Commodity Market With Special Refernce to Gold and Silver | Futures Contract | Commodity Markets

Commodity Market: With Special Reference to Gold & Silver Page 1

Acknowledgement

It would be a great pleasure for me to take this opportunity in thanking everybody who had been of great help in the completion of my summer project. This project has been a p l a t f o r m i n my l e a r n i n g a n d a c q ui r i n g knowledge a b o u t t h e f i n a n c i a l s e c t o r s o a s t o h e l p me i n my f u t u r e endeavors. First & foremost I would like to thank Mr. Hemant Agrawal (Assistant Vice President) for giving me an opportunity to work as a management trainee in Bonanza Portfolio Ltd, Pune. I wo u l d a l s o l i k e t o t h a n k M r . M o h s i n S h a i k h ( S e n i o r R e l a t i o n s h i p M a n a g e r & my P r o je c t He a d ) f o r g i vi n g me g u i d a n c e a n d t r a i n i n g i n u n d e r s t a n d i n g t h e commodity market and helping me to complete my project successfully. I also express my sincere thanks to Prof. Sonali Saripalli, who is my internal guide f o r t h e p r o je c t . He r c o – o p e r a t i o n ma d e me wo r th y o f b e i n g a b l e t o p u r s u e s u c h a challenging project and complete it successfully.

Gaurav Patel

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Executive summary
India is one of the largest agrarian economies makes it a natural territory for trading in commodities. Agriculture’s share in India’s GDP stands at 26%, while the commodity sector, including non-agro commodities and bullion-related industries, constitutes about 58% of the country’s GDP. India is essentially a commodity-based economy and the physical commodity market in India is around Rs.11, 00,000 crore. India also happens to be one of the largest importers of gold (80% of demand of 800 tones) and silver (70% of demand of 3800 tones). It is also the largest producer of cotton (15 % of world production). Therefore, it is necessary to study the Indian Commodity Market.

The scope of this study is as follows:      Origin of Commodities Market. Meaning of and Objectives of Commodity Futures. Pricing of Commodity Futures. Using commodity futures for Risk Management. Commodity profiles of gold & silver.

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INDEX
Introduction  Company Profile  Objectives  Research Methodology Conceptual Background:  Literature Review  What is commodity market?
o History o Early history of commodity markets

o India and the Commodity Market
   When did Commodity Market start in India? History of commodity market in India Present commodity market in India

 Derivatives
 

o Indian commodity market structure o Commodities Traded in India o Meaning of Derivatives: o Using commodity futures
Hedging: Speculation: Arbitrage:

 How the commodity market works (Working Procedure): Commodity Profile  Gold
o o o o o o o

Production Global and domestic demand-supply dynamics Demand Supply Price trends and factors that influence Prices of the Gold History of Derivatives markets in Gold Analysis of Prices of Gold in India in last 5 years Production Demand Supply Factors influencing Prices of the silver Historical background of Silver market Analysis of Prices of Silver in India in last 5 years
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Silver
o o o o o o

Commodity Market: With Special Reference to Gold & Silver

Introduction
Commodities are raw materials used to create various products. Commodities include agricultural products such as grains, oilseeds, vegetable oils, pulses and also meats and livestock; energy products such as crude oil and gasoline; and metals such as gold, silver, aluminum and mild steel ingots. There are many other commodities like polypropylene, sugar, cotton, cocoa and coffee, etc., that are also traded. A commodity is something for which there is demand, but which is supplied without qualitative differentiation across a given market. Characteristic of commodities is that their prices are determined as a function of their market as a whole. Well-established physical commodities are actively traded on various spot and derivative markets. The commodity market has evolved significantly from the days when farmers hauled cartloads of wheat, rice and other produce to the local market. In the 1800s, demand for standardized contracts for trading agricultural products led to the development of commodity futures exchanges. Commodities (commodity) are basic raw materials and foodstuffs such as metals, petroleum, coffee, grain etc. Commodities are traded on a commodity exchange both by the companies that use them (e.g. chocolate manufacturers) and by speculators. Futures contracts allow commodity producers and commodity users to bring some predictability and stability to pricing. By buying futures contracts, they can hedge against underlying price changes in the commodity. Commodity exchange are the exchanges where the trading of futures and forwards take place, basically commodity exchange are trading in future contracts on those commodities which have some regional relevance it is not going to be as easy as a share of a company to get listed in a different exchange. Commodity exchanges in India are expected to contribute significantly in the strengthening Indian economy to face the challenges of globalization. The Commodity Exchange makes commodity money available to all as a medium of exchange, store of wealth and unit of account.

