An Introduction to Commodities

AN INTRODUCTION TO COMMODITIES

By Chen Zhenxiong

20 October 2010 

TABLE OF CONTENTS

1. INTRODUCTION 3

2. HISTORIC OVERVIEW OF COMMODITY MARKETS 3

2.1 General Movement of Prices 3

2.2 History 4

3. MODERN DAY OVERVIEW OF COMMODITY MARKETS 5

3.1 End of a Sustained Boom from 2003-2008 5

4. OUTLOOK OF COMMODITIES IN 2010 6

4.1 The Impact of Chinese Economic Growth on Commodities 6

4.2 Continued Asian Economic Growth in 2010 8

5. CORRELATION BETWEEN COMMODITIES AND OTHER ASSET CLASSES 9

5.1 Correlation between Commodities and a) Equities b) Bonds c) Inflation 9

5.2 Simple Cross-Asset Correlations: Returns and Return Volatilities 10

6. CONCLUSION 12

7. REFERENCES 13

1. INTRODUCTION

Commodities are everywhere. From the coffee that we drink to the gas that we use to power our vehicles and heat our homes, commodities play an important role in our everyday lives. They can be found literally all over the world, and can be traded on the global marketplace as part of a diversified investment portfolio. Some prominent commodities exchanges include Chicago Board of Trade (CBOT), Chicago Mercantile Exchange (CME), Kansas City Board of Trade (KCBT) and New York Mercantile Exchange (NYMEX), just to name a few. Markets for trading commodities can be very efficient, particularly if the division into pools matches demand segments. These markets will quickly respond to changes in supply and demand to find an equilibrium price and quantity.

While commodities can be traded on either spot or futures markets, most individual commodities are traded as a futures contract. This means that what is being traded is not the actual commodity itself, but rather a contract to buy or sell it for a certain price for a stated date in the future. Most investors are keen to trade commodities for profit purposes and few might actually desire for the delivery of the commodity to their doorsteps.

Commodities form an important class of assets which should not be ignored by investors. They influence a significant portion of the world economy, and can be viewed as the largest “non-financial” market in the world. With a keen understanding of market demand and supply forces, commodities are not just a good way to diversify a portfolio