Most producers and users of commodities buy and sell them in the
cash market,
also called the spot market, because the full cash price is paid on the spot. Cash prices are determined by supply and demand, which in many cases move in predictable seasonal cycles. Fresh fruits and vegetables are cheapest in the summer when they're plentiful (and most flavorful). So soup, juice, and jam manufacturers plan their production season to take advantage of the highest-quality produce at the lowest prices.
But supply and demand is also affected by unpredictable events. Drought might wipe out a wheat crop, causing the cash price of wheat to soar. Political turmoil in the Gulf region might threaten the oil supply and cause the cash price of energy commodities to rise. The futures market is designed to help protect producers and users from just such price risks. Farmers, loggers, manufacturers, and bakers can buy futures contracts in the products they produce or use to smooth out the unexpected price fluctuations.
Supply and demand, plus expectations
Futures prices tend to track cash prices closely, but not identically. The difference between the futures contract price and the cash price of the
underlying commodity
is the
basis.
Futures prices are determined not only by supply and demand, but also by traders' expectations of a host of other factors, including weather changes, environmental conditions, political situations, and what the market will bear.
