/ HISTORY

Comprehensive History of the Commodity Market

Trading in commodities has been a part of human civilization since time immemorial. The commodities markets have transformed from simple derivative contracts trading to sophisticated commodity exchanges. Here is a chronicle of the history of the commodity market and the significant events that have led to its evolution.

Key Takeaways

  • Between 4500 BC and 4000 BC, people in Sumer or modern-day Iraq used clay tablets to denote the number of goods to be delivered at a predetermined date.1
  • The code of Hammurabi in 1700 BC in Babylonia contained the closest references to modern-day futures and options.2
  • In 1180 AD, the Champagne fairs in Northern France served as networking places for traders where OTC derivatives trading took place.3
  • Between 1530 and 1608, Amsterdam Stock Exchange originated as the world’s first exchange for commodity markets.4
  • In 1730, the Dojima Rice Exchange in Japan saw spot trading of rice bills and futures trading for various rice grades.5
  • In 1848, the Chicago Board of Trade or the CBOT was established to standardize forward contracts for grain trading.7
  • In 1856, the Kansas Board of Trade served as a clearinghouse for grain exchange.10
  • 1870, the New York Cotton Exchange was established to facilitate trading in cotton contracts.10
  • In 1882, the Butter and Cheese Exchange of New York was renamed the New York Mercantile Exchange.9
  • Minneapolis Chamber of Commerce was established in 1881 to issue futures contracts on hard red spring wheat.13
  • In 1921, the Future Trading Act aimed at regulating futures trading in grain (oats, rye, etc.) came into force. In the same year, Grain Futures Act was also passed.15
  • In 1933, The Commodity Exchange (COMEX), primarily the largest exchange for metal trading, was formed.(18)
  • In October 1933, The Dow Jones Commodity Futures Index was formed.23
  • The Commodity Exchange Act (CEA) was passed in 1936 to regulate commodity futures trading in the United States.25
  • In 1974, the Commodity Futures Trading Commission (CFTC) was established.25
  • The commodity index funds were launched in 1990.26
  • Between 2002-2014, the commodity market witnessed a phase of exponential price rise due to demand shortage.21

Table of Contents

Commodities trading is as old as human civilization itself. A commodity trader is the one who transfers the commodity from the place of its origin to the end customer. This customer may then use it as a raw material for further production.

A commodity is a tangible product with definite demand but supplied with a standardized quality across markets. This means no matter where the commodity is sold, there is no significant difference in the quality within each commodity group. These commodities are not manufactured goods but the ones sold in their original form or with minimal processing. These are primarily agricultural produce, energy raw materials, cotton, wood, etc., sold by suppliers and purchased by dealers. Some hard commodities such as crude oil, gold, silver, and other non-precious metals are mined.

Commodities markets can either operate as spot markets or derivatives markets. Spot markets, also known as the “physical markets,” is an arrangement where the physical exchange of commodities for instant delivery occurs.

On the other hand, derivatives trading can be done in various forms such as forward contracts, futures contracts, options on swaps. For centuries, farmers have used futures contracts as the most simplistic form of derivative trading in the commodity market for hedging price risk. A futures contract is a written agreement that specifies the quantity, price, quality, and terms for delivering these goods at a predetermined future date. These contracts are traded to mitigate risk and generate a profit from price movement.

Future trading is a way to handle the challenges of maintaining a perennial supply of products, especially the seasonal crops. It also protects producers and suppliers from massive swings in prices for a commodity. Besides managing price risk, futures also help in price discovery.

From serving as simple futures markets in the past to currently operating as exchanges backed by advanced analytics and sophisticated products, commodities markets have come a long way. Here’s a detailed look at the evolution of the commodity markets over the ages.

4500 BC: The Early History

The earliest form of commodity trading is said to have originated between 4500 BC and 4000 BC in Sumer, located between the Tigris and Euphrates river region (which is in modern-day Iraq).1 Initially, Sumerians used clay tokens enclosed in a clay vessel known as an ‘envelope,’ as well as clay writing tablets to denote the number of goods to be delivered. These kinds of commitments of time and date of delivery closely resemble a futures contract. These contracts used to be settled after the seller delivered their goods by the date imprinted on the token.

