Time To Bet On Raw Deals With Commodity Trading?
In the modern era, investment horizons are expanding, and investors are seeking new opportunities. However, very few investors know about the unique opportunity offered by commodities. Commodities make a significant impact on the rest of the industries and other financial instruments in the market. Let us learn more about the commodity markets and their various aspects in detail.
What Is Commodity Market?
We often come across news that read…‘stock market slowdown due to crude prices’ or ‘Gold prices are shooting up’, and so on. Crude oil, gas, gold, and agricultural produce may seem to be mere commodities, but they have a crucial impact on our daily lives. Due to this, they can also significantly impact other markets of the economy, such as equity.
In layman's terms, the commodity markets are bustling bazaars that trade crucial raw materials in different forms. They trade commodities that are used as raw materials for almost everything in the world, from large skyscrapers to your first tea in the morning! They are one of the most sought-after alternative investments and offer diversification to an investor's portfolio. Globally, the commodity market is generally categorised into two parts: agricultural and non-agricultural produce.
How Does It Work?
Financial instruments, in the form of contracts of commodities, are traded on the virtual commodity markets along with regular physical markets. Some of the ways how commodity market works are as follows:
- Physical
In this marketplace, tangible commodities are bought and sold. The parties bargain to reach satisfactory prices. However, governments also take the initiative to fix minimum prices for some items.
- Spot
These markets also have delivery features, but the contracts are traded for future transactions. The futures and forward contracts are part of these markets. Investors pre-decide the commodity prices.
- Derivatives
These are only contracts and are not concerned with delivery features. The domestic spot prices form the base for such financial contracts. Further, the traders buy and sell option contracts. They function like regular equity derivatives.
Types Of Traded Commodities
Based on the nature and usage of the commodities, the following classification is used:
- Hard commodities include the following, which are the raw material for the capital heavy industries:
Commodity | Example |
Precious Metals | Gold and silver |
Other Metals | Copper, aluminium, lead, nickel, and steel are traded. |
Energy | Crude oil and natural gases |
- Soft commodities include one which are consumer products that can be directly consumed or used as intermediate commodities:
Commodity | Example |
Agriculture Produce | Cotton, soybean, wheat, rice, turmeric, and other items |
Livestock & Meat | Cattle stocks, meat and other livestock materials |
Factors Affecting Commodity Prices
We all use these items in our daily lives in one way or the other. Therefore, ascertaining the concerned factors requires a holistic view. Some of the factors are:
- Natural - Products like agricultural and mining produce are greatly affected by natural calamities or seasonal changes.
- Economic - Factors like inflation, interest rate changes, economic growth or recession can have a crucial impact on commodity prices.
- Geopolitical - Some instances such as war, unrest and diplomatic clashes on the global level can affect the procurement of commodities, and eventually, the commodities market.
- Technological - Technical advancement can significantly affect the supply of commodities.
- Speculations - The derivatives trading of some commodities can potentially speculate the prices of commodities.
Commodity Markets In India
The contracts of the commodities market are primarily categorised under the derivatives market. Before 28th September 20151, this market was regulated by the Forward Markets Commission or FMC. However, this body was later merged with the Securities Exchange Board of India or SEBI. Some of the exchanges used for such trading in India are as follows:
- Multi Commodity Exchange of India, also known as MCX.
- National Commodity and Derivatives Exchange, also known as NCDEX.
- Indian Commodity Exchange, also known as ICEX.
- National Multi Commodity Exchange, also known as NMCE.
In India, the commodity markets have been soaring to newer heights in the past few years. However, in FY 2023-24, the market experienced a decline due to a combination of several reasons, such as the El Nino effect in May 2023, the Russia-Ukraine war, fear of global recessions, and many more. It was reflected on the global level, where the charts remained flat2.
Growth Of Commodity Trading In India
In India, these instruments are specifically traded on:
- MCX
- NCDEX
- National Stock Exchange (NSE)
- Bombay Stock Exchange (BSE)
Options and futures contracts for varied commodities are traded on these exchanges. The turnover of the commodity derivatives segment massively surged by 86.9% in 2023-24.
The composite index of MCX India Commodity Indices has delivered 14.6% 1-year returns as of June 20243. As discussed, the index experienced a decline in 2023-24 and generated just 10% returns compared to 16.3% in 2022-234. Due to global pressure, crude oil prices remained flat, agri commodities declined, and gold futures increased by nearly 13.6% in a similar period4.
How To Invest In Commodities?
Commodity trading for beginners in India has been simplified over the years due to technological aids like brokerage applications, exchange websites and real-time market data. One of the prerequisites of investing in commodity markets is a dematerialised account, also referred to as a demat account.
Investors should try to gain at least basic knowledge of the concerned market and analyse the investments before investing in futures and options. Some of the common ways to invest are options and futures contracts, Exchange Traded Funds (ETFs) and Commodity-linked mutual funds.
Commodity trading in India can be a unique alternative investment for investors. However, one should consider some factors while investing in the commodity market:
- Assess your financial aspirations and comfort zone for the commodity markets.
- Due to different investment structures, the risk factors of this investment are also different. Also, assess the risk aversion conditions before investing.
- Research well about the commodities before investing.
- Do not invest everything in a single commodity. Diversification can facilitate the balance between risk and returns on your investments.
- Tax implications and fees/costs concerning commodity trading should be checked.
Pros And Cons Of Commodity Trading
Pros | Cons |
Helps in diversification and hedging one’s investments against volatility. | Commodity trading is affected by a diverse range of factors. Therefore, one may experience volatility. |
One can get access to global markets through commodity trading. | The market structure is complex and may confuse the investors. |
Bottomline
Commodity markets are unique investment avenues in modern-day scenarios. The agricultural and non-agricultural commodities traded on such markets can potentially make a significant impact on overall economies. However, investing in commodity markets should be preceded by proper research and knowledge of the markets. You must diversify your portfolio to earn stable returns. To learn more about investment opportunities and diversification login to Grip Invest.
Frequently Asked Questions On The Commodity Market
1. What is meant by the commodity market?
These are investment avenues where individuals invest in goods like agricultural products, precious metals, livestock, meat, and so on. There are also derivative and spot markets where commodity traders decide to bet on the future prices of a particular commodity based on weather, geopolitical, production, and market conditions.
2. What are commodity futures in India?
Commodity futures are contracts to buy or sell a particular commodity in the future at a pre-decided price. In India, it is regulated by SEBI and FMC. It provides a unique diversification opportunity to the traders. Usually, these commodities are significant raw materials to other sectors in the market and have an impact on their share price movements in the regular cash markets.
3. How do commodity traders trade?
The underlying commodity in the particular contract is analysed, and based on overall conditions that affect that commodity, trades are placed in the market. These contracts can be spot, futures or options. Speculations by the traders lead the contracts to be marked to market, prices of which are later settled by the clearing corporation at the end of the day.
References
- SEBI, Accessed from https://www.sebi.gov.in/media/press-releases/sep-2016/developments-in-commodities-markets-post-merger_33395.html#:~:text=SEBI%20took%20over%20the%20Regulation,rare%20event%20across%20the%20world.
- SEBI, Accessed from https://www.sebi.gov.in/reports-and-statistics/publications/aug-2024/annual-report-2022-23_74990.html.
- MCX, Accessed from https://www.mcxindia.com/docs/default-source/market-data/mcx-icomdex/factsheet/mcx-icomdex-composite-fact-sheet.pdf?sfvrsn=1a329990_36.
- SEBI, Accessed from https://www.sebi.gov.in/reports-and-statistics/publications/aug-2024/annual-report-2022-23_74990.html.
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