Last Updated on 11 September, 2023 by Samuelsson
History of the Commodity Market
Whether you trade commodities or not, you directly or indirectly interact with the commodity market every day via the foods and other resources you use. It will be interesting to know how the commodity market came about.
The commodity market is as old as human existence. It has remained a significant part of human history from the beginning of civilization. However, the commodity market has experienced massive growth throughout its history: it has transformed from simple spot commodity trading to complex derivative contracts trading on commodity exchanges.
In this post, we will take a look at the history of the commodity market and the significant events that have led to its evolution. Here are the things we will cover:
- What is the commodity market?
- The premodern history: 4500 BC
- The early European market
- The Asian commodity market of the 18th century
- The commodity market in the US: 1848 to date
- The establishment of the Chicago Board of Trade (CBOT) in 1848
- The launch of the Kansas City Board of Trade in 1856
- The creation of the Minneapolis Grain Exchange (MGEX) in 1881
- The establishment of COMEX in 1933
- The creation of Commodity Price Indices in 1933
- The Commodity Exchange Act in 1936
- Commodity Exchange Act adds livestock (1968)
- The establishment of the Commodity Futures Trading Commission (CFTC) in 1974
- The creation of Commodity Index Funds in 1990
- The emergence of electronic commodities trading in 1999
- The 2002 commodities supercycle
What is the commodity market?
The commodity market is a marketplace where buying, selling, and trading of raw materials or primary products is carried out. The marketplace can be either spot markets or derivatives markets. The spots markets, which are also known as “physical markets” or “cash markets,” allow traders to buy and sell physical commodities with cash instantly.
In contrast, the derivatives markets enable buyers and sellers to exchange cash for the right to future delivery of that product. The derivative markets include commodity futures, forward contracts, and options. In the case of commodity futures, the price of a contract is specified in real time, but the commodity is scheduled for delivery at the expiration of the contract. In the spot market, trades are settled in less than two business days from the trade date.
The premodern history: 4500 BC
It is believed that commodity trading began in Sumer (modern-day Iraq) between 4500 BC and 4000 BC. During this period, the Sumerians would denote the number of goods to be delivered using clay tokens that were enclosed in clay vessels and writing tablets. This practice is similar to the futures contracts of the present day as these contracts used to be settled after the seller had delivered their goods on the date that was imprinted on the token.
Another instance of early commodities trading can be traced to the late 1700s B.C. During this time, the laws governing trade and commerce are determined by the ruler’s code. King Hammurabi, a Babylonian king, engraved the laws on stone slabs. Interestingly, King Hammurabi’s code covered every significant aspect of trade law at that time, making it the background for Babylonian and Assyrian laws.
For instance, one of the codes of King Hammurabi would read thus: “A farmer who has a mortgage on his property is required to make annual interest payments in the form of grain.” However, if crop failure happens, the farmer has the right not to pay anything, and the creditor has no alternative but to forgive the interest due. Modern-day commodities traders argue that this code is very similar to the put option.
Several commodities, including rare seashells, pigs, grains, gold, silver, and more, have been used as money. But traders have always found ways to standardize contract trades and simplify them. For example, since gold is malleable, traders could easily melt and reshape it; little wonder it’s one of the choicest trading assets.
The early European market
Around 1180 AD, several trade fairs were held in Champagne, France. The trade fairs featured merchants and financiers from all over Europe. These markets worked with over-the-counter derivatives, wherein trade happened without a formalized exchange. Also, “fair letters” were used as a line of credit between buyer and seller instead of traditional currency payment.
Subsequently, between 1530 and 1608, the Amsterdam Stock Exchange was launched; it was dubbed the world’s first-ever stock exchange, and it served as a market for commodity exchanges throughout this period. The Amsterdam Stock Exchange allowed traders to use various sophisticated contracts, such as short sales, forward contracts, and options; This marked the inception of a proper European financial market.
The Asian commodity market of the 18th century
One of the most famous instances of early futures trading was in Japan in the 17th century, and the first-ever commodity to be traded as a futures contract was rice. It happened during the Edo period (1603–1867) in Japan when rice merchants hoarded rice and stored it in warehouses and residences for future consumption. Subsequently, these merchants would sell the accumulated receipts as a promise to exchange the rice at a future date. These rice receipts/tickets would later form the foundation of the current model of U.S. futures trading.
