Having discussed the markets for financial assets, let's now turn our attention to a market for real assets, the commodity markets. Companies, like our Kellogg's, go to markets to source their primary commodities, their raw materials. Kellogg's would be comparing the prices of grains inputs into its cereals. So the graph here would tell Kellogg's what the price performance of wheat has been over the past 15 odd years as compared to the price developments in corn. And it could make its business decisions of sourcing the relevant raw materials accordingly. Primary commodities are, in fact, traded globally. They're traded globally in wholesale over-the-counter markets, similar to the foreign exchange markets, similar to the debt markets as a trading platform. Many very large corporations would source their raw materials directly from large producers. But many others would source them through a set of intermediaries. And the intermediaries of relevance for Kellogg's could be the major grain merchants, or it could be a set of commodity brokers. Markets in primary commodities like agricultural commodities, metals, energy, assets are somewhat different from the markets for financial assets, the capital markets that we've discussed so far. So for example at any particular point in time, there might, in fact, be five maybe even ten different prices for arabica coffee. Now how can that be? How can it be that there are so many different prices? Aren't markets meant to eliminate that price dispersion and deliver a single point of truth in price discovery? Well, clearly that doesn't apply here, so why would that be the case? It turns out that it is, in fact, very, very difficult to obtain what we call a comprehensive transparent market price signal. It would require standardization of quality, purity, delivery location, the geographical location where the coffee is coming from, transportation costs involved, etc. You might want to take off that list and see whether it has any relevance in the debt markets or the foreign exchange markets or equity markets even. The answer would be no. It doesn't apply in that setting but it does for commodities. So the example here in the graph is the wheat price in US dollars per metric ton and then we see the raft of information provided there which makes it very specific about what particular commodity we're talking about. Number one, hard red winter, ordinary protein, free on-board, Gulf of Mexico. A lot of information is required to pinpoint the relevance of this particular price for a particular commodity. Beyond aggregating for a single commodity, the wheat price, the market here also aggregates across different commodities. So we could describe the commodity market as a market characterized by the commodity price index that you see on the screen which is provided by the US Bureau of Labor Statistics. Similar to the price indices we've seen for equities where the Dow Jones Index presents an average price performance of about 30 industrial stocks. The same has occurred here for a commodity price index. So the commodity price index is a basket of commodities appropriately translated into an index. So why is the US Bureau of Labor Statistics providing this particular index? Well, they use it as you can see in the shaded area as in indicator to signal changing business activities. So the purchases and the price developments in primary commodities is typically a leading indicator of what will happen next in the manufacturing of those prized primary commodities. So it gives an indication of changing economic conditions ahead of time. If corporations decide to slow down their rate of production, they would use less primary commodities, less demand for those primary commodities would mean a lower price for these primary commodities. And that would be reflected in the commodity price index. So some of the issues worth considering for commodity markets including liquidity. Liquidity can truly be a problem. There are significant supply variations for many agricultural commodities, for example. It's seasonally defined. But there are also demand variations. There are peak periods in the use of certain primary commodities, certain raw materials, and that will have a significant impact on price developments. We've already hinted at the fact that transparency might be less than perfect. There's no such thing as a single arabica coffee price. In addition to that, many transaction happen, in fact, off-market. Bilateral negotiations between large corporations and large primary producers. The nature of those long term contracts negotiated by the large corporations would disadvantage many smaller buyers and sellers in this market. That suggests that this market is often not fully competitive and that will have its impact on price discovery and the fairness of the prices to every trader involved. So what are the key markets for trading commodities? Again, the same culprits as before, New York, Chicago, London, the traditional commodity centers. But you have to keep in mind that because of this dispersion in quality and location, in fact commodity markets are quite geographically dispersed. Nonetheless, more and more commodities are nowadays listed on automated trading platforms and the information thereby gets much more efficiently pooled overcoming many of those problems that we've just discussed. Commodity trading is in fact becoming evermore a global marketplace, making life that much easier for the corporation's processing commodities into manufactured goods.