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Company Profile
Bonanza mission statement
Our mission is to be a leading, preferred service provider to our customer, and we aim to Achieve this leadership position by building an innovative, enterprising and technology-Driven organization which will set highest standards of service and business ethics. Bonanza is a premier integrated financial services provider, and ranked among the top five in the country in all its business segments, services over 16 million individual investors in various capacities, and provides investor services to over 300 corporate, comprising the who is who of Corporate India. Bonanza covers the entire spectrum of f i n a n c i a l s e r v i c e s s u c h a s S t o c k b r o k i n g , D e p o s i t o r y P a r t i c i p a n t s , D i s t r i b u t i o n o f financial products mutual funds, bonds, fixed deposit, equities, Insurance Broking, Commodities Broking, Personal Finance Advisory Services, M e r c h a n t B a n k i n g & Corporate Finance, placement of equity, IPO’s, among others.

Bonanza – early days
The birth of Bonanza was on a modest scale in 1981. It began w i t h t h e v i s i o n a n d enterprise of a small group of practicing Chartered Accountants who founded the flagship c o m p a n y . B o n a n z a C o n s u l t a n t s L i m i t e d . I t s t a r t e d w i t h c o n s u l t i n g a n d f i n a n c i a l accounting automation, and carved inroads into the field of registry and share accounting by 1985. Since then, we have utilized our experience and superlative expertise to go from strength to strength…to better our services, to provide new ones, to innovate, diversify and in the process, evolved Bonanza as one of India’s premier integrated financial service enterprise. Bonanza is a leading Financial Services & Brokerage House working diligently since 1994 c a n b e d e s c r i b e d i n a s i n g l e w o r d a s a " F i n a n c i a l P o w e r h o u s e " . W i t h a c k n o w l e d g e d industry leadership in execution and clearing services on E x c h a n g e T r a d e d D e r i v a t i v e s a n d c a s h m a r k e t p r o d u c t s . B o n a n z a h a s s p r e a d i t s trustworthy tentacles all over the country with more than 1025 outlets spread across 340cities. It provides an extensive smorgasbord of services in equity, c o m m o d i t i e s , c u r r e n c y derivatives, wealth management, distribution of third party products etc. Keeping in par with the modern tech-savvy world , Bonanza makes an integrated and innovative use of technology; it also enables its clients to trade online as well as offline and the strategic tie -ups with the latest technology partners has earned Bonanza this prestigious place in one of the top
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brokerage houses in the country. Client -focused philosophy backed by memberships of all principal Indian Stock and Commodity Exchanges makes Bonanza s t a n d a p a r t f r o m i t s c o m p e t i t o r s a n d a p r e f e r r e d s e r v i c e p r o v i d e r i n t h e i n d u s t r y f o r value-based services. To add to our evergrowing achievements, a study by Dun and Bradstreet has rated Bonanza as the SIXTH largest broking house in terms of equity terminal listings in the country. If this is not enough, Bonanza Portfolio Ltd was recently nominated amongst the Top 3 Retail Financial Advisors of the country in an event conducted by CNBC-TV18and OptiMix Financial Advisor Awards 2008. Also Bonanza has been awarded by BSE the “Major Volume driver for the year 2004-2005, 2006-2007 and 20082009".

Achievements
1. Top Equity Broking House in terms of branch expansion for 2008*. 2. 3rd in terms of Number of Trading Accounts for 2008*. 3. 6th in terms of trading terminals in for two consecutive years 2007 2008*. 4. 9 t h i n t e r m s o f S u b B r o k e r s f o r 2 0 0 7 * 5. Awarded by BSE 'Major Volume Driver 04 -05, 06-07, 07-08’. 6. N o m i n a t e d a m o n g t h e T o p 3 f o r t h e " B e s t F i n a n c i a l A d v i s o r A w a r d s ' 0 8 " i n t h e c a t e g o r y o f National Distributors - Retail instituted by CNBC-TV18 and OptiMix. *As per the survey by DUN & BRADSTREET Corporate tie ups The company has Corporate Tie ups with Birla Sun life, Bajaj Allianz, ICICI Prudential, SBI, Aviva, Kotak Mahindra and Reliance for Life Insurance and General Insurance. In General Insurance, Bonanza provides Insurance for Motor, Health, Travel, Housekeeper, Shopkeeper, Marine, Personal and Group Insurance.

Reasons to choose Bonanza Portfolio Ltd.
 EXPERIENCE Bonanza Portfolio ltd has more than eight decades of trust and credibility in the Indian stock market. In the Asia Money broker’s poll held recently, SSKI won the ‘India’s best broking house for 2004 award’. Ever since it launched Company as its retail broking division in February 2000, it has been providing institutional-level research and broking services to individual investors.  TECHNOLOGY
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With our online trading account you can buy and sell shares in an instant from any PC with an Internet connection. You will get access to our powerful online trading tools that will help you take complete control over your investment in shares.  ACCESSIBILITY Company provides Advice, Education, Tools and Execution services for investors. These services are accessible through our centers across the country (over 250 locations in 123 cities), over the internet as well as over the voice.  KNOWLEDGE In a business where the right information at the right time can translate into direct profits, you get access to a wide range of information on our content-rich portal, sharekhan.com. You will also get a useful set of knowledge-based tools that will empower you to take informed decisions.  CONVENIENCE You can call our Dial-N-Trade number to get investment advice and execute your transactions. We have a dedicated call-centre to provide this service via a toll free number from anywhere in India.  CUSTOMERSERVICE Our customer service team will assist you for any help that you need relating to transactions, billing, Demat and other queries. Our customer s e r v i c e s c a n b e contracted via a toll-free number, email or live chat on sharekhan.com.  INVESTMENT ADVICE Company has dedicated research teams for fundamental and technical research. Our analyst constantly track the pulse of the market and provide timely investment advice to you in the form of daily research emails, online chat, printed reports and SMS on your phone. BENEFITS  Secure Order by Voice Tool Dial-n-Trade.  Automated Portfolio to keep track of the value of your actual purchases.  24x7 Voice Tool access to your trading account.  Personalized Price and Account Alerts delivered instantly to your cell phone &email address.  Special Personal Inbox for order and trade confirmations.  On-line customer service via web chat.  Anytime Ordering

