Futures Provide Liquidity To Business Inputs
There are two components that provide benefits to those who exchange the goods involved in futures commodity contracts, and that’s to provide a mechanism for hedging the purchases and sales of their goods, as well as to provide a means where these exchanges can be readily made at fairly efficient prices.
The foundation for futures contracts are those who are engaged in the creation of these contracts, which are always people who are involved in the actual buying and selling of the business inputs. The goal of these people is to reduce their risk as far as either what price they will pay for a business input or what they will receive from its sale at a given point in the future.
If that was the end of it, then it would merely be a private contract between two parties, but the purpose of an exchange is to allow the contract to be traded on the free market. This provides more liquidity to both those who are looking to buy or sell the business input as well as making the contract available to whomever else may want to get involved.
Many people may look at these contracts and wonder why individuals who neither provide commodities or are interested in purchasing them may ever want to get involved in futures trading. The reason they might is that trading financial securities, even future contracts, do not require people to retain their positions until the contract expires.
So, you may buy or sell a certain amount of corn, or wheat, or crude oil, or copper, or any type of commodity that is traded on futures exchanges, without ever intending to deliver or take delivery of any of these things.
The number of participants in the actual delivery of commodities is fairly limited, and there are far more people who do have money to buy and sell these commodities over a shorter duration, or just are happy to settle the contracts with cash, and the futures market becomes more efficient when these additional participants become involved in the trading.
The more the participants in a market, the more liquid it becomes. If we limited this to just those who are planning on delivering or taking delivery of a commodity, there would be considerably less contracts for something up for sale at any given time, and also less demand for them.
Less liquidity cashes out to less price efficiency, and more liquidity equals lower spreads and therefore more price efficiency. This is the reason why exchanges and public markets in general exist, to provide more liquidity and make the trading of something more efficient.
This allows those who have no interest at all in a given commodity to buy and sell futures contracts with the goal of speculating on future price movements. Many traders buy and sell futures contracts on all sorts of commodities for this reason, and there is no need at all to have any interest in a commodity to trade it, beyond just looking to speculate on it.
The main commodities that are traded on futures markets, by both producers and users of commodities as well as speculators, are agricultural products such as corn, rice, soybeans, wheat, coffee, cocoa, cotton, and sugar, livestock and meat products such as lean hogs, pork bellies, live cattle, and feeder cattle, energy products such as crude oil, gasoline, heating oil, and natural gas, and metals such as gold, silver, platinum, palladium, and copper.
There are other commodities that are traded but all fall into one of these sectors. One chooses a commodity to trade futures on based upon either business need when hedging, or an expectation that the price will move in a certain direction based upon either fundamental or technical analysis, or both, if one is looking to speculate.
Precious Metals Futures
While precious metals are a commodity and are used to some extent as a business input, for making jewelry for instance, or for industrial uses such as electronics or catalytic converters, precious metals are distinct in the sense that a lot of the trading with them, in both the spot or immediate delivery market, and in the futures market, are based upon these metals being a store of wealth and an investment in themselves.
In these cases, the non-business use participants, the speculators in other words, may actually possess the goods or be looking to take delivery of them, as precious metal ownership in itself can be and often is speculative.
Even governments speculate in precious metals in this sense, although they actually serve as more of a hedge, and a lot of investors take ownership of precious metals as a hedge as well. Precious metals do not tend to perform as well as other investments over the long term, stocks for instance, and even bonds tend to outperform them, so people use them as hedges against their other investments quite often.
All futures trading is speculation to some degree though, as you have one side of the contract, the seller, speculating that they will gain from the contract, with the buyer doing the same thing. What makes hedging different is that those looking to hedge are willing to take a loss on what is being hedged in order to help protect themselves from other risks.
Since futures trading is based upon the relatively short term though, those looking to speculate on precious metals futures do so primarily as a short term speculation play, just as they would with other commodities.
Financial Based Futures Contracts
Stock index based futures have really grown in popularity over the last while, and many of the participants are looking to play the market as a whole and are using futures as a means to speculate on price changes.
Since index futures are based upon a financial product, other securities in this case, the entire market for this type of futures is speculative. People trade index futures with the same view and purpose as they trade stocks, or ETF stock index shares, or mutual fund index shares, the goal is to make money from them, although in some cases they can be used to hedge other investments.
People also trade contracts for foreign exchange futures, which works the same way as the forex market does other than the contracts are set for a certain date in the future as all futures contracts are. Foreign exchange futures do serve a business purpose though, as a business may have an interest in locking in a certain exchange rate in the future, although like all futures, they involve speculators as well.
The other main type of financial based future is one based upon interest rates, where it may be to the benefit of parties to get certain rates or certain interest rate swaps down the road. This may involve futures contracts for things like bonds, treasury bills, or things like the Eurodollar and other products whose value is based upon changing interest rates.
The futures market is a vibrant one and has attracted a great deal of participants, those who need to trade in this market for business purposes, as well as those who are just trading for the sake of making money.
The futures market does not favor one type of participant over another, and speculators and hedgers are all well accommodated, and with things like allowing people to just roll over positions into the next contract as well as allowing them to settle for cash instead of exchanging commodities, speculators in particular are well taken care of and are seen as a very important component of the futures market.