1

Commodities Trading in
India




Northbridge Capital Asia
June 2010

2


C o mmo d i t i e s t r a d i n g i n I n d i a
T a b l e o f C o n t e n t
I n t r o d u c t i o n 0 3
1 ) I n t r o d u c t i o n t o c o mmo d i t i e s t r a d i n g 0 4
2 ) P s y c h o l o g y o f t r a d i n g i n c o mmo d i t i e s ma r k e t 1 1
3 ) R i s k s o f T r a d i n g 1 3
4 ) B a s i c s o f c o mmo d i t i e s ma r k e t F AQ s 1 5
5 ) G o l d
F u n d a me n t a l s 1 8
T e c h n i c a l s 2 1
P s y c h o l o g y i n Go l d t r a d i n g 2 6
T r a d i n g i n Go l d 2 7
6 ) S i l v e r
F u n d a me n t a l s 3 0
T e c h n i c a l s 3 3
T r a d i n g i n S i l v e r 3 8
7 ) C o p p e r
F u n d a me n t a l 4 0
T e c h n i c a l s 4 2
P s y c h o l o g y i n c o p p e r t r a d i n g 4 6
8 ) S u g a r
F u n d a me n t s 4 8
T e c h n i c a l s 5 1
G l o s s a r y 5 3

3


Introduction
Indian markets have recently thrown open a new avenue for retail investors and traders to
participate: commodity derivatives. For those who want to diversify their portfolios beyond
shares, bonds and real estate, commodities are the best option.
Till some months ago, this wouldn't have made sense. For retail investors could have done very
little to actually invest in commodities such as gold and silver -- or oilseeds in the futures market.
This was nearly impossible in commodities except for gold and silver as there was practically no
retail avenue for punting in commodities.
However, with the setting up of three multi-commodity exchanges in the country, retail investors
can now trade in commodity futures without having physical stocks!
Commodities actually offer immense potential to become a separate asset class for market-savvy
investors, arbitrageurs and speculators. Retail investors, who claim to understand the equity
markets may find commodities an unfathomable market. But commodities are easy to understand
as far as fundamentals of demand and supply are concerned. Retail investors should understand
the risks and advantages of trading in commodities futures before taking a leap. Historically,
pricing in commodities futures has been less volatile compared with equity and bonds, thus
providing an efficient portfolio diversification option.
In fact, the size of the commodities markets in India is also quite significant. Of the country's
GDP of Rs 13, 20,730 crore (Rs 13,207.3 billion), commodities related (and dependent)
industries constitute about 58 per cent.
Currently, the various commodities across the country clock an annual turnover of Rs 1,40,000
crore (Rs 1,400 billion). With the introduction of futures trading, the size of the commodities
market grow many folds here on.
Like any other market, the one for commodity futures plays a valuable role in information
pooling and risk sharing. The market mediates between buyers and sellers of commodities, and
facilitates decisions related to storage and consumption of commodities. In the process, they
make the underlying market more liquid
This book should help the reader to understand the basics of commodities trading system in
India. It will also introduce the reader with different terminologies, trading procedures, various
commodities, futures trading and so on, which are available to trade in India. You will also read
about the four main commodities that are traded on the MCX and NCDEX Gold, Silver, Copper
and Sugar. Before trading in these commodities, you should have thorough knowledge about the
fundamentals of each of these commodities and how and what are the factors affect their demand
and prices.
4



