A:

Commodities are extremely important as they are essential factors in the production of other goods. A wide of array of commodities exist, including coffee, wheat, barley, gold and oil. Even orange juice is traded as a commodity. These commodities are traded constantly on commodity exchanges around the world such as the Chicago Mercantile Exchange, Winnipeg Commodities Exchange (WCE) and the New York Mercantile Exchange (NYMEX).

Since commodities are traded on exchanges, their prices are not set by a single individual or entity. On the exchanges, commodities are traded via futures contracts. These contracts obligate the holder to buy or sell a commodity at a predetermined price on a delivery date in the future. Not all futures contracts are the same - their specifics will differ depending on the respective commodity being traded.

The market price of a commodity that is quoted in the news is often the market futures price for that respective commodity. As with equity securities, a commodities futures price is determined primarily by the supply and demand for the commodity in the market. For example, let's look at oil. If the supply of oil increases, the price of one barrel of oil will decrease. Conversely, if the demand for oil increases, which often happens during the summer, the price of oil will increase.

There are many economic factors that will have an effect on the price of a commodity. Although commodities are traded using futures contracts and futures prices, events that occur now will affect the futures prices. This can be seen in the volatility of oil prices during the Gulf War in Iraq. The price of oil constantly changed in respect to what was going on in the war, and was also affected by the likelihood that Saddam Hussein would be able to retain control of Iraq. For other commodities such as crops, weather plays an extremely significant role in price changes. If the weather in a certain region is going to affect the supply of a commodity, the price of that commodity will be affected directly.

As with other securities, many traders use commodity futures to speculate on future price movements. These investors analyze various events in the market to speculate on future supply and demand. They subsequently enter long or short futures positions depending on which direction they believe supply and demand will move.

To learn more, see Commodities: The Portfolio Hedge, Futures Fundamentals and Interpreting Volume for the Futures Market.

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