provide rules or insurance to reduce risks. This helps a commodity market start trading. This is why there can be arguments in markets like energy. People might prefer electricity from clean sources like wind, even if it costs a bit more, rather than from coal or nuclear power.

Different Types of Contracts

Sometimes, there are different levels of quality or risk for a commodity. For example, there might be different standards for electricity or soybeans. In these cases, it's easy to create separate contracts for the more desirable and less desirable types. If buyers accept these differences, trading can begin.

Because industries and consumers have different needs, many types of contracts have developed. These contracts have become very complex. They are used for many reasons, from simple buying and selling to protecting against price changes.

Oil and Global Markets

In the late 1900s, many commodity markets grew quickly, especially for oil. Oil was the first energy source to be widely traded. Changes in oil prices can have a big impact on politics and countries.

Sometimes, speculation in the oil market is linked to how stable certain countries are. For example, during the Gulf War, people wondered if the government in Iraq would survive. This could affect oil prices. Most markets are not so tied to politics in unstable areas. Natural gas, for instance, tends to be more stable.

Commodity Markets and Trade Rules

Many developing countries have joined international groups like the IMF and the WTO. This helps them have stable money and clear rules for trade. Joining these groups is like a "hedge" against being left out of global trade. It helps countries avoid being isolated.

However, this system is not perfect. Sometimes, countries still put limits on trade to protect their own industries or jobs.

New Kinds of Commodities

Nature's Products as Commodities

Some experts believe that things like air, water, and food calories are the only true commodities. They argue that these natural products are mostly interchangeable if they are clean and healthy. Whether we should trade these basic things like commodities is a big debate in many countries.

Many environmental economists think it's important to measure these natural resources. They believe that focusing on the flow of these basic commodities can help protect nature and link a country's wealth to how well it protects its environment. They want to find ways to measure well-being over long periods, like "seven generations," as some Native American traditions suggest.

Weather Trading

Commodity trading can also involve the weather. Hedging started as a way to deal with problems caused by natural conditions. Now, it has grown into a system that can even trade on the actual damage caused by weather. This is done using "weather derivatives."

For a price, these derivatives can protect you from worries like:

Will a freeze hurt the coffee crop in Brazil?
Will there be a drought in the U.S. Corn Belt?
Will a cold winter make natural gas prices go up?
What will El Niño do?

Emissions Trading

Weather trading is one example of "negative commodities." These are units that represent harm instead of good.

Another example is "cap and trade" markets. These markets are used to trade the right to release pollution, like sulfur dioxide (SO2), into the air. In this market, the atmosphere's ability to absorb pollutants is measured and divided into units. Companies that pollute more must pay those who pollute less.

Critics say that pollution can still happen without being regulated. They also worry that some big polluters, like government agencies or poorer countries, might be allowed to pollute more. Even if the pollution floats across borders and causes problems elsewhere.

Despite these concerns, political pressure has often led to such systems. For example, the Kyoto Protocol created a similar market for global greenhouse gas emissions, even without the support of the U.S.

Community as a Commodity?

For a commodity market to work, people must believe that the trading agreements are real and can be enforced.

Some people who are against globalization worry that things like a country's money, its independence, and traditional cultures are being treated like commodities. They believe that the global financial system doesn't always lead to better lives for people around the world. They want a fairer way for societies to compete in global markets. They hope this will not require using up natural resources or forcing people to move to richer countries to find work.

Some economists suggest replacing the "gold standard" (where money was backed by gold) with a "biodiversity standard." This would mean that a country's wealth is linked to how well it protects its natural environment. It's still being discussed whether such ideas can truly work or if they mainly help draw attention to how capitalism affects life.

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Oil traders at work in Houston, 2009.