Market commodities are agricultural or natural resources that represent the underlying value in contracts traded on a commodity exchange. As part of a trade arrangement, a buyer and seller agree to exchange a commodity at a future date for a predetermined price. There are multiple commodities that trade in the market, including grains, such as corn and wheat; livestock, such as cattle and hogs; and energy products, such as oil and gas.
The primary function of commodities markets is to facilitate trades between producers and consumers, and to provide an efficient market place for both parties to conduct business. Farmers are the typical seller of market commodities, and rely on the financial markets to ensure profitability from a crop in spite of commodity prices, which tend to be volatile. Investors, including hedge funds, use market commodities to hedge or protect a portfolio that is filled with stocks and bonds, which increases the likelihood for gains if one of those asset classes is under-performing.
Market commodities can be traded in a variety of ways. One way is on the spot markets, where contracts can be bought and sold on a daily basis in large or small amounts. Another option is the futures market; it is designed to allow farmers, who are the sellers, and traders to hedge against the volatile nature of commodity prices. On the futures market, commodity prices for a product, such as grain, are locked in for a future date. The lions share of commodity trading takes place on the futures markets.
Contracts trade individually, but some are also included as part of a broader index. Industry participants form indexes to provide an indication of directional trading in the commodities markets, similar to the S&P 500 index in the equity markets. Price is derived based on a composite value of commodities in the index.
The Goldman Sachs Commodity Index, for example, includes a basket of commodity products. Each contract's influence on the index is based on that particular commodity's world production output. Energy commodities comprise half of this particular index, because these products are the most pervasive market commodities. These products are not limited to fossil fuels, and extend to renewable energy products, including solar and wind power.
In addition to farmers and traders, there are other dominant players that trade market commodities. Airlines hedge the volatile price of transportation fuel by purchasing the commodity in advance in the futures markets. Power and utility companies similarly are active in the commodity markets to hedge against rising energy costs, especially in regions such as Europe and the US, where power industries face deregulation, which can promote increased competition.