The Global Financial Crisis: A Short Course on Commodity Trading
Due to all the recent global financial strife, DBKP wanted to look at one segment of the global financial sector, commodity trading, and how it fits into the world’s economy.
Commodities
What is a commodity? Lets start with a textbook definition:
Commodities are products that can be traded on an exchange: i.e., agricultural products, metals, petroleum, gasoline, heating oil, and natural gas. The term commodity may refer to physical products, such as oil, gasoline, or building supplies that are purchased in the cash market that have nothing to do with a futures exchange.
Basically, a commodity can cover from a pig, (the barnyard variety), a bushel of corn, and other agricultural items, to energy products such as crude oil and heating gas, to building supplies such as steel, lumber, and cement.
One of the centers of global commodity trading is located here in Chicago. I had the honor and privilege of clerking on the trading floor of the Chicago Mercantile Exchange for a number of years. I worked in pretty much all the trading pits there, from the cattle and pork belly pits to the foreign currency pits.
How big is the global commodity market? Here’s a quote straight off the CME website:
‘We handle more than one billion contracts per year, worth more than $1,000 trillion.’
For more information on the size and importance of global commodity markets follow this link.
If you scroll down to the bottom of the Wiki link, read the report that is listed in the Reference section. It is in a PDF format, so I’ve copied and pasted a couple bullet points about the size of commodity markets:
* ‘In the five years up to 2007, the value of global physical commodities increased by 17%’.
* ‘Global physical and derivative trading of commodities on exchanges increased by more than a third in 2007 to reach 1,684 million contracts’.
* ‘Worldwide, there are around 50 major commodity exchanges that trade in more than 90 commodities’.
Basically, the commodity market is huge (both in terms of trading volume and in value of everything that is traded) and global.
A fantastic article about how commodities fit into everyday life and why they are so important to the world’s economy can found at this link.
How are the prices of commodities determined? The short answer is “supply and demand”. A more complex answer is at this link.
It’s important to note that generally, commodity prices rise during times of inflation. Few assets (stocks in particular) go up during periods of Inflation, but since commodities do, they are considered a hedge against rising inflation. A major downside of commodity investments is that they are also more volatile than other assets.
There are some nations that export their commodities to other countries around the world. Therefore if these exports either increase or decrease in value their national currencies can change in value. This link contains an article about commodity prices and the correlation to some national currencies:
To illustrate how a “rise” and “fall” in a single commodity can effect a national currency, I’ve presented the following charts:
Crude Oil Futures Chart
click on image to enlarge source - barchart.com
As you can see, the price of crude oil hit a record high of around $150 in July, then thanks to all the global financial trouble, and the resulting fall off in demand for oil, it is now worth about $100 less and is trading around $50.
Lets now take a look at a currency chart of a oil-exporting country like Canada:
[click on simile to enlarge] provenance -
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