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Objectives

   

To study the Indian Commodity Market. To study and analyze the gold and silver commodity in India. To know the nature of Clients of Bonanza Portfolio Ltd. To generate the awareness of trading in gold and silver among the Clients of Bonanza Portfolio Ltd.

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Research Methodology

Basically, there are two tools of data collection namely:  Primary Data  Secondary Data

Primary Data: Primary data is the original information gathered for a specific purpose. It is usually collected by coming in direct contact with people. It is the raw data. The Most important source of primary data is Telephonic Study and Questionnaire.

Secondary data: Secondary data is the information which already exists having been collected for some purpose. The information is already formatted. Various sources of secondary data are INTERNET, MAGAZINES, PAST RECORDS, REFERNCE BOOKS etc. For this project websites of broking firm were referred.

Collection of Data: For this research secondary data is used such as websites, discussions with seniors, obtaining information from senior authorities and also make a use of same financial reference book.

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Literature Review
While doing this project I studied the previous researches which helped me to get a broader prospective for my project. I also referred various books and journals to have a better understanding about the topic of my project. For the better understanding the commodity market I referred books on commodity market and extracted the desired contents. With the help of moneycontrol.com and commodityonline.com I gathered the required data. I also made use of questionnaire method of research for my project work and acquired the complete information for my project.

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What is commodity market?
Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts. This article focuses on the history and current debates regarding global commodity markets. It covers physical product (food, metals and electricity) markets but not the ways that services, including those of governments, nor investment, nor debt, can be seen as a commodity. Articles on reinsurance markets, stock markets, bond markets and currency markets cover those concerns separately and in more depth. One focus of this article is the relationship between simple commodity money and the more complex instruments offered in the commodity markets.

History
The modern commodity markets have their roots in the trading of agricultural products. While wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th century in the United States, other basic foodstuffs such as soybeans were only added quite recently in most markets. For a commodity market to be established there must be very broad consensus on the variations in the product that make it acceptable for one purpose or another. The economic impact of the development of commodity markets is hard to overestimate. Through the 19th century "the exchanges became effective spokesmen for, and innovators of, improvements in transportation, warehousing, and financing, which paved the way to expanded interstate and international trade."

Early history of commodity markets
Historically, dating from ancient Sumerian use of sheep or goats, other peoples using pigs, rare seashells, or other items as commodity money, people have sought ways to standardize and trade contracts in the delivery of such items, to render trade itself more smooth and predictable. Commodity money and commodity markets in a crude early form are believed to have originated in Sumer where small baked clay tokens in the shape of sheep or goats were used in trade. Sealed in clay vessels with a certain number of such tokens, with that number written on the outside, they represented a promise to deliver that number. This made them a form of commodity money - more than an I.O.U. but less than a guarantee by a nation-state or bank. However, they were also known to contain promises of time and date of delivery - this made them like a modern futures contract. Regardless of the
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details, it was only possible to verify the number of tokens inside by shaking the vessel or by breaking it, at which point the number or terms written on the outside became subject to doubt. Eventually the tokens disappeared, but the contracts remained on flat tablets. This represented the first system of commodity accounting. Classical civilizations built complex global markets trading gold or silver for spices, cloth, wood and weapons, most of which had standards of quality and timeliness. Considering the many hazards of climate, piracy, theft and abuse of military fiat by rulers of kingdoms along the trade routes, it was a major focus of these civilizations to keep markets open and trading in these scarce commodities. Reputation and clearing became central concerns, and the states which could handle them most effectively became very powerful empires, trusted by many peoples to manage and mediate trade and commerce.

