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Revealed: How commodity markets work

by , 26 May 2014

Commodities trade on specialist commodity markets. The largest commodity market in the work is the Chicago Mercantile Board of Exchange. Here you'll find commodities ranging from gold to orange juice and oil to coffee trading. So how do commodity markets work? And what determines commodity prices? Let's take a closer look…

Commodity markets all come down to supply and demand

The buyers and sellers in established commodity markets know each other. This relationship means that buyers and sellers can anticipate demand and supply in advance.

For example, a coffee producer will know their output in advance of it coming to market. And the coffee buyers will know how much they need before they buy it on the commodity market.

It’s for this reason that to succeed as a speculator in the commodity market, you need to look out for disruptions to either supply or demand.

Commodity markets in the past

Years ago, many cartels that brought together producers of commodities, tried to organise their production into quotas. The idea behind this was to maximise the price that buyers would pay and essentially control commodity prices.

But for commodity producers of sugar, cocoa and tin, cartels failed miserably trying to control production. Producers found it very difficult to stick to the agreed quota.

OPEC, which controls about a third of the world’s oil supply, has also struggled keeping production in check. If they fail on this and oil floods the market, the price of oil falls.

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Commodity markets are very efficient

The commodity markets are very efficient in pricing due to the supply and demand. Since the end of World War II, there hasn’t been any prolonged shortage of any major commodity.

And under normal circumstances, it’s rare to see large price movements occurring unless there’s good reason. For example, a prolonged drought affects the yield of coffee producers. This in turn affects the supply of coffee. Until the supply of coffee is back to normal, there may be a temporary rise in the price of coffee.

So there you have it, how commodity markets work.

Revealed: How commodity markets work
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