Sumarian Clay Tablet

Another early reference of commodities trading can be found in Mesopotamia in the late 1700s B.C, where the ruler’s code governed laws of trade and commerce. Hammurabi was a king of Babylon who engraved the laws on stone slabs.2 The code of Hammurabi covered almost every trade law at that time and formed the background for Babylonian and Assyrian laws.

Steve Kummer and Christian Pauletto, from Switzerland’s State Secretariat for Economic Affairs (SECO), revealed the translation of one of the codes would read as “A farmer who has a mortgage on his property is required to make annual interest payments in the form of grain. However, in the event of a crop failure, this farmer has the right not to pay anything, and the creditor has no alternative but to forgive the interest due.” According to experts, this closely resembled a put option. Some of the other laws mentioned contracts that resembled futures.

Initially, civilizations also used rare seashells, pigs, grains, or other commodities as money. Since that time, traders have always found out ways to standardize trade contracts and simplify them. Even precious metals like gold and silver have been used for trading. The futures markets have evolved since the classical civilizations. Initially, the precious metals were only used as a symbol of wealth and royalty.

Rare Sea Shells

Over the period, they began to be exchanged for other commodities and labor payments. As gold was malleable, which means it could be quickly melted and reshaped, it came to be used as a preferred trading asset.

At the outset of the late 10th century, commodity markets were instrumental in allocating land, labor, goods, and capital across Europe. Urbanization, specialization, and improved infrastructure across England towards the late 11th and the late 13th century marked the formal beginning of commercialization and commodity markets.

Around 1180 AD, the county of Champagne, located in France, hosted a series of trade fairs that was the meeting point of merchants and financiers from all over Europe.3 These markets worked with over-the-counter derivatives, wherein the trade happened without a formalized exchange. In the Champagne fair, “fair letters” were used as a line of credit between buyer and seller instead of traditional currency payment.

Often cited as the world’s first-ever stock exchange, Amsterdam Stock Exchange, originated as a market for commodity exchange between 1530 and 1608.4 However, unlike before, Antwerp traders no longer purchased commodities. Instead, trading bills of exchange allowed merchants to mitigate transportation risks related to the goods. Relatively sophisticated contracts such as short sales, forward contracts, and options were used during the early trading at the Amsterdam Stock Exchange. This marked the beginning of a proper European financial market.

1700: Japan Rice Exchange

A prominent reference for early futures trading was also found in Japan in the 17th Century. The first-ever commodity to be exchanged was rice.

During the Edo period (1603-1867) in Japan, rice was stored in warehouses known as kurayashiki (combined warehouses and residences) around Nakanoshima by rice merchants for future consumption. These merchants would then sell the receipts of the stored rice, also known as “rice tickets’ or vouchers, as a promise to exchange rice as a mode of raising funds.5

Gradually, these rice tickets became a form of all-purpose currency. As rice tickets trading became more widespread, the markets introduced ways to standardize the norms of trading. These rules laid the foundation of the current standards of US futures trading.

Dojima Rice Exchange

In 1730, the Tokugawa shogunate, or the feudal military government of Japan, allocated a spot market for the trading of rice bills and a futures market to trade authorized brands of rice in Dojima. This marked the start of an official market called the Dojima Rice Exchange. Like the organized exchanges of the modern era, the Dojima exchange also had a membership system and clearing function. The rice price determined at the Dojima Rice Exchange was publicized far and wide across the capital and other major cities through couriers or flag signals.

During the period, two forms of exchange emerged: the Shomai market and the Choaimai market. In the Shomai market, different grades of rice were sold at spot price and settled with rice vouchers. The rice was traded on books, and the futures were based on rice grades for each season.6 In the Choaimai market, the record books were settled by the clearinghouse. Therefore traders established lines of credit with the house.

Several of the trading rules and practices developed in Dojima are still followed in today’s commodity, equity, and financial futures markets.

1848: Chicago Board of Trade Established

In the US, futures trading began only in the mid-1800s. The Chicago Board of Trade (CBOT) was set up in April 1848 as one of the world’s oldest futures and options exchanges.7 The CBOT emerged due to railroads and the telegraph connecting the agricultural hub of Chicago with New York and other cities in the eastern U.S. The Chicago Board of Trade started as a voluntary association of a few well-known Chicago grain merchants.

After a weak pickup, Chicago became the predominant grain market in the Midwest. When the exchange began, the railroad to Chicago was being laid. The city soon became a rail hub for ten significant railroads. Over a hundred trains arrived and departed from Chicago in the coming years.