India and the Commodity Market
When did Commodity Market start in India?
Organized commodity derivatives in India started as early as 1875, barely about a decade after they started in Chicago. However, many feared that derivatives fuelled unnecessary speculation and were detrimental to the healthy functioning of the markets for the underlying commodities. As a result, after independence, commodity options trading and cash settlement of commodity futures were banned in 1952. A further blow came in 1960s when, following several years of severe draughts that forced many farmers to default on forward contracts (and even caused some suicides), forward trading was banned in many commodities considered primary or essential. Consequently, the commodities derivative markets dismantled and remained dormant for about four decades until the new millennium when the Government, in a complete change in policy, started actively encouraging the commodity derivatives market. Since 2002, the commodities futures market in India has experienced an unprecedented boom in terms of the number of modern exchanges, number of commodities allowed for derivatives trading as well as the value of futures trading in commodities, which might cross the $ 1 Trillion mark in 2006. However, there are several impediments to be overcome and issues to be decided for sustainable development of the market.

History of commodity market in India
The history of organized commodity derivatives in India goes back to the nineteenth century when Cotton Trade Association started futures trading in 1875, about a decade after they started in Chicago. Over the time derivatives market developed in several commodities in India. Following Cotton, derivatives trading started in oilseed in Bombay (1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur (1913) and Bullion in Bombay (1920). However many feared that derivatives fuelled unnecessary
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speculation and were detrimental to the healthy functioning of the market for the underlying commodities, resulting in to banning of commodity options trading and cash settlement of commodities futures after independence in 1952. The parliament passed the Forward Contracts (Regulation) Act, 1952, which regulated contracts in Commodities all over the India. The act prohibited options trading in Goods along with cash settlement of forward trades, rendering a crushing blow to the commodity derivatives market. Under the act only those associations/exchanges, which are granted reorganization from the Government, are allowed to organize forward trading in regulated commodities. The act envisages three tire regulations: (i) (ii) (iii) Exchange which organizes forward trading in commodities can regulate trading on day-to-day basis; Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government. The Central Government- Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution- is the ultimate regulatory authority

After Liberalization and Globalization in 1990, the Government set up a committee (1993) to examine the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodity groups. It also recommended strengthening Forward Markets Commission. Forward Contracts (Regulation) Act 1952, particularly allowing option trading in goods and registration of brokers with Forward Markets Commission. The Government accepted most of these recommendations and futures‟ trading was permitted in all recommended commodities. It is timely decision since internationally the commodity cycle is on upswing and the next decade being touched as the decade of Commodities. Commodity exchange in India plays an important role where the prices of any commodity are not fixed, in an organized way.

Present commodity market in India
Today; commodity exchanges are purely speculative in nature. Before discovering the price, they reach to the producers, end-users, and even the retail investors, at a grassroots level. It brings a price transparency and risk management in the vital market. By Exchange rules and by law, no one can bid under a higher bid, and no one can offer to sell higher than someone else’s lower offer. That keeps the market as efficient as possible, and keeps the traders on their toes to make sure no one gets the purchase or sale before they do. Since 2002, the commodities future market in India has experienced an unexpected boom in terms of modern exchanges, number of commodities
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allowed for derivatives trading as well as the value of futures trading in commodities, which crossed $ 1 trillion mark in 2006. In India there are 25 recognized future exchanges, of which there are four national level multicommodity exchanges. After a gap of almost three decades, Government of India has allowed forward transactions in commodities through Online Commodity Exchanges, a modification of traditional business known as Adhat and Vayda Vyapar to facilitate better risk coverage and delivery of commodities. The four exchanges are: (i) (ii) (iii) (iv) National Commodity & Derivatives Exchange Limited, Mumbai Multi Commodity Exchange of India Limited, Mumbai. National Multi- Commodity Exchange of India Limited, Ahmadabad. Indian Commodity Exchange Limited, Gurgaon.

INDIAN COMMODITY MARKET STRUCTURE

Commodities Traded in India

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Commodities Traded in India

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Derivatives
Another major leap in the development of commodities markets is the growth in commodities derivative segment. Derivatives trading have a long history. The first recorded incident of commodities trade was traced back to the times of ancient Greece. In the year 1688 De la Vega reported the trading in 'time bargains' which were the then commonly used terms for options and futures. Though the first recorded futures trade was found to have happened in Japan during the 17th century, evidences reveal that the trading in rice futures was existent in China, 6000 years ago. Derivatives are useful for both the producers and the traders for the mitigation of risk in their business. Trading in futures is an outcome of the mankind's efforts towards maintaining the supply balance of seasonal commodities throughout the year. Farmers derived the real benefits of derivatives contracts by assuring the prices they want to procure on their products. The volatility of prices has made the commodity derivatives not only significant risk hedging instruments but also strategic exchange traded assets. Slowly, traders’ and speculators, who never intended to take the delivery of goods, entered this segment. They traded in these instruments and made their margins by taking the advantage of price volatility in commodity markets. The dawn of the 21st century brought back the good times for commodity markets. With the end of a 20 year bear market for commodities, following the global economic recovery and increased demand from China and other developing nations, has revitalized t h e charisma of commodities markets. According to the forecasts given b y e x p e r t s commodities markets are likely to experience a bright future with the depreciation in the value of financial assets. Furthermore, increasing global consumption, declining U.S.Dollar value, rising factor -input costs and the recent recovery of the market from the clutches of bear trend are considered to be the positive symptoms, which contribute to the acceleration of growth in commodity markets segment.

