Diamonds: The Missing Commodity Derivative

By Investopedia. May 7th 2016

Derivative markets exist for most major commodities, with diamonds standing out from the crowd as a shining exception. The derivative markets for oil, corn, soybeans and other staples of the global economy are well established, with robust trading in financial contracts that derive their value from the underlying asset. Notably, while a derivative's value is based on an asset, ownership of a derivative doesn't require ownership of the asset. Commodity producers often use derivatives to lock in the prices of the items they will bring to market or purchase from the market at some point in the future.

The Reality of the Marketplace

For many years, diamonds and iron ore were two major commodities that many groups had been trying to create exchange-traded instruments for. Those in favor of the creation of derivative markets tout the market as a way for commodity products to hedge risk by locking in prices. While this is a valid argument, the reality is that a large part of the derivatives markets are fueled by speculators. The derivative market is often larger than the market for the actual commodity. This is because speculators don’t want to take physical delivery of the commodity, they want to trade contracts and make money.

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