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Marketing Agricultural Commodities_ Marketing The Fundamental Need 1.1

How to Determine Commodity Prices

A commodity is an economic good, usually a resource that is interchangeable with other goods of the same type. These goods or assets are important for us in everyday lives. Humans obtain commodities from primary economic activities like agriculture, mining, etc. and usually process them for further use. Also, large manufacturing companies use commodities as raw materials for manufacturing products or services and running their businesses.

Types of commodities are:

Metal Commodities–  Hard commodities, which include metals used in jewelry making such as gold, silver, and metals of industrial use such as copper, aluminum, nickel, zinc, platinum, lead, etc.

Energy Commodities– Hard commodities, they include petroleum, natural gas, heating oil, coal, uranium, gasoline, etc. It powers vehicles and generates electricity. Transportation activities also require energy commodities.

Livestock and meat– Soft commodities, they include goat, sheep, beef, pork, cattle, sheep meat, turkey meat, veal, etc.

Agricultural Commodities– Soft commodities, they include important food crops like wheat, soybean, maize, cotton, rice, groundnut, sugar, potato, barley, etc.

Commodity Prices

There are two ways to quote commodity prices. The market futures price is the price for futures trades. On the other hand, spot price is the price that traders pay on the day of purchase. It is the cash price of a commodity. 

Industries consider a variety of factors for determining commodity prices . Most important of them is the principle of demand and supply.

Demand and Supply

The market price for any commodity is profoundly influenced by the demand of that particular commodity in the market and the volume of goods supplied in response to it.

According to the law of demand, the price and quantity demanded of any good and service are inversely related to each other when other factors are constant. It explains natural consumer choice behavior in response to change in price. On the other hand, Law of Supply states that price and quantity supplied of a good are directly related to each other given that other factors are constant. When the price paid by buyers for a commodity rises, then suppliers increase the supply of that commodity in the market. It explains producer behavior in response to change in price in the market. Thus, these two laws interact to determine the actual market price for trading a commodity in the market.

Various factors influence the demand and supply for different commodities such as weather conditions, domestic and global conditions, rate of economic growth, rate of inflation, geopolitical concerns, etc.

Demand Speculations

In a commodity market, there are some people who only enter the market with the objective of making quick profits. They do so by predicting the direction of price movements and gain profit through price fluctuations. These speculative investors affect online trading. Investors opt for short or long positions in the market, depending on their expectation of price fall or price rise in future. Therefore, this system wholly depends on market assumptions based on previous data.

Global and Domestic Market Scenarios

International and domestic economic scenarios also play a crucial role in determining the price of the commodities. For example, amid the ongoing tragic events unfolding in Ukraine due to its invasion by Russia, many companies have announced to suspend operations or withdraw from market activities in Russia. This has caused a massive setback to the Russian Commodity Market. The prices of a commodity that are available within a country is affected by its financial condition and global economic activities and has an impact on its global trade in case of internationally used commodities.

Costs and Technology

It plays an important role in determining the cost of a commodity. The production cost firstly includes raw materials, wages, insurance, machinery, taxes, research and development, licensing and various other costs incurred by businesses. Technological developments may surge initial costs but in the longer term, they result in greater yields, thus, reducing the marginal cost of production.

Population growth

Growing population results in increased demand for commodities. Increasing urbanization and rise in income have also led to more consumption of resources which is enabling gradual market growth. 

Government Policies

Many governments across the world subsidize agricultural and energy commodities for their citizens belonging to financially weaker sections of the society. For instance, the Indian Government provides food grains and other commodities at subsidized prices to benefit people which fall below the poverty line in India. Whereas governments impose taxes on citizens for consumption of energy, such as fuel. Environmental costs are associated with tax consumption on commodities.

Weather

Agricultural yields are highly dependent on changing weather conditions over an area. Therefore, any undesirable change in weather can result in crop suffering. This results in the rise of market price of the particular crop. Weather also affects other commodities, such as metal and oil.

Marketing Agricultural Commodities_ Marketing The Fundamental Need 1.2

Commodity Trading

It refers to the buying and selling of commodities in bulk. Commodity trading can also mean physical exchange of commodities between the buyer and the seller, but a more common method is trading through future contracts agreements, often involving sophisticated financial instruments. These agreements state the terms of delivery of commodities for a specified date in the future. They are available for all categories of commodities. A commodity is traded on the market to discover its true price, manage price risk and speculate profit, somewhat like stock trading. The most commonly traded commodities in the world are crude oil, natural gas, gold and coffee.

In a commodity market there are mainly two kinds of  participants. Firstly, the manufacturers or industries that need raw materials in large quantities to meet their high demand at relatively low and stable prices. They are commonly known as hedgers. They hedge themselves from price fluctuations by entering the futures contracts. Hence, this protects them from price hikes and ensures that their demand for raw materials is fulfilled. The other participants are speculators who only wish to make profit from market fluctuations. They don’t have any real need for the commodity. Speculators make profit by buying the commodity at low prices and selling it when the prices are relatively high. However, they only participate in trading and never really possess the goods physically.  

Commodity Derivatives

These act as financial instruments to enable advanced trading.

