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Commodity Market: Definition,

Types, Example, and How It
Works
By ADAM HAYES Updated October 30, 2021

Reviewed by CHARLES POTTERS

Fact checked by VIKKI VELASQUEZ

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What Is a Commodity Market?

A commodity market is a marketplace for buying, selling, and trading raw
materials or primary products.

Commodities are often split into two broad categories: hard and soft
commodities. Hard commodities include natural resources that must be mined
or extracted—such as gold, rubber, and oil, whereas soft commodities are
agricultural products or livestock—such as corn, wheat, coffee, sugar, soybeans,
and pork.

KEY TAKEAWAYS
A commodity market involves buying, selling, or trading a raw product,
such as oil, gold, or coffee.
There are hard commodities, which are generally natural resources,
and soft commodities, which are livestock or agricultural goods.
Spot commodities markets involve immediate delivery, while
derivatives markets entail delivery in the future.
Investors can gain exposure to commodities by investing in companies
that have exposure to commodities or investing in commodities
directly via futures contracts.
The major U.S. commodity exchanges are ICE Futures U.S. and the CME
Group, which holds four major exchanges: the Chicago Board of Trade,
the Chicago Mercantile Exchange, the New York Mercantile Exchange,
and the Commodity Exchange, Inc.
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How Commodity Markets Work

Commodities markets allow producers and consumers of commodity products
to gain access to them in a centralized and liquid marketplace. These market
actors can also use commodities derivatives to hedge future consumption or
production. Speculators, investors, and arbitrageurs also play an active role in
these markets. Rise Above Your Competition

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Certain commodities, such as precious metals, have been thought of to be a
good hedge against inflation, and a broad set of commodities as an alternative
asset class can help diversify a portfolio. Because the prices of commodities
tend to move in opposition to stocks, some investors also rely on commodities
during periods of market volatility. Advertisement

In the past, commodities trading required significant amounts of time, money,

and expertise, and was primarily limited to professional traders. Today, there
are more options for participating in the commodity markets.

History of Commodity Markets

Trading commodities goes back to the dawn of human civilization as tribal
clans and newly established kingdoms would barter and trade with one another
for food, supplies, and other items. Trading commodities indeed predates that
of stocks and bonds by many centuries. The rise of empires such as ancient
Greece and Rome can be directly linked to their ability to create complex
trading systems and facilitate the exchange of commodities across vast swaths
via routes like the famous Silk Road that linked Europe to the Far East. [1] [2]

Today, commodities are still exchanged throughout the world and on a massive
scale. Things have also become more sophisticated with the advent of
exchanges and derivatives markets, Exchanges regulate and standardized
commodity trading, allowing for liquid and efficient markets.

Perhaps the most influential modern commodities market is the Chicago Board
of Trade (CBOT), established in 1848, where it originally traded only agricultural
commodities such as wheat, corn, and soybeans in order to help farmers and
commodity consumers manage risks by removing price uncertainty from those
agricultural products. [3] Today, it lists options and futures contracts on a wide
range of products including gold, silver, U.S. Treasury bonds, and energy
products. The Chicago Mercantile Exchange (CME) Group merged with the
Chicago Board of Trade (CBOT) in 2007, adding interest rates and equity index
products to the group's existing product agricultural offerings. [4]

Some commodities exchanges have merged or gone out of business in recent

years. The majority of exchanges carry a few different commodities, although
some specialize in a single group. In the U.S., the Chicago Mercantile
Exchange (CME) acquired three other commodity exchanges in the mid-2000s.
First, CME acquired the Chicago Board of Trade (CBOT) in 2007 and then in 2008,
acquired the New York Mercantile Exchange (NYMEX) and the Commodity
Exchange, Inc. (COMEX). [5] [6] All four exchanges make up the CME Group. Also
in 2007, the New York Board of Trade merged with Intercontinental Exchange
(ICE), forming ICE Futures U.S. [7] [8] Each exchange offers a wide range of global
benchmarks across major asset classes.

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Types of Commodity Markets

Generally speaking, commodities trade either in spot markets or derivatives
markets. Spot markets are also referred to as “physical markets” or “cash
markets” where buyers and sellers exchange physical commodities for
immediate delivery.

Derivatives markets involve forwards, futures, and options. Forwards and

futures are derivatives contracts that use the spot market as the underlying
asset. These are contracts that give the owner control of the underlying at some
point in the future, for a price agreed upon today. Only when the contracts
expire would physical delivery of the commodity or other asset take place, and
often traders will roll over or close out their contracts in order to avoid making
or taking delivery altogether. Forwards and futures are generically the same,
except that forwards are customizable and trade over-the-counter (OTC),
whereas futures are standardized and traded on exchanges.

