Basic Question

[bobmick]

Looking into commodity trading I have started to wonder what the prices of commodities 'on the exchanges' have to do with the price of commodities in the real world.
Maybe I'm just being thick but I just cant seem to put the two together. Supply and demand? I just cant get my head around it! Say that China is needing to import lots of oil, what is it doing to do this? Is it going direct to the oil producers and offering them more money for oil than they are currently getting? No of course not! So how does the extra demamd for oil actually push up price? The only bidding war I can see going on is between the traders on the exchanges who actually never take delivery of the product. They don't produce it, sell it or buy it in real terms!
And what about say, wheat for example, what if drought devastates the crop then wheat prices rise so traders buy like mad because the price is rising. Is this the traders setting the price or the price driving the traders? Is it the supply and demand in the real world or on the exchanges?
Is it just a game all of it?
Do the exchanges set the price of commodities in the real world?
What if there is a lack of sellers of say wheat in the real world but an abundance of sellers of wheat contracts on the exchanges what happens then?
I know I must sound stupid but if anyone can help my immense frustration may ease some!
Thanks,
James

 

[RUDEBOY]

That's futures for you.

Market price and futures price do diverse at times, but in general they have to follow each other. Us humans, eh? Nothing is ever good enough.

Do you know how the futures market came about?

Think of the word.......futures?

Then ask yourself this.........Why do market and future prices shadow each other?

 

[sandrab]

Then ask yourself this.........Why do market and future prices shadow each other?

If you take out your eyepatch you may see it.......

 

[oatman]

What if there is a lack of sellers of say wheat in the real world but an abundance of sellers of wheat contracts on the exchanges what happens then?

If the contract runs to maturity, then they'll have to find the wheat. If there ain't enough then they'll have to pay up and lose their a$$e$ :cheesy:

 

[bobmick]

ok I think I'm getting it.

 

[bmittal]

Physical versus Futures Markets...

Hey Bobmick,

Taking a real world example, the IEA said last week that world oil demand will slow next year, especially in China as its economy cools. Well, if you think about supply and demand in the static physical market, the price correction shouldn't occur until 2006, when oil demand actually goes down. However, text book Economics doesn't really work in the real world! Because people always look into the future, any percieved changes in supply and demand will make traders act now. Hence, you hear that when the FOMC raises rates, the dollar doesn't move very much on the day - the rate move has been 'priced in'.

Also, particularly in the oil markets, if you look at commercial demand (which includes gas stations, refineries, airlines, etc, that actually use the oil for daily operations or for hedging), it is fairly constant week on week. This is because, whatever happens, planes still fly, cars run and oil gets refined into jet fuel, unleaded gasoline, etc to feed real petroleum demand. Beacause of this fairly constant commercial demand for oil, the commercial users lose their ability to control prices by changing their demand.

The only other people who buy (or sell for that matter) oil are speculative traders, people like you and me, if you trade oil that is! Now, the demand for oil by us is VERY volatile day to day as we are just trying to make money by accurately predicting prices before everyone else! ie, exploiting imperfections in the underlying market. We base our decisions on fundamantals such as hurricanes disrupting oil supplies, refinery blasts in Iraq and Saudi Arabia, winter demand for heating oil, etc. Because our demand is volatile and the commercial demand is constant, its as though commercial demand doesn't exist! Think of commercial demand as a blank canvas and the speculative demand as the paint brush on top of it. Any changes in the picture you draw will only be determined by the paint brush as the colour of the canvas will always be white and plain (in the medium term until you decide that its time to replace the canvas!). The commercial demand will change gradually due to structural issues in the economy like recession, etc. But, speculative players have already forseen that and hence the futures price has already dictated the current price, when we get to that point in the future. Current spot prices lag futures prices. In other words, futures prices lead current prices!

Hope this helps.....

Kind regards....

 

[bobmick]

Thanks!
Now I'm getting my head around the nuts and bolts of it all I've got to do is figure out how to make money at it!!

 

[bmittal]

You're welcome...!

Welcome aboard the oil trader's bandwagon!