Futures contract

It is a legal document that specifies that a particular commodity will be bought or sold at a predetermined price at a specific time in the future. The seller agrees to deliver a particular asset when the futures contract expires. And the buyer agrees to buy that asset at the agreed upon price, regardless of the price fluctuation at the expiration date of the contract. The terms are not customizable in this standardized transfer of assets.

Forwards contract

It is somewhat like a futures contract as the buyer and seller commit to a transaction at a future date at a specified price. But it is also different in some distinct ways. Forwards are customizable contracts. The buyer and seller decide the price and quantity of the commodity during the time of contract but the payment and delivery, in future. But the major challenge to the development of the forward market is the issue of counterparty risk.

Options Trading

It is a contract which gives the buyer the option of buying or selling an underlying commodity, if he pays the option premium to the seller. Call option refers to the right of the buyer to buy the underlying commodity. Put option refers to the right of the buyer to sell the underlying commodity. However, in this financial contract there is no obligation for the options buyer to exercise the option. Traders only exercised it when the prices are in favor or leave as it is until the expiry of contract. 

Spot Commodity Contract

It is a contract for immediate delivery of a commodity on a specified spot date. Therefore, it involves instant payment and delivery between the buyer and the seller. A spot market for commodities deals with the current commodities such as agricultural products. Therefore, it is important to track the spot price of an asset in spot trading.

Commodity Exchanges

Commodity Exchange is a market where different commodities are traded.

Top Commodity Exchanges in the World

Chicago Mercantile Exchange (CME)

Founded in 1898, Chicago Mercantile Exchange is the world’s leading derivatives marketplace. However, it was originally a non profit organization for agricultural commodities exchange called the Chicago Butter and Egg Board. Its headquarters are located in Chicago, United States. It generated a revenue of US$ 4,883 billion in 2020. It offers the widest range of futures and options products for risk management. The CME Group resulted from the merger of four individual exchanges over the years- CME, NYMEX, COMEX and CBOT.

Intercontinental Exchange (ICE)

Founded on 11 May 2000, The Intercontinental Exchange is an American company that operates 12 regulated exchanges and marketplaces. Its headquarters are located in Atlanta, Georgia, United States. Its operations include futures exchanges, cash exchanges, market services , and also central clearing houses. It owns various commodity marketplaces. In November 2013, ICE purchased the New York Stock Exchange (NYSE) as a part of the NYSE Euronext acquisition. 

London Metal Exchange (LME)

Founded in 1877, the London Metal Exchange is the largest market in standardized forwards contracts, futures contracts and options on base metals. It sets global prices for metal commodities such as copper and aluminum. LME trades about $64 billion in futures contracts every day. Its parent organization is the Hong Kong Exchanges and Clearing and is located at Finsbury Square, London, United Kingdom.

Deutsche Börse

The Deutse Börse Group is a German company which gives companies and investors access to global capital markets. It was founded in 1993 and its headquarters is located at Frankfurt, Germany. Its services include derivatives markets, equity trading platforms, clearing in the electricity, gas, iron ore, steel, oil, pulp, paper, coal,etc. Its subsidiaries include European Energy Exchange, Clearstream, STOXX Qontigo etc.

Commodity Exchanges in India

India has following six commodity exchanges:

Multi Commodity Exchange (MCX)

It is the largest commodity exchange in India, holding a market share of 86%. Established in November 2003, MCX is also the world’s largest exchange in silver and gold. Its headquarters are located in Mumbai. Some traded commodities include metals, fibre, energy, spices, cereals, bullion, petrochemicals etc.

 Indian Commodity Exchange (ICEX)

Established in November 2009, ICEX is a screen based online derivatives exchange for commodities. It is headquartered in Gurgaon and primarily traded commodities include gold, silver, diamond, copper, lead, natural gas, crude oil and  iron ore.

National Commodity and Derivatives Exchange (NCDEX)

NCDEX was established in December 2003 and specialises mainly in agricultural commodities trading. Its promoters include NSE, ICICI Bank, LIC, NABARD, Intercontinental Exchange, Canara Bank etc. 

National Multi Commodity Exchange (NMCE)

It was established in 2002 in Ahmedabad. NMCE traded various commodities such as mustard, soya bean, castor seeds, rapeseed, black pepper, gram, aluminium, rubber, copper, lead, zinc, coffee etc

ACE Commodities and Derivatives Exchange (ACE)

It is India’s fifth national commodities exchange, launched in October 2010. It offers contracts on mustard seeds, soy oil, castor seeds, chickpeas, soybeans, metals and spices. Its investors include Kotak Mahindra Group, Bank Of Baroda, Union Bank, The Haryana State Cooperative Supply and Marketing Federation Ltd. etc.

Universal Commodity Exchange (UCX)

It is India’s sixth national level commodity exchange, founded in 2012. Located in Mumbai, UCX is a next-generation commodity exchange for derivatives across the various commodity segments. 

Conclusion

Price determination at  Myanmar Golden Heart is done by addressing different market forces and anticipating price movements around the world. It also determines the objective in the foreign market while developing export pricing strategies.

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