Meaning of Derivatives:
A derivative is a product whose value is derived from the value of one or more underlying variables or assets in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. In other words, Derivative means having no independent value. i.e. the value is derived from the value of the underlying asset. Derivative means a forward, future, option or any other hybrid contract of predetermine fi xed duration, linked for the purpose of c o n t r a c t f u l f i l l m e n t t o t h e v a l u e o f a s p e c i f i e d r e a l o f f i n a n c i a l a s s e t o r t o a n i n d e x securities. Thus, a derivative contract is an enforceable agreement whose value is derived from the value of an underlying asset. The four most common examples of derivative instruments are forwards, futures, options and swaps / spreads.

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Using commodity futures
Hedging:
Many participants in the commodity futures market are hedgers. They use the futures market to reduce a particular risk that they face. This risk might relate to the price of wheat or oil or any other commodity that the person deals in. The classic hedging example is that of wheat farmer who wants to hedge the risk of fluctuations in the price of wheat around the time that his crop is ready for harvesting. By selling his crop forward, he obtains a hedge by locking in to a predetermined price. Hedging does not necessarily improve the financial outcome; indeed, it could make the outcome worse. What it does however is, that it makes the outcome more certain. Hedgers could be government institutions, private corporations like financial institutions, trading companies and even other participants in the value chain, for instance farmers, extractors, ginners, processors etc., who are influenced by the commodity prices.

Speculation:
An entity having an opinion on the price movements of a given commodity can speculate using the commodity market. While the basics of speculation apply to any market, speculating in commodities is not as simple as speculating on stocks in the financial market. For a speculator who thinks the shares of a given company will rise, it is easy to buy the shares and hold them for whatever duration he wants to. However, commodities are bulky products and come with all the costs and procedures of handling these products. The commodities futures markets provide speculators with an easy mechanism to speculate on the price of underlying commodities. To trade commodity futures on the NCDEX, a customer must open a futures trading account with a commodity derivatives broker. Buying futures simply involves putting in the margin money. This enables futures traders to take a position in the underlying commodity without having to actually hold that commodity. With the purchase of futures contract on a commodity, the holder essentially makes a legally binding promise or obligation to buy the underlying security at some point in the future (the expiration date of the contract).

Arbitrage:
A central idea in modern economics is the law of one price. This states that in a competitive market, if two assets are equivalent from the point of view of risk and return, they should sell at the same price. If the price of the same asset is different in two markets, there will be operators who will buy in the market where the asset sells cheap and sell in the market where it is costly. This activity termed as arbitrage, involves the simultaneous purchase and sale of the same or essentially similar security in two different markets for advantageously different prices. The buying cheap and selling expensive
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continues till prices in the two markets reach equilibrium. Hence, arbitrage helps to equalize prices and restore market efficiency.

How the commodity market works (Working Procedure):
The futures market is a centralized market place for buyers and sellers from around the world who meet and enter into commodity futures contracts. Pricing mostly is based on an open cry system, or bids and offers that can be matched electronically. The commodity contract will state the price that will be paid and the date of delivery. Almost all futures contracts end without the actual physical delivery of the commodity. There are two kinds of trades in commodities. The first is the spot trade, in which one pays cash and carries away the goods. The second is futures trade. The underpinning for futures is the warehouse receipt. A person deposits certain amount of say, good X in a ware house and gets a warehouse receipt which allows him to ask for physical delivery of the good from the warehouse but someone trading in commodity futures need not necessarily posses such a receipt to strike a deal. A person can buy or sale a commodity future on an exchange based on his expectation of where the price will go. Futures have something called an expiry date, by when the buyer or seller either closes (square off) his account or give/take delivery of the commodity. The broker maintains an account of all dealing parties in which the daily profit or loss due to changes in the futures price is recorded. Squiring off is done by taking an opposite contract so that the net outstanding is nil. For commodity futures to work, the seller should be able to deposit the commodity at warehouse nearest to him and collect the warehouse receipt. The buyer should be able to take physical delivery at a location of his choice on presenting the warehouse receipt. But at present in India very few warehouses provide delivery for specific commodities. Following diagram gives a fair idea about working of the Commodity Market:

Commodity Profile
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Gold
For centuries, gold has meant wealth, prestige, and power, and its rarity and natural beauty have made it precious to men and women alike. Owning gold has long been a safeguard against disaster. Many times when paper money has failed, men have turned to gold as the one true source of monetary wealth. Today is no different. While there have been fluctuations in every market and decided downturns in some, the expectation are that gold will hold its own. There is a limited amount of gold in the world, so investing in gold is still a good way to plan for the future. Gold is homogeneous, indestructible and fungible. These attributes set gold apart from other commodities and financial assets and tend to make its returns insensitive to business cycle fluctuations. Gold is still bought (and sold) by different people for a wide variety of reasons - as a use in jewellery, for industrial applications, as an investment and so on.
Country-wise share in Gold Production, 1968 and 1999. Country South Africa Australia Canada USA China Indonesia India Rest of the world Total Tonnes, 1968 972 87 44 Share 1968 67 6 3 Tonnes, 1999 437 309 154 334 154 154 51 463 2571 Share, 1999 17 12 6 13 6 6 2 18 100