A new canal also created a link between the city and river traffic from the Mississippi. This strategic location helped Chicago become a center for meat packing.8 By the 1850s, the city gradually became the domestic and global center for agricultural commodities trading. In 1855 the French government shifted its grain buying practice from New York to Chicago. By 1858, access to the pit or the trading floor was limited to only the exchange members.

This video by CME explains the history of the Chicago Board of Trade in detail.

In 1859, the governor of Illinois signed a legislative act to grant a corporate charter to the CBOT.9 This charter granted a self-regulatory authority to CBOT over its members to standardize grades and established CBOT-appointed inspectors of grain whose decisions are binding on members. This is one of several steps in the evolution of forward contracts to current standardized futures contracts.

In 1865, CBOT eventually formalized grain trading by establishing standardized agreements known as “futures” contracts, officially the world’s first such agreements.10 However, CFTC Annual reports published before 2004 cites 1859 as the starting date for futures trading in CBOT wheat, corn, and oats.

World War II brought trading at the CBOT to almost a standstill. The government controlled the corn and wheat crops. Thus the CBOT traders could only trade in rye and soybeans. Soybean futures trading was introduced to the CBOT in 1936, and it gradually turned into one of the most actively traded commodities on the board. After the war, the CBOT went back to facilitating buying and selling a variety of agricultural commodities. In 1969, the CBOT added two more essential commodities to its trading list: plywood and silver. Silver was the first precious metal to be traded on the Chicago exchange.37 Five years later, CBOT launched the gold futures.

The objective behind CBOT was to usher in a more efficient and standardized method of exchanging and payment of commodities through futures contracts. Instead of managing multiple contracts between interested parties, the exchange systematized the process of trading future delivery. CBOT standardized the contracts and made them identical in asset quality, delivery time, and terms.

The first traded futures contracts in the US were for corn. For more than 100 years, agricultural products accounted for the maximum trading business conducted at the CBOT.

Chicago Board of Trade

After trading exclusively in agricultural products such as wheat and corn for over a century, the CBOT diversified and included financial contracts in 1975. It went to feature futures contracts in 1982, while in 1997, CBOT started trading in futures and options contracts.10

CBOT was one of the largest commodity exchanges in the US. The New York Commodity Exchange, Chicago Mercantile Exchange, New York Mercantile Exchange, and New York Coffee, Sugar, and Cocoa Exchange are among the other established exchanges.

In 2005, the CBOT transformed into a subsidiary of CBOT Holdings. On July 12, 2007, the CBOT merged with the Chicago Mercantile Exchange (CME) and formed the CME Group.10

1856: Kansas City Board of Trade Founded

In 1856, the KCBOT was founded to serve as a clearinghouse for grain merchants, and it continued to be primarily a grain exchange for the longest time. Kansas City Board of Trade is a futures exchange that mainly deals with hard red winter wheat. Prices discovered at the Kansas City Board of Trade are the benchmark for global wheat prices.9

Kansas City Board of Trade

Merchants from across the globe came together to trade over 10,000 contracts on an average per day, and most of it is wheat products. In 2014, Mariner Real Estate Management LLC, a Leawood real estate investment firm, acquired the Kansas City Board of Trade.11

1870: New York Board of Trade is Established

After corn and wheat, the next market to begin trading futures contracts was cotton. In the 1870s, forward contracts in cotton started to trade in New York, leading eventually to the establishment of the New York Cotton Exchange (NYCE).

In 1872, a group of dairy merchants from Manhattan created the Butter and Cheese Exchange of New York. In January 1882, the Butter and Cheese Exchange was renamed the New York Mercantile Exchange.9

In the same year, Coffee Exchange joined the NYCE while forming the Coffee and Sugar Exchange in 1916 after it launched the first sugar contracts. The Coffee, Sugar, and Cocoa Exchange (CSCE) was created as the Cocoa Exchange merged with the CSE. In 2004, the NYCE and CSCE officially merged to form the NYBOT 2004. The IntercontinentalExchange® (ICE) acquired the NYBOT in 2007.12

1881: Minneapolis Grain Exchange (MGEX) Created

The MGEX, founded as the Minneapolis Chamber of Commerce in 1881, has acted as a marketplace for millers, processors, and producers, processors for over 120 years.13 The National Register of Historic Places has all the three iconic Grain Exchange buildings in Minneapolis listed under it. In 1883, the Minneapolis Chamber of Commerce issued its first futures contract on hard red spring wheat or HRSW, one of the principal derivatives markets for this unique commodity.

