Commodity, economic term with two meanings: in economic theory it is a tangible good or service that is the result of a production process; in general terms it is a primary product (or raw material) that is grown, such as coffee, tea, rubber, or cotton, or an extracted mineral resource, such as gold, copper, or tin; it may also be something that is (in effect) reared, such as wool. Here we concern ourselves only with the second meaning.

Countries that are rich in commodities or natural resources have the advantage over others that are not so well endowed in that their economies are (up to a point) less dependent on the ingenuity and effort of their inhabitants. They are, however, dependent on the market for commodities, which determines price. Experience has shown that commodity prices are more vulnerable to dramatic price shifts than are manufactured goods. In the past two decades many commodities, including oil, tin, copper, and coffee, have been subject to huge price fluctuations, that were often not foreseen or prepared for by both producers and consumers. Some of these price increases were to a large extent the result of natural conditions that have resulted in crop failures or crop surpluses. Other price shifts have resulted from one or other of a combination of politics and changing markets.

Because, on balance, consumers and producers have tended to be in favour of more stable commodity prices, attempts have been made to achieve commodity price stability through agreements that have involved export and/or production quotas; intervention in the market by buying a commodity when the price is falling (which helps slow or reverse the fall) and storing it until the price has recovered; and long-term contracts between suppliers and purchasers. None of these have worked consistently well, and there have been some serious failures, notably the dramatic collapse of the tin agreement in the mid-1980s. Increasingly, international organizations such as the International Monetary Fund (IMF) have been using other ways to help those developing countries whose commodity exports are crucial sources of foreign exchange earnings.

There are a number of commodity markets in the world, most of which concern themselves primarily with rights of ownership rather than physical possession. A “spot” price for a commodity is the current price. A “future” price is one agreed for the transfer of ownership of a specified quantity of the commodity on a specific date in the future (perhaps a month, perhaps a year). The futures market allows buyers to know in advance what they are going to have to pay for a commodity and protects them from unforeseen fluctuations in the spot price. It also offers speculators opportunities to profit from price fluctuations they have foreseen (or have been prepared to gamble on) but which the market has not. Suppose you judge that the spot price will be 5 per cent higher in 30 days’ time than the current (30-day) future price for a commodity, you will (if your judgement is correct) make a 5 per cent profit (less commission costs) by buying at the future price and selling the commodity on the spot market in 30 days’ time. However, if the spot price has fallen below the future price you paid, you will have incurred a loss.

Credited Images: Yesstyle


Facebook Comments