87 1450

6 100

Production
Traditionally South Africa has been the largest producers of gold in the world accounting for almost 80% of all non-communist output in 1970. Although it retained its position as the single largest gold producing country, its share had fallen to around 17% by 1999 because of high costs of mining and reduced resources. Table 4.1 gives the country-wise share in gold production. In contrast other countries like US, Australia, Canada and China have increased their output exponentially with output from developing countries like Peru and other Latin American countries also increasing impressively. Mining and production of gold in India is negligible, now placed around 2 tonnes (mainly from the Kolar gold mines in Karnataka) as against a total world production of about 2,272 tonnes in 1995.

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Global and domestic demand-supply dynamics The demand for gold may be categorized under two heads - consumption demand and investment demand. Consumption of gold differs according to type, namely industrial applications and jewellery. The special feature of gold used in industrial and dental applications is that some of it cannot be salvaged and thus is truly consumed. This is unlike consumption in the form of jewellery, which remains as stock and can reappear at future time in market in another form. Consumer demand accounts for almost 90% of total gold demand and the demand for jewelry forms 89% of consumer demand. In markets with poorly developed financial systems, inaccessible or insecure banks, or where trust in the government is low, gold is attractive as a store of value. If gold is held primarily as an investment asset, it does not need to be held in physical form. The investor could hold gold-linked paper assets or could lend out the physical gold on the market attaining a higher return in addition to savings on the storage costs. Japan has the highest investment demand for gold followed closely by India. These two countries together account for over 50% of total world demand of gold for retail investment. Investment demand can be split broadly into two, private and public sector holdings. There are several ways in which investors can invest in gold either directly or through a variety of investment products, each of which lends it to specific investor preferences: • • • • • • Coins and small bars Gold accounts: allocated and unallocated Gold certificates and pool accounts Gold Accumulation Plan Gold backed bonds and structured notes Gold futures and options • Gold-oriented funds

Demand
The Consumer demand for gold is more than 3400 tonnes per year making it whopping $40 billion worth. More than 80% of the gold consumed is in the form of jewellery, which is generally pre-dominated by women. The Indian demand to the tune of 800 tonnes per year is making it the largest market for gold followed by USA, Middle East and China. About 80% of the Physical gold is consumed in the form of jewellery while bars and coins occupy not higher than 10% of the gold consumed. If we include jewellery ownership, then India is the largest repository of gold in terms of total gold within the national boundaries. Regarding pattern of demand, there are no authentic estimates, the available evidence shows that about 80% is for jewellery fabrication for domestic demand, and 15% is for investor-demand (which is relatively elastic to gold-prices, real estate prices,
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financial markets, tax-policies, etc.). Barely 5% is for industrial uses. The demand for gold jewellery is rooted in societal preference for a variety of reasons - religious, ritualistic, a preferred form of wealth for women, and as a hedge against inflation. It will be difficult to prioritize them but it may be reasonable to conclude that it is a combined effect, and to treat any major part as exclusively a store of value or hedging instrument would be unrealistic. It would not be realistic to assume that it is only the affluent that creates demand for gold. There is reason to believe that a part of investment demand for gold assets is out of black money. Rural India continues to absorb more than 70% of the gold consumed in India and it has its own role to fuel the barter economy of the agriculture community. The yellow metal used to play an important role in marriage and religious festivals in India. In the Hindu, Jain and Sikh community, where women did not inherit landed property whereas gold and silver jewellery was, and still is, a major component of the gifts given to a woman at the time of marriage. The changeover hands of gold at the time of marriage are from few grams to kgs. The gold also occupies a significant position in the temple system where gold is used to prepare idol and devotees offer gold in the temple. These temples are run in trust and gold with the trust rarely comes into re-circulation. The existing social and cultural system continues to cause net gold buyer market and the government policies have to take note of the root cause of gold demand, which lies in the social and cultural system of India. The annual consumption of gold, which was estimated at 65 tonnes in 1982, has increased to more than 700 tonnes in late 90s. Although it is likely that, with prosperity and enlightenment, there may be deceleration in demand, particularly in urban areas, it would be made good by growing demand on account of prosperity in rural areas. In the near future, therefore, the annual demand will continue to be over 600 tonnes per year.