HRSW is the highest-protein variety of wheat used in bread, cereals, noodles, and cookies. This form of wheat is mainly planted in the Northern Plains of the United States and the Canadian Prairies.

Minneapolis Grain Exchange Traders

In 1947, the Chamber of Commerce became the Minneapolis Grain Exchange. The exchange mainly operates as a grain futures clearinghouse and trades both the commodities contracts and agricultural index futures. MGEX offers two index products based on the HRSW: Hard Red Spring Wheat Index (HRSI), and the Hard Red Winter Wheat Index (HRWI). The other agricultural index products offered by the MGEX are Soft Red Winter Wheat Index (SRWI), National Corn Index (NCI), and National Soybean Index (NSI).

Since December 19, 2008, the MGEX discontinued the open outcry trading floor, but its daily operations for the electronic trading platform continue to date.14 Currently, HRSW futures trade electronically alongside the options

1921: The Future Trading Act

During the period between the 1920s and 1930s, the federal government started to regulate commodities more strictly.
In August 1921, the Future Trading Act regulated futures trading in grain (corn, wheat, oats, rye, etc.).15 The 7th United States Congress passed the act to regulate futures exchanges after the brief anti-gold Futures Act of 1864.

Under the Future Trading Act, the Secretary of Agriculture could authorize exchanges complying with the specific requisites to act as “contract markets” in grain futures. The Future Trading Act also had the power to impose a prohibitive tax of 20 cents per bushel on all options and grain futures trades that failed to be executed in the contract market designated by the US Department of Agriculture.

The primary purpose of this tax was to compel trade boards to comply with the Federal regulation instead of following the Constitution Interstate trade clause to establish Federal jurisdiction. However, the Supreme Court ruled that such an imposition of taxes was unconstitutional.

1922 – Grains Future Act

Passed on September 21, 1922, the US government passed the Grain Futures Act to regulate trading in particular commodity futures.16 Like the Futures Trading Act, the Grain Futures Act established that all grain futures must be traded on regulated futures exchanges. The act also demanded the exchanges publish their information publicly and limit the quantum of market manipulation.

However, unlike the Futures Trading Act, the Grain Act is based on an interstate commerce clause. It also bans contract-market futures trading instead of imposing a tax.

To administer the Grain Futures Act, the Grain Futures Administration acts as an agency of the U.S. Department of Agriculture (USDA). The Grain Futures Act also formed the Grain Futures Commission, comprising the Secretary of Commerce, Secretary of Agriculture, and the Attorney General. The Grain Futures Commission has the authority to suspend or revoke the designation of contract market designation.

However, in case of compliance failure, the Grain Futures Act of 1922 took disciplinary action against the exchange instead of individual traders. This acted as a deterrent and made it extremely difficult to enforce it. This loophole was fixed in 1936 with the enforcement of the Commodity Exchange Act (CEA).17 Thus, the Grain Future Act is also considered as a predecessor to the Commodity Exchange Act.

1933: Formation of COMEX

In the US, COMEX is one of the most recognized exchanges for metal trading. The Commodity Exchange (COMEX) resulted from the merger of the National Metal Exchange, the Rubber Exchange of New York, the National Raw Silk Exchange, and the New York Hide Exchange (the oldest of these exchanges was founded in 1882) in 1933.17 In 1942, the Commodity Exchange Administration merged with other agencies forming the Agricultural Marketing Administration. At present, this organization is known as the Commodity Exchange Branch of the Agricultural Marketing Administration.

By the 1970s, COMEX evolved into an exchange that primarily trades gold, silver, and copper futures. Between the 1970s and 1990s, the COMEX and NYMEX operated on the same trading floor in the World Trade Centre, but it moved to a new building before the 9/11 terror attacks.

CME Group

Since 1994, COMEX has operated as a subsidiary of the New York Mercantile Exchange (NYMEX). In 2008, NYMEX became a subsidiary of the CME Group 2008. According to CME, more than 400,000 futures and options contracts are executed on the COMEX on an average day.18

1933: Commodity Price Indices

Prices are a unifying force in a fragmented commodities trading market. The Dow Jones Commodity Futures Index, or the Dow Jones Index, launched in October 1933, is said to be the first diversified investable commodity futures price index.19 At the index launch, Dow Jones published an annual “Dow Jones Commodities Handbook” containing the index history and methodology. It also published a backfilled index history to 1924.

