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Consumable Commodities

Modern life depends on raw materials — the products that keep people and businesses going. Anticipating what they’ll cost is what fuels the futures market.

Commodities are the raw materials that are consumed in the process of creating food, fuel, clothes, cars, houses, and the thousands of other products that people buy — the wheat in bread, the silver in earrings, the oil in gasoline. Most producers and users buy and sell commodities in the cash market, commonly known as the spot market, because the full cash price is paid on the spot.



DETERMINING CASH PRICES
Commodity prices are based on supply and demand. If a commodity is plentiful, its price will be low. If it’s hard to come by, the price will be high.

Supply and demand for many commodities move in fairly predictable seasonal cycles. Tomatoes are cheapest in the summer when they’re plentiful and most flavorful, and most expensive in the winter when they’re out of season. Soup manufacturers plan their production season to take advantage of the highest-quality tomatoes at the lowest prices.

But it doesn’t always work that way. If a drought wipes out the Midwest’s wheat crop, cash prices for wheat surge because bakers buy up what’s available to avoid a short-term crunch. Or if political and economic turmoil threatens the oil supply, prices at the gas pumps jump in anticipation of supply problems.

MINIMIZING FUTURE RISK
Since people don’t know when such disasters will occur, they can’t plan for them. That’s why futures contracts were invented — to help businesses minimize risk. A baker with a futures contract to buy wheat for $4.20 a bushel is protected if the spot price jumps to $4.85 — at least for the purchase covered by the contract.

Farmers, loggers, and other commodity producers can only estimate the demand for their products and try to plan accordingly. But they can get stung by too much supply and too little demand — or the reverse. Similarly, manufacturers have to take orders for future delivery without knowing the cost of the raw materials they will need to make their products. That’s why they buy futures contracts on the products they make or use: to smooth out the unexpected price bumps.

CASH PRICES AS CLUES
The fluctuation in cash prices provides clues to what consumers can expect to pay in the marketplace for products made from the raw materials.

Unlike the stock market, though, where a particular economic situation is likely to have a similar impact — up or down — on many of the equities being traded, in the cash market each product operates independently of the others. Futures prices tend to track cash prices closely, but not identically. The difference between the futures contract price and the cash price of the underlying commodity is called the basis.

The prices tend to change constantly, though rarely dramatically, from day to day. But during a period of several months or a year, you may find significant increases or decreases in some products and surprisingly little change in others.

CORNERING THE MARKET
Some commodities traders aren’t satisfied with the money they can make by betting on price fluctuations. They‘d rather control prices by engineering a financial corner, or monopoly, on the commodity itself. Frederick Phillipse has the dubious distinction of introducing the technique in North America. In 1666, he successfully cornered the market on wampum — Native American money — by burying several barrels of it. Fur traders had to pay his prices to carry on their business.
CONTRACTS ON COMMODITIES
Currently, the futures contracts that are available on organized exchanges for consumable commodities cover a variety of grains, fibers, and textiles, several types of food products, fats and oils, precious and nonprecious metals, lumber, and energy products.

Every contract on a particular product has standard terms that include the specific grade, or quality, the quantity, the delivery month, how the price is calculated, and the minimum tick, or the allowable incremental price change. You find the current value of the contract by multiplying the current price times the official quantity.