Supply
Indian gold holding, which are predominantly private, is estimated to be in the range of 10000-13000 tonnes. One fourth of world gold production is consumed in India and more than 60% of Indian consumption is met through imports. The domestic production of the gold is very limited which is around 9 tonnes in 2002 resulting in more dependence on imported gold. The availability of recycled gold is price sensitive and as such the dominance of the gold supply through import is in existence. The fabricated old gold scraps is price elastic and was estimated to be near 450 tonnes in 2002. It rose almost more than 40% compared to the previous year because of rise in gold price by more than 15%. The demand-supply for gold in India can be summed up thus:
1. Demand for gold has an autonomous character. Supply follows demand. 2. Demand exhibits income elasticity, particularly in the rural and semi-urban areas. 3. Price differential creates import demand, particularly illegal import prior to the
Commodity Market: With Special Reference to Gold & Silver Page 22

commencement of liberalization in 1990.

Price trends and factors that influence prices
Indian gold prices follow more or less the international price trends. However, the strong domestic demand for gold and the restrictive policy stance are reflected in the higher price of gold in the domestic market compared to that in the international market at the available exchange rate. Since the demand for gold is closely tied to the production of jewelry, gold prices tend to increase during the time of year when demand for jewellery is greatest. Christmas, Mothers Day and Valentine Day are all major shopping seasons and hence the demand for metals tends to be strong a few months ahead of these holidays. Also, the summer wedding season sees a large increase in the demand for metals, so price strength in March and April is not uncommon. On the other hand in November, December, January and February prices tend to decline and jewelers tend to have holiday inventory to unwind.

History of derivatives markets in Gold
Gold futures trading debuted at the Winnipeg Commodity Exchange (Comex) in Canada in November 1972. Delivery was also available in gold certificates issued by Bank of Nova Scotia and the Canadian Imperial Bank of Commerce. The gold contracts became so popular that by 1974 there was as many as 10,00,000 contracts floating in the market. The futures trading in gold started in other countries too. This included the following: • The London gold futures exchange started operations in the early 1980s. • The Sydney futures exchange in Australia began functioning with a contract in 1978. This exchange had a relationship with the Comex where participants could take open positions in one exchange and liquidate them in the other. • The Singapore International Monetary Exchange (Simex) was set up in 1983 by way of an alliance between the Gold Exchange of Singapore and the International Monetary Market (TMM) of Chicago. • The Tokyo Commodity Exchange (Tocom), which launched a contract in 1982, was one of the few commodity exchanges to successfully launch gold futures. Trading volume on the Tocom peaked with seven million contracts. • On December 31, 1974, the Commodity Exchange, the Chicago Board of Trade, the Chicago Mercantile Exchange and the Mid-America Commodity Exchange introduced gold futures contracts. • The Chinese exchange, Shanghai Gold Exchange was officially opened on 30 October 2002.
Commodity Market: With Special Reference to Gold & Silver Page 23

• Mumbai's first multi-commodity exchange, the National Commodities and Derivatives Exchange, NCDEX launched in 2003 by a consortium of ICICI Bank Limited, Life Insurance Corporation, National Bank for Agriculture and Rural Development and National Stock Exchange of India Limited, introduces gold futures contracts. Gold has a very active derivative market compared with other commodities. Gold accounts for 45 per cent of the world’s commercial banks commodity derivatives portfolio.

Analysis of prices of gold in India in last 5 years

YEAR 2007 2008 2009 2010 2011

GOLD RATE 10800 12500 14500 18500 26400

VALUE TRADED(in lakhs)
74786092.36 184054386.35 207797608.29 248477853.35 384270982.58

Commodity Market: With Special Reference to Gold & Silver Page 24

Silver
The dictionary describes it as a white metallic element, sonorous, ductile, very malleable and capable of high degree of polish. It also has the highest thermal and electrical conductivity of any substance. Silver is somewhat harder than gold and is second only to gold in malleability and ductility. Silver remains one of the most prominent candidates in the metals complex as far as futures' trading is concerned. Thanks to its unique volatility, silver has remained a hot favorite speculative vehicle for the small time traders. Though futures trading were banned in India since late sixties, parallel futures markets are still very active in Delhi and Indore. Speculative interest in the white metal is so intense that it is believed that combined volume of Indian punters represent almost 40 percent of volume traded at New York Commodity Exchange. Delhi, Rajasthan, MP and UP are the active pockets for the silver futures. Until recently, Rajkot and Mathura were conducting futures but now players have diverted toward comex trade. Most of the world's silver is mined in the US, Australia, Mexico, Peru, and Canada. Cash markets remain highly unorganized in the silver and impurity and excessive speculation remain key issue for the trade. Taking cue from gold, government of India is planning to introduce hallmarking in silver which is likely to address quality and credibility of Indian silverware and jeweler industry. The unique properties of silver restrict its substitution in most applications.

Production
Silver ore is most often found in combination with other elements, and silver has been mined and treasured longer than any of the other precious metals. Mexico is the world’s leading producer of silver, followed by Peru, Canada, the United States, and Australia. The main consumer countries for silver are the United States, which is the world’s largest consumer of silver, followed by Canada, Mexico, the United Kingdom, France, Germany, Italy, Japan and India. The main factors affecting these countries demand for silver are macro economic factors such as GDP growth, industrial production, income levels, and a whole host of other financial macro-economic indicators.