The commodity market in the US: 1848 to date
Now, let’s take a look at the key events that shaped the commodity market in the United States and how the market has evolved.
The establishment of the Chicago Board of Trade (CBOT) in 1848
Futures trading in the US only started in the mid-1800s. This came on the heels of establishing the Chicago Board of Trade (CBOT) in April 1848 by a few popular grain merchants. As a result, Chicago became recognized as the leading grain market in the Midwest. By the 1850s, Chicago had established itself as a domestic and global center for agricultural commodities trading. In 1855, the French government shifted its grain buying practice from New York to Chicago.
The market started as forward contracts, but in 1859, the governor of Illinois signed a legislative act to grant a corporate charter that granted self-regulatory authority to the CBOT over its members to standardize grades and establish CBOT-appointed inspectors of grain whose decisions are binding on members. This became one of several early steps in evolving forward contracts to the current standardized futures contracts.
Grain trading was eventually formalized in 1865 following the CBOT’s move to establish standardized agreements known as “futures” contracts. The futures contracts were the world’s first standardized agreements.
The CBOT functioned seamlessly until the period of the second world war when the government took control of the corn and wheat crops, allowing the CBOT to trade only in rye and soybeans. But, at the end of World War II, the CBOT resumed trading in several agricultural commodities. Then, in 1975, the CBOT diversified and included financial contracts such as futures and options contracts.
The launch of the Kansas City Board of Trade in 1856
The Kansas City Board of Trade (KCBOT) was launched in 1856 as the official clearinghouse for grain merchants. The KCBOT became mainly known for trading hard red winter wheat, trading an average of over 10,000 contracts per day. As such, prices determined at the KCBOT were used as the benchmark for global wheat prices.
The creation of the Minneapolis Grain Exchange (MGEX) in 1881
In 1881, the Minneapolis Chamber of Commerce was founded to serve as an ideal marketplace for millers, producers, and processors. But it issued its first futures contract on hard red spring wheat in 1883. Later, in 1947, the Chamber of Commerce was renamed the Minneapolis Grain Exchange, operating entirely as a grain futures clearinghouse while trading commodities contracts and agricultural index futures.
The establishment of COMEX in 1933
Following the merger of the National Raw Silk Exchange and the New York Hide Exchange, the Commodity Exchange (COMEX) was formed in 1933. And by the 1970s, COMEX was already actively trading gold, silver, and copper futures. COMEX has been a major subsidiary of the New York Mercantile Exchange (NYMEX) since 1994. Also, the NYMEX became affiliated with the CME Group in 2008. Interestingly, over 400,000 futures and options contracts are executed on the COMEX daily.
The creation of Commodity Price Indices in 1933
The commodities trading market is fragmented, but prices are often a unifying force, which is why several commodity price indices were created. In 1933, the Dow Jones Commodity Futures Index was formed as the first diversified investable commodity price index. The Dow Jones Commodity Futures Price index appreciated by 3.7% per year between 1933 and 1998. In 1934, the U.S. 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 commodities.
The Dow Jones Commodity Futures Price Index was later renamed in 2009 to the Dow Jones-UBS Commodity Index. And in 2011, the S & P launched its version of the Dow Jones Commodity Index.
The Commodity Exchange Act
Given the deficiencies in the previous regulation frameworks for commodity trading — the Trading Futures Trading Act of 1921 and the Grains Futures Act of 1922 — the Commodity Exchange Act (CEA) was passed in 1936 to address the regulation loopholes.
The CEA regulates commodity futures trading in the United States. It also provided the framework for the Commodity Futures Trading Commission (CFTC). The CFTC was eventually established in 1974, and in 1982, it created the National Futures Association (NFA). The CEA was amended in 1938 to add wool tops, ready to manufacture processed wool, to regulated commodities.
Commodity Exchange Act adds livestock (1968)
In 1968, the Commodity Exchange Act was amended to include livestock and some livestock products as commodities. This amendment also included advanced reporting requirements, which increased criminal penalties for manipulating the Act or violating it. The new Act also stated that any board that cannot implement its own rules could be withheld from the contract market designation.
