1. Mohd Zahid Laton, FPP UiTM Pahang
CHAPTER 7
MARKETING OF AGRICULTURAL COMMODITIES
1. Commodity exchanges. At commodity exchanges, buyers and sellers call or
wire in their orders. Commodities are bought or sold in specified contract unit
amounts for present or future delivery. Product quality must conform to trading
rules. Sales representatives on the trading floor match the buy and sell offers, at
either stipulated or bargained prices, to consummate sales.
2. Centralized commodity exchanges. Centralized commodity futures
exchanges like the KLCE have a bid-and-offer floor auction of futures contracts.
Floor traders for brokerage firms call out bids and offers to arrive at maximum
obtainable trading prices. Trading occurs at a designated location on the exchange
floor called a trading pit. The KLCE acts as a middleman between the buyers and the
sellers.
3. Kuala Lumpur Commodities Exchange KLCE. The Malaysian commodity
exchange for trading futures in crude palm oil, crude palm kernel oil, tin, rubber,
and cocoa. The Kuala Lumpur Commodity Exchange (KLCE) is a futures exchange
set up in 1980 after the Malaysian Parliament passed a new legislation known as the
Commodities Trading Act, 1980. It was subsequently restructured in 1985 after the
default crisis in 1984. The rules and regulations of the KLCE are very similar to
those of other established futures exchanges in the world. The KLCE provides a
market-place for trading in several types of commodity futures contracts such
as the Crude Palm Oil (CPO) Futures, Tin Futures, Rubber (SMR20) Futures and
Cocoa Futures1. The CPO Futures trading is the only active futures contract trading
in the KLCE and in fact accounts for more than 90 per cent of its trading volume.
4. The KLCE is the only futures exchange in the world that trades in CPO
Futures. It is located in Kuala Lumpur, Malaysia, which is in Southeast Asia, the palm
oil roducing region in the world. This region currently accounts for about 80 per
cent of global palm oil production and 70 per cent of exports.
5. Definitions of term in commodities exchange:
5.1 Physical market. Physical market is a place where buying and selling
of commodities and price of the commodities has been accepted and
consulted between the parties.
5.2 Future market. Future market is a place where buying and selling a
contract and price of the commodities has been consulted.
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2. Mohd Zahid Laton, FPP UiTM Pahang
5.3 Commodity exchange. Commodity exchange specializes in the
buying and selling of agricultural goods precious metals or foreign
currencies.
5.4 Spot price. Price determination and delivering of the commodities are
done immediately in the cash market.
5.5 Spot market. The purchase and sale of commodities for immediate
delivery.
5.6 Future price. Todays price of the commodities to be delivered in the
future market.
5.7 Future market. The purchase and sale of goods for delivery in the
future. In the future market, speculative profits can be made from either
rising or falling prices.
5.8 Bull market. Bulls are trader who feel prices will rise, so they ‘go
long’ (buy). A bull market is associated with increasing investor confidence,
and increased investing in anticipation of future price increases capital gains.
5.9 Bear market. Bears feel prices will fall, so they ‘go short’ (sell). A bear
market is a general decline in the stock market over a period of time. It is a
transition from high investor optimism to widespread investor fear and
pessimism.
5.10 Future contract. Future contract is an agreement to delivered or
received commodities at a specified time that has been accepted. Delivery of
commodities only accepted when the contract matures. The price remains as
accepted previously.
6. Future contract promises can be fulfilled in either of two ways. The
commodity can be delivered or accepted at contract maturity, or the promises can
be nullified by an offsetting futures market transaction prior to contract maturity.
7. The future markets consists of traders and capable of buying and selling
future contracts for the public in future. It consists of a trading floor where buying
and selling for the future contracts of commodities. In this place, the buyers and the
sellers will meet and exchange for contracts. The presence of governing bodies will
enforce the guidelines of transaction and the clearing house is to ease transaction
and transportation of the commodities.
8. In the future market operation, delivering the commodities from seller to the
buyer transaction can be deal through;
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3. Mohd Zahid Laton, FPP UiTM Pahang
8.1 F.O.B. (Free On Board). A shipping term which indicates that the
supplier pays the shipping costs from the point of manufacture to a specified
destination, at which point the buyer takes responsibility. It covers term of
sale under which the price invoiced or quoted by a seller includes all charges
up to placing the goods on board a ship at the port of departure specified by
the buyer. Also called collect freight, freight collect, or freight forward. FOB
includes tariff apply to product value as it leaves export country.
8.2 C.I.F. (Cost Insurance Freight). Term of sales signifying that the
price invoiced or quoted by a seller includes insurance and all other charges
up to the named port of destination. In comparison, carriage and insurance
paid to (CIP) terms include insurance and all charges up to a named place in
the country of destination (usually the buyer’s warehouse). CIF indicates that
a quoted price includes the costs of the merchandise, transportation, and
insurance. Cost, insurance, and freight is a phrase used in an offer or a
contract for the sale of goods indicating that the quoted price includes the
combined cost of the goods, insurance, and the freight to a named
destination.
9. Speculator/speculative middlemen. Speculative middlemen are those who
buy and sell product with the major purpose of profiting from price movement.
