Q: What influences pricing in commodities futures markets?
This is a complex question. A good place to start is by answering the question, “What are futures markets?” Essentially, a futures market is made up of buyers and sellers that are making trades related to the future price of something. There are many different futures markets: agricultural products, oil, precious metals and interest rates to name a few. At Avendra, we care primarily about corn, soybean, coffee, cattle, hog and cotton futures because they influence the prices our clients pay for their food and textiles. Agricultural futures markets are fundamentally driven by supply and demand. The key supply factors for agricultural commodities tend to be the number of acres planted, the weather in the growing region, and the yield from the crop. Demand for agricultural products tends to be relatively steady (there are some exceptions, but they are more short term in nature), driven by population growth and evolving dietary preferences.
Buyers and sellers use futures markets to mitigate risks. For example, a farmer growing soybeans can mitigate the risks of a disease that could harm his crop by locking in prices several months in advance of the crop being harvested. Or a company manufacturing coffee drinks may want to create input cost certainty by locking in prices, thereby eliminating the weather and political risks associated with coffee production. The abstract from the Federal Reserve Bank of St. Louis in the side bar has a concise overview and some definitions that provide further explanation.
Q: What role do speculators play in futures markets?
Some investors in commodities futures have no direct relationship to the commodity — they neither grow it, nor do they want to take ownership of it — but are in the markets purely for financial gain. This group is generally referred to as speculators. Depending on your point of view, speculators play a valuable role or a destructive role in futures markets. Arguments favoring speculation in the commodity market typically center on the idea that it is a free market and additional investors add liquidity, and therefore greater price accuracy, to the market. Importantly, futures markets are a zero-sum game – so if someone (a speculator or a corn farmer) expects future prices to move higher and wants to trade that price movement, they must find someone else (for example, another speculator or a different corn farmer) that expects the price will not go up in order for a trade to occur.
Those against speculators argue that the commodities markets are increasingly large and not adequately regulated. A 2010 study by Barclays Capital noted, “$320 billion of institutional and retail money is now devoted to commodities, compared with just $6 billion in 2000.” Detractors argue that these massive amounts of money skew supply and demand fundamentals, which can increase pricing volatility in the commodity markets. There are studies that argue both sides and introduce further stratification of the issue.