The Mechanics of Commodity Futures Market:
Most people have the depression that commodity markets are very complex and difficult to understand. Actually, commodity markets are not like that. There are many basic facts that one must know, and once these factors are understood one should have little difficulty understanding the nature of future markets and how they are function. First, a commodity futures market (or exchange) is, in simple term, nothing more or less than a public marketplace where commodities are contracted for purchase or sale at an agreed price for delivery at a specified date. These purchases or sales, which must be made through a broker who is a member of an organized exchange, are made under the terms and conditions of a consistent futures contract.
The major transformation among the commodity futures market and the market in which reliable commodities are bought and sold, either for instant or later delivery, is that in the futures market one contracts in standardized contractual agreements only. These deals (futures contracts) provide for delivery of a specified amount of a particular commodity during a specified future month, but include no immediate transfer of ownership of the commodity involved. In other words, one can buy and sell commodities in a futures market irrespective of whether or not one has, or owns, the particular commodity involved. When one agreements in futures one need not be anxious about having to receive delivery (for the buyer) or having to make delivery (for the seller) of the actual commodity, providing of course that one does not buy or sell a future during its delivery month. One can cancel out a previous sale at any time by an equivalent equipoising purchase, or a previous purchase by an identical equipoising sale. If done preceding to the delivery month the trades stop out and consequently there is no receipt or delivery of the commodity. Essentially, only a very less percentage, usually less than 2 percent, of the total futures contracts that are arrived into are continually established through deliveries.
The Organized Markets or Exchanges:
New York Mercantile Exchange – Comex Division
Gold, Silver and Copper
New York Mercantile Exchange:
Crude Oil, Natural Gas
How Prices are Determined:
A common misapprehension is that commodity exchanges determine, or establish, the prices at which commodity futures are bought and sold. This is totally incorrect. Prices are determined solely by supply and demand conditions. If there are more buyers than there are sellers, prices will be enforced up. If there are more sellers than buyers, prices will be enforced down. Buy and sell orders, which originate from all sources and are guided to the exchange trading surface for execution, are really what determine prices. These tips are to buy and sell are interpreted into real acquisitions and sales on the exchange trading surface, and according to directive this must be done by public uproar across the trading colliery and not by private conciliation.
The prices at which transactions are made are recorded and immediately released for distribution over an enormous telecommunications network. Probably the best way to visualize how purchases and sales are made on the surface of a commodity exchange is to think in terms of what happens at a public sale. The principle is the same, except in the futures market a 2 way sale is continuously going on during trading hours. This 2 way mart is made possible because of the consistent futures contract, which requires no description of what is being offered at the time of sale. Also, the 2 way auction is made feasible because the intonation of both buying and selling orders to the exchange surface is normally in sufficient volume to make buying and selling of equal importance. In a public sale the enunciation is on selling. The determination of the commodity exchange is to provide the systematized marketplace in which members can freely buy and sell several commodities in which they have an interest. The exchange itself does not operate for profit. It simply provides the facilities and pulverized rules for its members to trade in commodity futures, and for non-members also to trade by selling through a member broker and paying a broker commission.