Demand
Demand for silver is built on three main pillars; industrial and decorative uses, photography and jewelry & silverware. Together, these three categories represent more than 95 percent of annual silver consumption. In recent years, the main world demand for silver is no longer monetary, but industrial. With the growing use of silver in
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photography and electronics, industrial demand for silver accounts for roughly 85% of the total demand for silver. Jewelry and silverware is the second largest component, with more demand from the flatware industry than from the jewelry industry in recent years. India, the largest consumer of silver, is gearing up to start hallmarking of the white precious metal by April. India annually consumes around 4,000 tonnes of silver, with the rural areas accounting for the bulk of the sales. India's demand for silver increased by 177 per cent over the past 10 years as compared to 517 tonnes in 1991. According to GFMS, India has emerged as the third largest industrial user of silver in the world after the US and Japan.

Supply
The supply of silver is based on two facts, mine production and recycled silver scraps. Mine production is surprisingly the largest component of silver supply. It normally accounts for a little less than 2/3 rd of the total (last year was slightly higher at 68%). Fifteen countries produce roughly 94 percent of the world’s silver from mines. The most notable producers are Mexico, Peru, the United States, Canada and Australia. Mexico, the largest producer of silver from mines. Peru is the world’s second largest producer of silver. Silver is often mined as a byproduct of other base metal operations, which accounts for roughly four-fifths of the mined silver supply produced annually. Known reserves, or actual mine capacity, is evenly split along the lines of production. The mine production is not the sole source - others being scrap, disinvestments, government sales and producers hedging. Scrap is the silver that returns to the market when recovered from existing manufactured goods or waste. Old scrap normally makes up around a fifth of supply. Scrap supply increased marginally last year up by 1.2%. The other major source of silver is from refining, or scraps recycling. Because silver is used in the photography industry, as well as by the chemical industry, the silver used in solvents and the like can be removed from the waste and recycled. The United States recycles the most silver in the world, accounting for roughly 43.6 million ounces. Japan is the second largest producer of silver from scrap and recycling, accounting for roughly 27.8 million troy ounces in 1997. In the United States and Japan, three-quarters of all the recycled silver comes from the photographic scrap, mainly in the form of spent fixer solutions and old X-ray films.

Factors influencing prices of the silver
The prices of silver, like that of other commodities, are dictated by forces of demand and supply and consumption. Besides, a host of social, economic and political factors have powerful bearing on silver prices. As in the case of gold prices, political tensions, the threat affects the price of silver too. When trading and movement of silver is restricted, within or outside national boundaries, prices move in accordance with demand and supply conditions prevalent in mat environment Price of silver is also influenced by
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changes in factors such as inflation (real or perceived), changing values of paper currencies, and fluctuations in deficits and interest rates, etc. Although prices and incomes are important factors, they are also influenced by factors such as tastes, technological change and market liberalization. Approximately 70 percent of the silver mined in the western hemisphere is mined as a byproduct of other metal products, such as gold, copper, nickel, lead, and zinc. As such, the price of these metals greatly affects the supply of silver mined in any year. As die price of die omer metal products increases, die increased profit margin to mine operations stimulate greater production of die omer metals, and as a result, die production of silver increases in tandem. Because silver is a precious metal, its price is determined by die supply and demand ratio at any given moment. As is the case with other precious metals, there is a limited amount of silver in the world. It is not a product mat can be manufactured en masse, and, mere fore is subject to issues such as weamer and politics mat may affect silver mining operations.

Historical background of Silver markets
Major markets like the London market (London Bullion Market Association), which started trading in the 17th century provide a vehicle for trade in silver on a spot basis, or on a forward basis. The London market has a fix which offers the chance to buy or sell silver at a single price. The fix begins at 12:15 p.m. and is a balancing exercise; the price is fixed at the point at which all the members of the fixing can balance their own, plus clients, buying and selling orders. Trading in silver futures resumed at the Comex in New York in 1963, after a gap of 30 years. The London Metal Exchange and the Chicago Board of Trade introduced futures trading in silver in 1968 and 1969, respectively. In the United States, the silver futures market functions under the surveillance of an official body, the Commodity Futures Trading Commission (CFTC). Although London remains the true center of the physical silver trade for most of the world, the most significant paper contracts trading market for silver in the United States is the COMEX division of the New York Mercantile Exchange. Spot prices for silver are determined by levels prevailing at the COMEX. Although there is no American equivalent to the London fix, Handy & Harman, a precious metals company, publishes a price for 99.9% pure silver at noon each working day.

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Analysis of prices of Silver in India in last 5 years

YEAR

SILVER RATE 18960 17800 26850 46300 51350

QUANTITY TRADED(in thousands)
306790.07 KGS 393747.525 KGS 431439.545 KGS 599843.995 KGS 1013923.254 KGS

VALUE TRADED(in lakhs)
57424526.09 83980721.19 103092321.07 194143239.53 246117507.12

2007 2008 2009 2010 2011

Commodity Market: With Special Reference to Gold & Silver Page 28

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