Ever wonder how the coffee you drink in the morning actually got there? Or where the wheat that went into your toast came from? Or what sultanate pumped the oil that was turned into the gas in your car that got you to work so that you could make the money to buy the coffee in the first place?
Probably not, but you may want to. Some very nervy people make a lot of money every day betting whether there's going to be more or less of those things available.
All of these things -- coffee, wheat, oil and dozens more -- are called commodities. They are the raw materials of life. They don't have brand names, they haven't been turned into anything. They're just the stuff from which fortunes are made.
The way those fortunes are made is by people who buy and sell contracts to deliver a set amount of a commodity, say cocoa from West Africa, on a set date for a set price. Those contracts are called futures.
A futures contract is a legally binding obligation for the holder of the contract to buy or sell a particular commodity at a specific price and location at a specific date. They can change value very fast because of changes in the weather, or politics, or people's expectations about what's going to happen.
People who trade futures pay a lot of attention to the weather because a lot of commodities are things that grow, such as wheat, oranges, cocoa and cotton. They also pay a lot of attention to politics because things like wars and revolutions can affect the price of oil and natural gas and gold.
Because so many commodities are agricultural products, the Commodity Research Bureau Futures Price Index is among the most closely watched indicators of future futures activity.
A futures contract is valuable because it lets the owner control a lot of something. One cotton contract represents 100 bales, or 50,000 pounds of cotton, for example.
There are at least a couple of reasons why people might want to buy a futures contract.
One reason is to protect your business against fluctuations in the price of the things that you need to make your products.
For instance: If you're a baker and you need to have wheat to bake your special walnut wheat sourdough bread next summer, and you're not sure that there's going to be enough wheat available then, you can buy a futures contract to guarantee that you'll have it.
Whether the price of wheat goes up or down, you know you'll have your wheat and you know how much it will cost. If wheat goes up between now and when the contract expires, you save money. If wheat goes down, you lose money. But either way, you know you'll have the wheat.
On the other hand, if you grew the wheat, and you're worried that all your brother and sister farmers around the world are growing wheat too, you might buy a contract giving you the right to sell your wheat at the current price. That way, even if prices fall, you'll still get the higher price agreed to in the futures contract.
Another reason to trade futures is to make money. The people who do this, called speculators, don't have bakeries, or chocolate factories or anything that they need the commodities for. They just want to bet on which way the futures contracts are going to go. Of course, if they're wrong, they may wind up having to figure out what to do with 50,000 bushels of cotton.
Futures contracts, like stocks, are traded on exchanges, found mostly in New York and Chicago.
They can be pretty lively places because the prices are usually set by people shouting at each other at the top of their lungs and using hand signals to show how much they are willing to buy and sell for because its too hard to hear.
The top ten U.S. futures exchanges are:
- Chicago Board of Trade – grains, precious metals, financial indexes
- Chicago Mercantile Exchange - livestock, currency
- New York Mercantile Exchange - precious metals, natural gas, energy futures
- Commodity Exchange division of the New York Mercantile Exchange - precious metals, copper, financial indexes
- Coffee, Sugar and Cocoa Exchange - food
- New York Cotton Exchange - cotton, orange juice
- Kansas City Board of Trade - grains, livestock, food and fiber, stock indexes
- Mid America Commodity Exchange - financial futures, currency, agriculture
- Minneapolis Grain Exchange - grains
- Philadelphia Board of Trade - foreign currency
Naturally the trading of futures is completely above board and honest. But just in case someone like Nelson Bunker Hunt tries to corner the market for silver, as he did, the trading at these exchanges is monitored by the Commodity Futures Trading Commission (CFTC).
If you want to find out the latest commodity prices, check out Futures Contracts. And to get a handle on which way the markets are moving you can look at Futures Movers every day.
So the next time you're struggling to wake up with a cup of lukewarm coffee and a piece of dry toast, think about how they got there, and thank your new friend the futures contract.