The index methodology remained constant until 1982, after which its construction rules and constituents were substantially revised. In 1998 when Dow Jones joined hands with AIG to co‐brand the DJ‐AIG Commodity Index. The index appreciated by 3.7% per year between 1933 and 1998, even as trading was suspended for several index constituents.

In 2009, the UBS group purchased the rights to the index and renamed it the Dow Jones-UBS Commodity Index; however, it pulled out from the alliance in 2014. In 2011, the S&P launched its version of the Dow Jones Commodity Index.20

In 1958, the Commodity Research Bureau (CRB) also published a commodity futures price index including a basket of 28 commodities. However, the CRB index didn’t showcase the characteristics of a typical futures index for two main reasons. Firstly, the index was geometrically weighted, and secondly, the prices of some of the constituents were obtained from spot markets instead of futures markets.

Another prominent Commodity Price Index was the Goldman Sachs Commodity Index (GSCI), founded in 1991 by Goldman Sachs Corporation. In February 2007, Standard & Poor’s bought the index from Goldman Sachs and was renamed the S & P Goldman Sachs Commodity Index (S & PGSCI).21 The index covers 24 commodities, out of which the energy sector has a weightage of 60 to 70% of the overall index. The S&P GCI is one of the most popular commodity indices reflecting the performance of an investment in the commodity market.

Goldman Sachs Tower

In 1934, the US Bureau of Labor Statistics started to compute a daily commodity price index and made it available to the public in 1940. By 1952, the Bureau of Labor Statistics issued a Spot Market Price Index measuring the price movements of “22 sensitive basic commodities which were likely to be among the first to respond to the changes in economic conditions.

Today, the American Bureau of Labor Statistics produces the commodity price index as part of the Producer Price Index (PPI) report.22 There are more than 3500 items mentioned on the commodities list. Here, you can view price indexes for table grapes, wine grapes, juice grapes, slaughter chickens, slaughter turkeys, and slaughter ducks. The S&P GSCI and the Dow Jones Index were the first generations of passive indexes and were designed to represent the most widely produced commodities.23 They focussed on the most liquid portion of the futures curve.

The second generation of indexes, such as The UBS Bloomberg Constant Maturity Commodity Index (CMCI) and the JP Morgan Commodity Curve Index (JPM CCI), also represented the most widely produced commodities but made almost the entire futures curve available for investment. On the other hand, the third generation of a commodities index, such as the UBS Bloomberg CMCI Active Index, focuses on an active selection of the commodities and their weightage based on discretionary analysis. 1936: The Commodity Exchange Act and Regulations (CEA)

The Commodity Exchange Act (CEA) regulates commodity futures trading in the United States.24 It also removes obstacles on interstate trade in commodities through its regulatory measures. The CEA also established the foundational framework for the Commodity Futures Trading Commission (CFTC). In 1938, the Commodity Exchange Act was amended to add wool tops, ready to manufacture processed wool to regulated commodities.25 The CFTC was established in 1974, and in 1982, the CFTC created the National Futures Association (NFA).

1968: Commodity Exchange Act Adds Livestock

In one of the biggest legislation since 1936, the Commodity Exchange Act was amended to add livestock and livestock products such as live cattle and pork bellies among regulated commodities.10 The CEA also instituted minimum net financial requirements for futures commission merchants.

The 1968 amendments also included advanced reporting requirements, which had increased criminal penalties for manipulating the Act or violating it. Also, under the new provisions, the contract market designation of any board of trade that fails to enforce its own rules could be suspended.

Livestock

1974: The Commodity Futures Trading Commission (CFTC) Established

In the US, Futures trading is regulated by a Department of Agriculture’s sub-agency known as the Commodity Futures Trading Commission (CFTC).25

It was established in October 1974 and has regulatory authority over commodity advisors, brokerage firms, futures exchanges, and money managers. Congress passed the CFTC Act of 1974, which President Gerald Ford signed. The goal of CFTC was to foster an efficient and competitive futures market. It also aimed to protect investors against unfair trade practices and manipulation.

