Commodities

What is a Commodity Market?

Commodity market is the market where buying and selling of commodities takes place. It is the primary economic sector for the exchange/trading of essential goods and products. The commodities can be segmented as

i) Agricultural commodity and

ii) Non Agricultural commodity.

Agricultural commodity includes farm produces like cotton, coffee, tea, sugar, wheat, etc.

Non Agricultural Commodities consists Precious metals (Gold, Silver, Platinum), Industrial Metals (Copper, Lead, Zinc, Nickel), and Energy (Crude oil, Natural Gas)

Commodity market has evolved significantly from time to time. From barter system to the cutting edge trading through electronic platforms commodities are being traded globally on various platforms. Traders’ and investors’ interest in commodity trading has increased significantly over the past few years with availability of different financial products.

Indian commodity market has always been center of attraction for global investors. Being major producer and exporter of agro commodities, Indian commodity market is known for global agro physical traders. The recent regulation changes and introduction of options derivatives has increased scope and will gradually increase size of Indian commodity market.

What are the commodities?

Commodities are the goods, a raw material or primary agricultural product that can be bought and sold. Commodities are generally used as inputs in the production of other goods and services. Commonly traded commodities are energy products like oil and natural gas, Precious metals like gold, silver, industrial metals like copper, and agricultural products like cotton, Jeera, Soybean.

How prices are determined?

Commodity prices are determined largely by supply and demand numbers at global market. Supply and demand is influenced by various factors like production, consumption, weather conditions, government policies, geo-political events etc.

How do you invest in commodity markets?

Apart from dealing in physical market and OTC, the most popular way to invest in commodities is via futures contract, which can be either buying or selling in future for a particular commodity at a particular price for a particular contract. Futures are available for commodities like crude oil, gold, silver, natural gas and also for agricultural products such as wheat, sugar, tea, coffee, etc.

Four categories of commodities trading

  • Energy (including crude oil, heating oil, natural gas and gasoline)
  • Metals (including gold, silver, platinum and copper)
  • Livestock and Meat (including lean hogs, pork bellies, live cattle and feeder cattle)
  • Agricultural (including corn, soybeans, wheat, rice, cocoa, coffee, cotton and sugar)

What is commodity trading?

Traders / Investors take positions in particular commodity forecasting prices trend taking consideration of supply demand factors and economic projection of production and consumption. Traders buy/Sell in the market with opportunity on a price trend. The most commonly traded commodities are Gold, Silver, Crude oil and Copper. There is also a market for cotton, sugar, tea, coffee, sugar, wheat, jeera and other Non-Agro Commodities.

Is commodity securities?

Securities and commodities both are traded on the exchange; since they are liquid they can be easily exchanged. The SEBI regulates Commodity Derivative Markets in India Since September 2015. Prior to SEBI, Forward Market commission regulated Commodities market.

What is a derivatives market?

A derivative is a financial instrument whose value is based on the value of another asset, and that trades on a regulated exchange. Futures and options are two of the most popular exchange traded derivatives. These derivatives can be used to hedge exposure or speculate on a wide range of financial assets like commodities, equities, currencies, and even interest rates. They are divided in two, OTC-Over the counter and ET-Exchange traded.

Commodity derivatives markets have been in existence for years, driven by the efforts of commodities producers, users, traders and investors to manage their business and financial risks.

Producers want to manage the exposure to changes in the prices they receive for their produce. They are mostly focused on achieving the same effect as fixed prices on contracts to sell their produce. A silver producer, for example, wants to hedge its losses from a fall in the price of silver for its current silver inventory. Agricultural producers need to hedge the risk of price changes in cotton, coffee, beans and other commodities they sell.

End-users want to hedge the prices at which they can purchase commodities. An oil refinery and oil marketing company wants to lock in the price of the crude oil it needs to purchase in order to satisfy the peak in demand. Investors and financial intermediaries can either buy or sell commodities through the use of derivatives. Today, the commodity derivatives market is the primary economic sector for the exchange/trading of essential goods and products.

Why to invest/trade in commodities?

The prices of the commodities tend to be correlated with price of other assets like stocks and bonds. The overall volatility tends be lesser. Risk by investor is volatility, so when the volatility is lower the risk is also lower.

  • Portfolio Diversification
  • Hedging (specially for physical traders)
  • Low margin – High leverage
  • High risk High return asset class
  • Limited Scripts to tracks
  • Extended Market hours (10 am to 11:30 pm)
  • Serves as a separate asset class for market savvy investors, arbitrageurs and speculators
  • Easy to understand with simple supply demand fundamentals
  • Far from Manipulation

What is an ‘Exchange Traded Derivative’?

An exchange traded derivative is a financial instrument whose value is based on the value of another asset, and that trades on a regulated exchange. Futures and options are two of the most popular exchange traded derivatives. These derivatives can be used to hedge exposure or speculate on a wide range of financial assets like commodities, equities, currencies, and even interest rates.

Key Tips:

  • Commodity prices are negatively correlated with currencies (Example: Gold and Dollar Index)
  • Commodity prices are sensitive to weather conditions (Example: Natural gas prices and winter/summer weather conditions)
  • Commodity prices are much correlated with economic data (Example: Stock position, ETF holdings etc.)