5


Commodities trading in India
Introduction

Indian markets have now started offering a new investment product for all retail investors, commodities
derivatives by setting up three multi-commodity exchanges. It is ideal for traders and investors who wish
to diversify their portfolio beyond stocks, bonds, mutual funds and real estate. Besides the retail investors
do not require to physically own the commodities they are trading in.
Commodities have potential to become a distinct asset class for skillful investors and traders.
Understanding commodities is relatively simple for investors as they are more align with the basic
fundamental economics of demand and supply. However retail investors should understand the risks
associated with commodities trading before investing in this new asset class.
Historically, commodity prices have been less volatile compared to equities, thus can be a good
diversification option.
Like any other market, the one for commodity futures plays a valuable role in information pooling and
risk sharing. The market mediates between buyers and sellers of commodities, and facilitates decisions
related to storage and consumption of commodities. In the process, they make the underlying market
more liquid.
Trading in Commodities market
Retail investors have three options to trade in commodities futures National Commodity and Derivative
Exchange (NCDeX), Multi commodity Derivative Exchange (MCX) and National Multi Commodity
Exchange of India Limited (NCME). All the three have electronic trading and settlement systems and a
national presence.
But before we begin trading in commodities, let us first understand the basic market structure and
mechanism. Commodities market like stock market works in spot or cash market and futures market.
Spot market
Market where commodities are bought and sold in physical form by paying cash is a spot market. The
price on which commodities are traded in this market is called spot price. For example, if you are a farmer
or dealer of Chana and you have physical holding of 10 kg of Chana with you which you want to sell in
the market. You can do so by selling your holdings in either of the three commodities exchanges in India
in spot market at the existing market or spot price.
Futures Market
The market where the commodities are bought and sold by entering into a contract to settle the transaction
at some future date and at a specific price is called futures market. The unique feature of futures market
is that you do not have to actually hold the commodities in physical form or for that matter take the
delivery in physical form. Every transaction is settled on cash basis.
6


The prime objective of futures market is to hedge or mitigate the price risk in commodities. As you are
aware the prices in the spot market are volatile and are always fluctuating. And as a trader or investor,
you would want to eliminate or at least minimize your exposure to such price risk. Hence you can use
futures market to settle your contract.
For example, the current spot price of Gold is Rs 18000 per 10 grams. You expect the gold price to reach
Rs 18500 in next 1 month, but you do not want to miss this chance to earn money and at the same time
you dont even want to own any physical gold. Hence you enter into gold futures contract with a futures
price of Rs 18000 (the price at which the futures contract is currently being traded in futures market) with
an expiry date (the date on which the futures contract will be settled at futures price) of 1 month from
now. i.e. 30
th
June 2010. Hence you will make a profit if the spot or market price of gold is more than Rs
18000 on the settlement date or the expiry date of your futures contract.
Futures contract are standardized contracts made by the commodities exchange and come with specific set
of prices with minimum lot size to trade and with a specific expiry or settlement date. Let us look at each
of these terminologies and how are they used in a futures contract.
There are about 22 local Commodity Exchanges recognized by FMC (Forward Markets Commission),
Which is a division of Government of Consumer Affairs and Public Distribution that are permitted for
Futures Trading. The commodities are standardized as per the following criteria for facilitating trading in
the futures market: -

COMMODITY Commodity such as Gold, Silver Aluminum, etc
QUANTITY/ CONTRACT
SIZE OR TRADED ABLE
LOTS
These are the minimum quantity specified in a single
order and all orders should be in multiples of it. Just
like in case of stocks, when you fill-up an IPO
application, you have to bid for some minimum
number of shares. Similarly in commodities futures
contract or for that matter in any futures contract,
there is a minimum specified limit in terms of
contract size to be traded in a contract. For example
100gms is the lot size for GOLD100 futures contract
on National Commodities Exchange of India, where
if you want to trade, you need to enter into futures
contract of minimum 100 gms.
DELIVERY MONTHS A commodity Futures contract can be traded for a
delivery of all those months for which the Exchange
has allowed it. So at a time there can be more than 1,
2 or 3 contract months of the same commodity for
which, the price might be quoted for trading with
different delivery months. (The time duration from
the start of the contract for trading until the expiry
7


date is know as the cycle of the contract)
PRICE QUOTES Price for a commodity futures are quoted on its
minimum quantity tradable in the spot market,
irrespective of the contract or lot size of its futures.
E.g.: - Silver may be quoted as RS/25000 per kg
(which is the minimum tradable quantity in spot
market) while the contract size is 30 kgs. Therefore
in this example the Price quoted has to multiplied by
30 to get the trade value of one contract in Silver
QUALITY SPECIFICATIONS They are quality or grades and other specifications of
the commodities are also standardized and will be
available with the Business rules of the exchange

