Agricultural commodities are fungible marketable goods which are produced in large quantities and traded on an exchange in standard amounts.
Commodities are, generally speaking, marketable goods which are produced in large commercial quantities and fungible, meaning that any quantity of a specified commodity is considered to be equivalent to another, regardless of its point of origin or producer. For trading purposes, the term commodity refers to a commodity which is traded on an exchange. Agricultural commodities are those which are living things grown by farmers or ranchers, or, in some cases, such things which have been minimally processed. Agricultural commodities are often referred to as soft commodities to distinguish them from metals, energy and other non-agricultural commodities.
What are Agricultural Commodities?
There are a handful of grains and meat which make up the core of agricultural commodity trading. Grains include corn, wheat, oats, rice, soybeans. Other agricultural commodities include rape seed, milk, cocoa, coffee, sugar, frozen orange juice concentrate, and cotton. Livestock include hogs, pork bellies and cattle. These commodities are traded in a variety of different grades and types, and there are other exchange-traded agricultural commodities.
Agricultural commodities trading have sometimes been referred to as the grandfather of all markets. The same basic challenges have been around since the beginning of agriculture, agricultural production, vulnerable to weather, insects, disease and the like, is an inherently uncertain undertaking, and is both capital and labor intensive. A farmer would like a guaranteed minimum return and would prefer money now over money later. A purchaser would like to plan on a maximum price for an agricultural product now and so has an incentive to mitigate the risk of a price rise at harvest time. Commodities markets were established in the ancient world in rice and other grains. Supply and demand and unpredictable market conditions have always added price volatility to agricultural commodities markets, and trading and hedging techniques have been developed over long periods of time to help everyone in the market manage their risk.
While spot trading, with physical inspection and delivery, does take place, most trading in financial markets is done through futures contracts. A futures contract is an agreement between a producer and purchaser that a transaction for a certain quantity of a specific commodity will take place at a future date and at a particular price. This smooth out the volatility for both parties and provides liquidity to the market. There is also an options market which adds an additional hedging mechanism. A call gives the right, but not the obligation, to buy the underlying commodity at a specified price on or before its expiration date. A put gives its owner a similar right to sell. (Options are actually on futures contracts, rather then the commodity itself.)
A major innovation in the commodities market in the last twenty years has been the advent of Exchange traded funds. These are basically extensions of the mutual fund concept, meaning that investors are offered shares in a basket of commodities, which can be bought and sold just as stocks can. These funds are increasing the breadth of the investing public for agricultural commodities trading, since to some extent there is less specialized knowledge required, but even in this form risk from price volatility and market conditions are still present.
Generally, commodities trading demands a great deal of knowledge, sophistication and experience to be pursued prudently. As one market insider put it: “If you're thinking of wading into the futures market, here's some advice: don't. Amateurs lose early and often in the futures pits.” On the other hand, there are forces at work which guarantee that the market for agricultural commodities will offer significant opportunities for quite some time. The Malthusian pressures of an ever-increasing global population and a shrinking stock of viable farm land means that the upward price pressure on most commodities will continue to grow.
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