Commodities: The Heart Of The Global Economy

Throughout history, commodities have played a major role in economies worldwide. The more important commodities and raw materials have seen supply-side constraints, which has led to an upside pressure on prices. A shortage of commodities has caused numerous wars the world over, as countries fight for possession of these all-important raw materials. During World War II, Japan had ventured into foreign lands in order to secure oil and rubber. Even now, the major commodity consuming nations with strong economic fundamentals are trying hard to create stable and strong supplies by increasing their reserve capacities and investing in countries with commodity assets.

Growing populations and rising incomes put pressure on the supply-side. Going forward too, we expect nations to continue to build commodity reserves in order to create a supply back-up, thus securing their position in times of world crisis. While the supply constraint of a commodity can cause global havoc, the oversupply of a commodity can also be devastating for the country or region producing the commodity as the prices could get devalued. All in all, commodities are the lifeline of the world economy and play a major role in development and growth.

Evolution of Global Commodity Markets

Trading in commodities began in prehistoric times, when there were no regulated exchanges or platforms to provide a proper price discovery mechanism. But despite an unstructured market, commodities from gold to livestock to spices and grains were traded. Either a dearth or an oversupply of commodities can create a major imbalance on a global level.

The formation of organised and structured marketplaces for commodities was a result of inefficiencies like high transaction costs and uncertain pricing structures in the unorganised trade, along with low information and statistics on demand and supply. With the evolution of formal exchange structures in commodities, what began was a revolution in the world markets, which eventually became connected. Thus was created a common price platform for commodities. Today, all major agricultural and non-agricultural commodities are internationally traded and priced in dollar terms, thereby making prices standardised across the globe.

The development of commodity exchanges began during the late 19th century. The Chicago Board of Trade (CBOT), the world’s first formal commodities futures and options exchange, was launched in 1848, and this phenomenal platform continues to remain the world’s largest exchange. It offers trading in more than 50 agricultural commodity futures and options contracts that are traded by more than 3600 CBOT members through the electronic and open outcry trading mechanisms.

In the last decade, the CBOT has seen a sharp increase in volumes. In 2007, CBOT merged with the Chicago Mercantile Exchange (CME) to form the CME Group. Today, the CME Group is the world’s largest futures exchange platform, and offers trading in futures and options based on interest rates, equity indices, currencies, agricultural commodities, rare and precious metals and real estate.

While agricultural commodities got a futures and exchange platform on the CBOT, the launch of the London Metal Exchange (LME) created an exclusive market for base metals. The LME was founded in 1877, but its history reveals that the origins of the exchange dates back to 1571. While China is the world’s largest consumer of base metals, LME prices are considered a global benchmark.

Current Scenario

Today, the world’s largest commodity exchanges which account for major global trade in commodity futures and options are the CME Group, Tokyo Commodity Exchange, NYSE Euronext, Dalian Commodity Exchange, Multi Commodity Exchange of India and ICE (Intercontinental Exchange). With MCX, India has created a strong foothold in the commodities space and is one of the major players along with other global exchanges.

As regards specialisation, certain exchanges follow a focused model while others are diversified. CBOT is known for trading in agri-commodities, the LME is focused on base metals, while trading on the Nymex is done mainly in energy commodities followed by precious and base metals. The Shanghai Metal Exchange plays a crucial role in the non-ferrous metals segment, and the ICE’s business is targeted on Brent crude, IPE gas futures, electricity and emission futures contracts.

Overall, the global commodities market has become a comfortable trading platform, wherein a few major exchanges have a strong base. This has helped to create a worldwide standardised trading mechanism, which is ever-evolving in nature. The best example of this is the CBOT, which began as an agricultural commodities exchange but later widened its base by way of a merger with the CME.
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World’s Major Commodity Exchanges

(Naveen Mathur is Associate Director of the Commodities & Currencies businesses at Angel Broking. With a rich industry experience of about 19 years in financial markets, he has been associated with commodities trading right from 2003, the year when two online commodities exchanges started trading activities.)

(The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Dalal Street Investment Journal.)