The five main divisions of CFTC are the:

  1. Division of Clearing and Risk
  2. Division of Data
  3. Market Participants Division
  4. Division of Market Oversight
  5. Division of Enforcement

In 1978, the Futures Trading Act was passed as law by President Carter. The act renewed the regulatory authority of CFTC’s for four years. The Act also required the CFTC to communicate effectively with the Securities and Exchange Commission, the Department of the Treasury, and the Federal Reserve Board. The CFTC was also authorized to incorporate some technical changes to the Commodity Exchange Act.

1990: Commodity Index Funds

Investors aim to gain exposure to commodities to diversify their equity and bond holdings or protect the portfolio returns from inflation. One convenient way to do so is through commodity index funds.

Beginning in the 1990s, a new commodity-based financial product named the Commodity Index Fund was launched. A commodity index fund where the assets are invested into commodity index-linked financial instruments. This fund either trades futures to mimic the index’s performance or enter into swap agreements with investment banks who opt for trading in the futures market themselves.

A commodity index fund is different from pure commodity funds, which invest in raw materials or primary agricultural commodities. They can also invest in precious metals, like gold and silver, as well as energy resources.

Irrespective of the form, the common objective of the commodity index funds is to offer investors buy-side exposure to returns being generated by commodity index funds. According to analysts, investors can earn significant risk premiums and hedge their portfolios by investing in long-term commodity index funds.26

However, many experts have also criticized these Commodity Index Funds for being the primary cause of food inflation in the United States in 2005. An analytical article released by journalist, Frederick Kaufman, covers it in detail.27

Commodity Inflation

Many economists believe that the Goldman Sachs Commodities Index (GSCI), established in 1991, created the food crisis.28 The commodity index funds allowed open speculation in commodities, and the prices spiraled. Goldman Sachs even sought exemption on speculative limits for corn from the CFTC. The hard red spring wheat price doubled on the Minneapolis Grain Exchange alongside corn, soy, oats, oil, and rice.

Leading publications also announced that the actual price of food had climbed to its highest level since 1845. Millions of investors, including investment banks, pumped money into commodity index funds leading to widespread speculation and sky-high food prices.

The long-only commodity index funds began just before the commodity supercycle, and they became popular during that phase. It is said that the commodity prices increased 71% and investment in the funds climbed from $90 billion in 2006 to $200 billion towards the end of 2007. This was quite a coincidence and raised several eyebrows as to whether these index funds were the cause behind the commodity bubble.29

Today, some of the most popular commodity index funds are Pinco Real Return Strategy Fund, VanEck CM Commodity Index Fund, Oppenheimer, Barclays, and the iShares S&P GSCI Commodity Indexes Fund.

1999: Electronic Commodities Trading

After introducing the Financial Information eXchange (FIX) protocol in 1992, real-time international information about market transactions was allowed. Eventually, commodity exchanges across the globe also adopted FIX-compliant interfaces using the FIX Protocol. In 2001 the Chicago Board of Trade and the Chicago Mercantile Exchange launched their FIX-compliant interface.

In 1999, the volume of transactions on the CBOT began to decline; however, the real reason behind this drop wasn’t specific. While some thought it was due to economic conditions, others thought it was due to open-pit trading.35 Most commodity exchanges worldwide, such as the London International Futures and Options Exchange, Tokyo International Financial Futures Exchange, Marche a Terme International de France (MATIF) in Paris, and the Deutsche Terminborse in Frankfurt, followed the open pit outcry method.

Outcry Traders

A large trading exchange floor was divided into various pits specialized in the open outcry system for a particular contract. Each pit was a polygonal arena with steps wherein traders sat face to face to carry out the transactions. Traditionally, runners used to carry the order to the traders. At a later stage, a hand signal was flashed directly across the booths. On the other hand, Electronic trading used computers to match the buy and sell orders instead of human interchange.

Electronic trading offers lower commissions for retail traders and a faster and more efficient execution of transactions. Electronic trading also makes it easier for authorities to monitor commodity trading amid stringent rules and regulations these days.

Concerned by the low trading volume in 1999, the CBOT allied with the German/Swiss Eurex to trade its financial contracts on Eurex’s electronic screen trading system.

Until recently, commodity traders could use pit trading alongside electronic trading platforms in several commodity markets. London Metal Exchange, which still trades in an open outcry method. However, things are changing slowly, and the days of pit trading may be ending.

