*** Index * < Previous * Next > ***
The prices of commodities -- such as crops, livestock and such metals as copper, gold, lead and tin -- tend to fluctuate from one period of time to the next. Commodity traders fall into two broad categories: hedgers and speculators. Hedgers are business firms (or individuals) that enter into a commodity contract to be assured access to the commodity at a guaranteed price. A firm secures a needed commodity and is protected against price fluctuation. Thousands of individuals, in contrast, trade in commodity futures as speculators.
The major reason for the rising volume of commodity speculation is the lure of huge profits which can be made on small or thin margins. Uncontrolled forces such as weather or wars can affect supply and demand and send commodity prices up or down very rapidly, thereby creating great profits or losses.
Speculating in commodities is done primarily at a commodities exchange, and there are a dozen such exchanges in the United States. These exchanges are voluntary trade associations, but they are called organized markets because members are required to follow set trading rules. Some of the most prominent are in Chicago, which is the historic center of America's agriculture-based industries. The Chicago Board of Trade is the largest center in the world for commodity futures in terms of volume and value of business. Another Chicago-based exchange is the Chicago Mercantile Exchange, which originally traded mainly in farm products, but has branched out to trade in foreign currency futures.
How does the commodity-trading system operate? Suppose a person bought a standard contract for 30,000 kilograms of cocoa. This buyer could pay the money and take possession of the cocoa. Or the buyer could make the purchase and then sell the contract to someone else. Most people have no need for that much cocoa, nor do they have a place to store it. Their purchase is purely a paper transaction; they hold the contract with the intention of selling it to someone else.
Commodity futures contracts, like stocks, are traded on margin. The difference typically is that a commodities margin is only about 10 to 20 percent of the value of the contract, which increases the opportunity for speculation, and large gains or losses.
Those who make money are often professional traders, well versed in the way the market is likely to react. It has been estimated that of all the small buyers who enter this market, 85 percent lose money. In practice this statistic suggests a few very large winners and a great many losers. The risks are high because a small price change raises profits or losses dramatically.