Question: What Are Commodities Futures?
Answer: Commodities futures, or futures contracts, are an agreement to buy or sell a commodity at a specific date in the future at a specific price. Just like the price of bananas at the grocery store, the prices of commodities can change on a weekly or even daily basis. If the price goes up, the buyer of the futures contract makes money, because he gets the product at the lower, agreed-upon price and can now sell it at the higher, market price. If the price goes down, the seller makes money, because he can buy the commodity at the lower market price, and sell it to the buyer at the higher, agreed-upon price.
Of course, if commodities traders had to actually deliver the product, very few people would do it. Instead, they can fulfill the contract by delivering proof that the product is at the warehouse, by paying the cash difference, or by providing another contract at the market price. As you can easily see, it can get very complicated very fast, and they use a lot of strange terms, so I won’t try to explain more. The Commodities Futures Trading Commission does a much better job, if you really want to get into the details.
The important things to know are:
- Commodities futures, since they are traded on an open market, do a great job of accurately assessing the price of each commodity.
- Since they are futures contracts, they also forecast the value of the commodity into the future.
- The values are set by commodities traders and analysts, who spend all day every day researching their particular commodity. This means they are very good at it, so you can totally trust their estimation. Of course, their forecasts are based on today’s information, so if North Korea suddenly tests a nuclear weapon, the commodities prices will change dramatically.
- The best way to either invest in or monitor commodities futures is through a commodities index or commodities fund. These can give you a single number that takes into account the broad spectrum of commodities futures that are occurring at any given time, such as the GSCI.
- The most commonly reviewed commodities are oil and gold. Many other agricultural products such as pork bellies and wheat are traded, but the individual investor doesn't really need to be concerned with them.
Commodities FAQ
- What Are Commodities?
- What Are Commodities Futures?
- How Does Commodities Trading Affect the Economy?
- How Are Oil Prices Determined? More US Economy Q&A