Examples of Commodities Markets

The major exchanges in the U.S., which trade commodities, are domiciled in
Chicago and New York with several exchanges in other locations within the
country. The Chicago Board of Trade (CBOT) was established in Chicago in 1848.
Commodities traded on the CBOT include corn, gold, silver, soybeans, wheat,
oats, rice, and ethanol. [9] The Chicago Mercantile Exchange (CME) trades
commodities such as milk, butter, feeder cattle, cattle, pork bellies, lumber, and
lean hogs. [10]

The New York Mercantile Exchange (NYMEX) trades commodities on its

exchange such as oil, gold, silver, copper, aluminum, palladium, platinum,
heating oil, propane, and electricity. [11] Formerly known as the New York Board
of Trade (NYBOT), ICE Futures U.S. commodities include coffee, cocoa, orange
juice, sugar, and ethanol trading on its exchange. [12] [13]

The London Metal Exchange and Tokyo Commodity Exchange are prominent
international commodity exchanges.

FAST FACT
Commodities are predominantly traded electronically; however,
several U.S. exchanges still use the open outcry method.
Commodity trading conducted outside the operation of the
exchanges is referred to as the over-the-counter (OTC) market.

Commodity Market Regulation

In the U.S., the Commodity Futures Trading Commission (CFTC) regulates
commodity futures and options markets. The CFTC's objective is to promote
competitive, efficient, and transparent markets that help protect consumers
from fraud and unscrupulous practices. The CFTC and related regulations were
designed to prevent and remove obstructions on interstate commerce
in commodities by regulating transactions on commodity exchanges. For
example, regulations look to limit, or abolish, short selling and eliminate the
possibility of market and price manipulation, such as cornering markets.

The law that established the CFTC has been updated several times since it was
created, most notably in the wake of the 2007-2008 financial crisis. The Dodd-
Frank Wall Street Reform and Consumer Protection Act gave the CFTC authority
over the swaps market, which was previously unregulated. [14]

Important: Regulation of commodity markets has continued to

remain in the spotlight after ten leading investment banks were
caught up in an international precious metals manipulation probe by
the CFTC and U.S. Department of Justice in 2015. [15]

Commodity Market Trading vs. Stock Trading

For most individual investors, accessing commodities markets, whether spot or
derivatives, is untenable. Direct access to these markets typically requires a
special brokerage account and/or certain permissions. Because commodities
are considered an alternative asset class, pooled funds that traded
commodities futures, such as CTAs, typically only allow accredited investors.
Still, ordinary investors can gain indirect access to commodities via the stock
market itself. Stocks on mining or materials companies tend to be correlated
with commodities prices, and there are various ETFs now that track various
commodities or commodities indexes.

Investors looking to diversify their portfolio can look to these ETFs, but for most
long-term investors stocks and bonds will make up the core of their holdings.
Moreover, because commodity prices tend by more volatile than stocks and
bonds, commodities trading is often most suited for those with higher risk
tolerance and/or longer time horizon.

Commodity Market FAQs

How Do I Find Out How the Commodity Markets Are Doing
Today?
Many online financial portals will provide some indication of certain
commodities prices such as gold and crude oil. You can also find prices on the
websites of commodity exchanges.

What Do Commodities Traders Do?

Commodities traders buy and sell either physical (spot) commodities or
derivatives contracts that use a physical commodity as its underlying.
Depending on what type of trader you are, you will use this market for different
purposes, for instance, buying or selling a physical product, hedging,
speculating, or arbitraging.

Are Commodities a Good Investment?

Like any investment, commodities can be a good investment but also come
with risks. An investor needs to understand the markets of the commodity they
wish to trade in, for example, the fact that oil prices can fluctuate based on the
political climate in the Middle East. The type of investment also matters; ETFs
provided more diversification and lower risks where futures are more
speculative and the risks are higher because of margin requirements. That
being said, commodities are seen as a hedge against inflation, and gold, in
particular, can be a hedge against a market downturn.

How Do Commodities Market Work?

For spot markets, buyers and sellers exchange cash for immediate delivery of
the physical product. In derivatives markets, buyers and sellers exchange cash
for the right to future delivery of that product. Oftentimes, derivatives holders
will roll over or close out their positions before delivery can happen. Forwards
trade over-the-counter and are customized between counterparties. Futures
and options are listed on exchanges and have standardized contracts that are
more highly regulated.

What Are Some Examples of Commodities?

There are several commodities available. Energy products include crude oil,
natural gas, and gasoline. Precious metals include gold, silver, and platinum.
Agricultural products include wheat, corn, soybeans, and livestock. Other
commodities you can trade are coffee, sugar, cotton, and frozen orange juice.

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Related Terms
Chicago Mercantile Exchange: Definition, History, and
Regulation
The Chicago Mercantile Exchange or CME is a futures exchange which trades in interest
rates, currencies, indices, metals, and agricultural products. more

The Chicago Board of Trade (CBOT): What Trades on This

Exchange
The Chicago Board of Trade (CBOT) is a commodity exchange established in 1848 where
both agricultural and financial contracts are traded. more

New York Mercantile Exchange (NYMEX)

The New York Mercantile Exchange (NYMEX) is the world's largest physical commodity
futures exchange and a part of the Chicago Mercantile Exchange Group. more

Guide to Futures Exchanges

A futures exchange is a central marketplace, physical or electronic, where futures
contracts and options on futures contracts are traded. more

What Is a Commodities Exchange? How It Works and Types

A commodities exchange is a legal entity that determines and enforces rules and
procedures for the trading commodities and related investments. more

Gold Option
A gold option is a call or put contract that has gold as the underlying asset. more

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