The establishment of the Commodity Futures Trading Commission (CFTC) in 1974
In 1974, the Commodity Futures Trading Commission (CFTC) was established to regulate futures trading in the United States. The CFTC exercised regulatory authority over commodity advisors, brokerage firms, futures exchanges, and money managers. The goal of the CFTC was to foster an efficient and competitive futures market. It also aimed to protect investors against unfair trade practices and manipulation.
The creation of Commodity Index Funds in 1990
In the early 1990s, new commodity-based products called “Commodity Index Funds” were launched. They are designed to expose investors to commodities, diversify their equity and bond holdings, or protect their portfolios from inflation. These commodity index funds can either trade futures following the index’s performance or enter into swap agreements with investment banks who opt to trade in the futures market themselves.
The general objective of commodity index funds is to provide investors with the returns that are realized from buying commodities. Analysts insist that investors can earn significant risk premiums and hedge their portfolios by investing in long-term commodity index funds.
However, commodity index funds have received criticism in the past for being one of the significant causes of inflation in the United States. For example, it was argued that the Goldman Sachs Commodities Index (GSCI) of 1991 caused the food crisis. It caused the prices to skyrocket by allowing open speculation in commodities.
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 Index Fund.
The emergence of electronic commodities trading in 1999
The introduction of the Financial Information exchange (FIX) protocol in 1992 paved the way for the real-time transmission of market transactions. In 2001, the Chicago Board of Trade and the Chicago Mercantile Exchange launched their FIX-compliant interfaces.
Traditionally, runners used to carry the orders to the traders. However, electronic trading uses computers to match the buy and sell orders instead of human interchange. As a result, electronic commodities trading comes with many benefits, such as lower commissions for retail traders and efficient execution of transactions. Also, it made it easier for the authorities to monitor commodity trading.
The success of electronic commodity trading can be attributed to the internet boom, as many investors could easily 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 the CME Group in 2006, the CME incorporated eCBOT into its Globex platform.
The 2002 commodities super-cycle
A “supercycle” is a phase of exceptionally high demand that is challenging for producers to meet. Such high demand is often accompanied by an exponential rise in the price of goods for a prolonged period—up to a decade in some rare cases. Around 2002, China experienced massive economic growth due to an unprecedented expansion in infrastructure development, urbanization, and construction. Following the rapid economic growth, there was an exponential rise in the demand for commodities, making it more difficult for producers to meet these demands due to the relatively short supply of natural resources that are essential for infrastructural development, such as iron ore, copper, and crude oil.
During these periods, agricultural commodity prices went up, too, in response to the increased energy consumption and fertilizer-rich agricultural commodities like edible oil, grains, and meats by the wealthy people of China and other emerging economies.
According to a report by the International Monetary Fund (IMF) commodity price data, copper, thermal coal, iron ore, and crude oil surged between 350% and 600% from 2001 to 2008. Nickel prices even increased seven-fold during the period. The U.N. Food and Agricultural Organisation reported that food prices also increased by 50% during this phase.
Due to the sovereign debt crisis, there was a sharp downward spiral in prices during 2008 and early 2009. However, prices rose, and demand recovered from late 2009 to mid-2010. As a result, the commodities supercycle peaked in 2011, led by strong demand from emerging countries and low supply growth. In the mid-2010s, China experienced a stock market crash and an economic slowdown as it transitioned from a manufacturing to a service industry. Gradually, the supercycle began to cool off.
Commodities have experienced this kind of supercycle about three times since the 20th century. The first occurred in 1900 and was triggered by U.S. industrialization, while global rearmament sparked another supercycle in the 1930s. Finally, the third phase of the supercycle was in the 1950s and 1960s, after the Second World War, during the reconstruction of Japan and Europe.
The commodity market has continued to grow over the years; the volume of commodity contracts traded over the past decade has nearly tripled. At the same time, the price of commodities traded on the standard electronic platforms doubled. But, various factors, like global political instability, economic crisis, trade wars, rapidly evolving technologies, and lastly, the pandemic have made commodity markets extremely volatile.