Speculative middlemen seek out and specialize in taking these risks and usually do a
minimum of handling and merchandising.
10. Brokers. Brokers do not have physical control or ownership of the product.
They follow the directions of buyers and sellers and have less influence in price
negotiations than commission men.
11. Factor contributing to the future market.
11.1 Lack of storage facilities.
11.2 Existence of legal contract.
11.3 Need of standard of grading.
11.4 Differing methods of payments.
11.5 Need of market information.
11.6 To guarantee the contract.
12. Preconditions where commodities can be traded in exchange commodities;
12.1 Market is expandable. Product exported either locally or
internationally is for the purposes of large scale production and to gain profit
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4. Mohd Zahid Laton, FPP UiTM Pahang
maximization. The commodities traded in the market is demanded by abroad
countries.
12.2 Government control. Governnment control is a preconditions in
order to monitored the efficiency of the trading of commodity either directly
or indirectly. Government will set-up the policy, contract and law, and
regulation of trading commodities.
12.3 Commodities can be graded. Grading of commodities will enhance
the differing in prices. Once the grading is applied, quality control can be
improved. Grading will influenced any buyers to freely choose their own
products.
12.4 Involvement of traders. Involvements of processors, speculators and
middlemen or buyers will influenced the presence of exchange commodities
in the market. Whatever it is, it will abide on the policies, principles and
regulations.
13. Types of future market traders. There are two types of future market
traders;
13.1 Speculators. Speculators are traders who attempt to anticipate and
profit from futures price movements. Speculators generally have neither the
capability nor interest in fulfilling their futures contracts by taking or making
delivery at contract maturity.
13.2 Hedgers. Hedgers also attempt to profit from anticipated price
changes, but they usually can take or make delivery of the commodity at
contract maturity. However, like speculators, hedgers seldom allow futures
contracts to mature. There are always many more speculators than hedgers
in the future market.
14. Hedging and risk management. Price risk is inherent in the ownership and
handling of agricultural commodities. A hedge implies a protective mechanism. A
futures market hedge is such a risk management device. It involves the temporary
substitution of a futures market transaction for a cash transaction. The mechanics of
a hedge consist of making opposite transactions on the cash and futures markets in
order to protect the firm against adverse cash price movement.
14.1 The hypothetical perfect hedge. The perfect hedge is a situation
where the gain in one market exactly offsets the loss in the other. The
process of hedging can be explained by the operations of the owner of a grain
elevator. The owner buys cash grain from farmers and ships it to a terminal
market for cash sale one week later. Owners of grain elevators normally
operate on a small profit margin per bushel, and attempt to make their
profits from handling charges rather than from speculative market positions.
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5. Mohd Zahid Laton, FPP UiTM Pahang
The elevator owner is long in the cash market when he originally purchases
the grain from farmers. Until this grain is sold, the owner is exposed to a cash
price risk because the price of grain could fall by the time it is sold one week
later. To protect against this possibility, the owner could hedge as follows;
Date Cashmarket Futures market Basis
March 19 Buy 100,000 bushel Sell 100,000 bushel RM0.50
at RM2.00 (LONG) at RM2.50 (SHORT)
March 25 Sell 100,000 bushel Buy 100,000 bushel RM0.50
at RM1.90 (SHORT) at RM2.40 (LONG)
Gain or Loss Loss RM0.10 Gain RM0.10
March 25 cash price = RM1.90
+ Future gain = RM0.10
Net value = RM2.00
- original cash cost = RM2.00
Profit or loss = RM0
14.2 The storage hedge. Businesses normally use the storage hedge when
commodities are to be held for a period of time during which the basis is
expected to narrow. This hedge purposes to protect the firm against adverse
cash price movements, and to assist the firm in earning carrying charges
(storage costs, interest, and insurance) during the storage period. The
storage hedge can be used by farmers and food marketing firms.
Date Cashmarket Futures market Basis
Nov 1 Buy corn at RM2.00 per Sell July corn contract RM0.50
bushel and store for next sale at RM2.50
Jun 1 Sell corn at RM2.30 per bushel Buy July corn contract RM0.10
at RM2.40
Gain or Loss +0.30 +0.10 -0.40
Jun 1 cash price = RM2.30
+ Future gain = RM0.10
Net value = RM2.40
- original cash cost = RM2.00
Return to storage = RM0.40
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6. Mohd Zahid Laton, FPP UiTM Pahang
14.3 The pre-harvest hedge. This hedge is appropriate for farmers during
the period between planting and harvesting a crop. It allows farmers to lock-
in a profitable selling price before or after the crop is planted and prior to
harvest.
Expected
Date Cashmarket Futures market Nov basis
March 1 Plant at estimated Nov cash Sell Dec futures RM0.40
Price of RM2.60 at RM3.00 per bushel
(RM3.00 – 0.40)
Nov 1 Harvest and sell locally Buy Dec futures RM0.40
at RM2.40 at RM2.80
Gain or Loss +0.20
Nov 1 cash price = RM2.40
+ Future gain = RM0.20
Net value = RM2.60
Estimated cash price= RM2.60
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