Participants in Commodity Future Markets

Public commodity markets are controlled as a central exchange where members trade standardized contracts to make and take delivery at a specified place at a specified future timeframe (futures markets).

Commodity Hedgers

They’re knowledgeable market participants, though they may not be accurate predictors of their product’s future supply and demand.

A hedger can make delivery (if short the futures contract) or take delivery (if long the futures contract). They are generally motivated by risk mitigation regarding cash flow, so the risk is more of an opportunity cost than an actual one.

Speculations and hedging aren’t synonymous with being long or short. Hedgers tend to speculate based on their perceived unique insight into market conditions and determine the suitable amount of appropriate hedging.

Therefore, the problem differentiates between hedging from speculating. It is this difference that separates commodity producers and consumers from other trading participants regardless of whether commercial participants are speculating.

Commodity Traders and Investors

These consist of informed investors, liquidity providers, and arbitrageurs.

• Informed investors: These are majorly represented by hedgers and speculators, including index and institutional investors.
• Liquidity providers: Can refer to speculators who know that producers and consumers may not be in the market simultaneously through buying when the producer wants to sell and selling when the consumer is ready to buy; they may profit.

In this sense, speculators are willing to step in, under the right pricing circumstances and provide insurance to hedgers in return for an expected, though not guaranteed, profit.

• Arbitrageurs: They attempt to capitalize on commodity and futures mispricing. They may own the storage facilities (bonded warehouses, grain silos, feedlots) and work to manage that inventory in conjunction with the futures prices. They do this in an attempt to make arbitrage-style profits.

Commodity Exchanges

These have resulted from the fact that people worldwide need food, energy, and materials. Exchanges have been formed globally to meet these needs.

The various commodities traded globally include livestock, oil, grains, industrial metals, rubber, etc.

Commodity Market Analysts

Their activities affect market behavior through market structure comparisons and the determination of inflation causes for commodity prices.

They also help governments understand future markets to promote or discourage investment and or raise revenue through taxes.

Commodity Regulators

They monitor the global commodity markets.

The interests of the financial sector strongly influence debates and legislation on financial market regulation, including commodities. The existing legislative instruments, particularly for commodity derivative markets, have been revised, and new regulations introduced to strengthen oversight and regulation. These regulations are subject to G–20 commitments.

Overseeing these different regulatory bodies is the International Organization of Securities Commissions (IOSCO), the international association of the world’s securities and futures markets.

Question

Commodity traders that often provide insurance to hedgers are best described as:

1. Informed investors.
2. Liquidity providers.
3. Arbitrageurs.

Solution

The correct answer is B.

Liquidity providers often provide insurance services to hedgers who need to transfer price risk by entering futures contracts.

A is incorrect. Investors capitalize on mispricing attributable to a lack of information in the market to maintain the efficiency of commodity futures markets.

C is incorrect. Normally, arbitrageurs seek to capitalize and profit on mispricing due to a lack of information in the marketplace.

Reading 35: Introduction to Commodities and Commodity Derivatives

LOS 35 (d) Describe types of participants in commodity futures markets.