With the internet boom, the online trading of commodities has gained popularity for many investors. Online commodity trading platforms allow traders to place orders with ease and convenience without relying on live brokers to place the orders. The online commodity platform also offers trading charts, commodity news, and technical analysis programs.

The CBOT’s electronic trading platform is known as e-CBOT. When the Chicago Mercantile Exchange acquired the CBOT to form CME Group in 2006, CME incorporated eCBOT into its Globex platform.36 The e-CBOT is quite well-known among traders transacting precious metals, agricultural goods, and energy products in the futures markets. Alongside commodity futures contracts, the e-CBOT is also used for trading financial derivatives, options, interest rate swaps, and index futures.

2002: Commodities Supercycle

Supercycle is a phase of exceptionally high demand that is challenging for producers to meet. As a result, it sparks an exponential rise in prices lasting over the years, sometimes a decade. In early 2002, China witnessed massive economic growth, led by an unprecedented expansion in infrastructure development, urbanization, and construction. It was challenging for producers to fulfill this level of demand for commodities. The short supply of natural resources critical to infrastructural development like iron ore, copper, and crude oil continued for a decade.

Even the agricultural commodity prices climbed as there was an increase in energy consumption and fertilizer-rich agricultural commodities like edible oil, grains, meats by the wealthy people of China and other emerging economies.

As revealed by the International Monetary Fund (IMF) commodity price data, from 2001 to 2008, copper, thermal coal, iron ore, and crude oil surged between 350% and 600%. In contrast, nickel prices increased seven-fold during the period. According to the UN Food and Agricultural Organisation, food prices also increased by 50% during the phase.3031

IMF Building

Due to the sovereign debt crisis, there was a sharp downward spiral in prices during 2008 and early 20is. However, prices began to rise, and demand recovered from late 2009 to mid-2010. As a result, the commodities supercycle peaked in 2011, led by a combination of strong demand from emerging countries and low supply growth. In the mid-2010s, China experienced a stock market crash and economic slowdown as it transitioned from a manufacturing to a services industry. Gradually, the supercycle began to cool off.

Since the beginning of the 20th century, commodities have witnessed three such supercycles. The first one was in early 1900, sparked by US industrialization, while global rearmament sparked another supercycle in the 1930s. The third phase of the supercycle was in the 1950 and 1960s, after the second world war during the reconstruction of Japan and Europe.32

2007: The Uranium Bubble

In the phase between 2004 and 2007, the spot price of uranium more than quadrupled and reached over $140 before plunging to less than $80 over the next few months.33

One possible cause that led to the bubble was the flooding of the Cigar Lake Mine in Saskatchewan in October 2006, which had the largest undeveloped uranium source in the world at that time. Experts attributed another possible reason to global warming and increased demand from nuclear power plants globally.

Uranium

Due to short-term supply concerns, the price of uranium spiraled to $300 per kilogram, while it was just $20 at the beginning of 2002. Even the stock prices of various uranium-related companies went sky-high during the frenzy.

At the same time, uranium companies lined up the market for IPOs. Even lesser-known exploration companies like Southern Uranium became oversubscribed. On the other hand, the more prominent players with uranium subsidiaries spun off their businesses to tap into the ‘investment opportunities to capitalize on the soaring prices.

Building a new nuclear power capacity to replace the Cigar Lake Mine was justifiably time-consuming. Additionally, most nuclear power facilities already secured their long-term supply needs. Thus when the demand began to plateau and the flooding at the Cigar Lake Mine ended, uranium prices corrected themselves and dropped to below $100 per kilogram. This sharp plunge in prices caused many Uranium mining and exploration players to run in deep losses and eventually go out of business.34

The Future

The volume of commodity contracts traded over the past decade has nearly tripled. At the same time, the commodities trading on the standard electronic platforms doubled. However, global political upheavals, economic crisis, trade wars, rapidly evolving technologies, and lastly, the pandemic have made commodity markets extremely volatile.

The functioning of the commodity market has already undergone a profound change over the past few years. Data intelligence and analytics are becoming increasingly influential in the way traders make decisions. There is a deluge of new and alternative data due to technology. These new data sources empower commodity traders to estimate events impacting their trading strategies with much more precision.

Sources: 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23, 24, 25, 26, 27, 28, 29, 30, 31, 32, 33, 34, 35, 36, 37

leo

Leo Smigel

Based in Pittsburgh, Analyzing Alpha is a blog by Leo Smigel exploring what works in the markets.