Market Participants
Brokers: The first kind of participant that comes to our mind when we talk about exchanges is the
brokers. Commodity brokers like stock broker are the people who take orders from clients and trade on
clients behalf in the exchange. They provide all the basic services like research reports, daily price
updates, trading information, news and other information that will help their clients to enter into a
transaction. Basically they smoothen the entire trading process for the clients.
Besides the commodity Brokers there are other participants whose purpose to trade in the futures market
could be quite interesting to know for all those who intend to participate in the Futures market.
They can be broadly classified into two main categories. First, the profit seekers who want to benefit from
the price fluctuations in the commodities with sole purpose of making money. People like investors,
traders, speculators and portfolio or hedge fund managers.
While the others are know as Hedgers
In order to hedge something, one needs to physically own it or is contemplating to buy and take a
physical delivery. The hedgers are basically people how actually own the commodities in physical form
with them.
These are the people who are worried about the potential losses they could incur due to volatile prices of
the commodities they could be physically holding with them. They trade in the futures market to transfer
their risk of movement in prices of the commodity they are actually physically dealing. Some of the
hedgers are listed below and their objective fro trading in this market: -
8


EXPORTERS: People who need protection against higher prices of commodities contracted from a
future delivery but not yet purchased.
IMPORTERS: People who want to take advantage of lower prices against the commodities contracted for
future delivery but not yet received.
FARMERS: People who need protection against declining prices of crops still in the field or against the
rising prices of purchased inputs such as feed
MERCHANDISERS, ELEVATORS: People who need protection against lower prices between the time
of purchase or contract of purchase of commodities from the farmer and the time it is sold.
PROCESSORS: People who need protection against the increasing raw material cost or against
decreasing inventory values.

Margin System
Futures market work on system called as Margin System
Margin is good faith deposit money that has to be kept with a registered Member of the exchange (they
can be clearing member, trading cum clearing Member, register broker or any other category of
membership of the exchange who are permitted to accept orders for the clients), in order to initiate or be
eligible for trading in commodity futures. The Member in turn has to maintain a MARGIN ACCOUNT
with the Exchange besides keeping a security Deposit with the clearing house of the Exchange

While the exchange takes care of the smooth and orderly execution of the trades, the clearinghouse acts as
the third party entity to ensure and guarantee all the trades done on the exchange floor or the electronic
platform. So trader need not have to directly deal with another trader, the clearing corporation takes the
role of the buyer for every seller and the role of the seller fro every buyer. In order to see and guarantee
the financial fulfillment of the trade, it takes margin deposit from both the buyer and seller before
allowing them to trade.

Every exchange is a Membership organization, regulated by the FORWARD MARKETS
COMMISSION, a division of Government of India, Ministry of Consumer Affairs and Public
distribution. While the Exchanges establish the rules for trading, the FMC establishes the regulations for
controlling the functioning of these commodities futures markets.

So when a trader wants to trade in commodities worth say 25,00,000 then he need not have to invest that
much. He can trade that much by keeping a margin amount that is a certain percentage of the actual value
(usually that is around 2% to 15%) depends on exchange to exchange and on commodity to commodity.
9


This is called as leveraging it can work for you Or against youdepend on how your trading style,
rule and need are???
Things to know before your first futures trade
Since Futures Contract are contracted for a future date, it is important know where the spot market is,
before you can make your analysis of what the futures price might be at the time of delivery, to arrive at a
reasonable level to buy or sell. While an Hedger would be just making his calculation to arrive at the price
protection level and the quantity that has to hedged.

The spot prices of various commodities that are permitted for futures trading are available at various
private and Government Sponsored web sites. We are in synergy with institutes to get the real time spot
market prices on our web site very soon. You can also get some fundamental news about the markets and
of the commodity of your choice in leading newspapers or other web-news agencies.

Theoretical relationship between the spot and futures prices are calculated as follows: -
Futures Price= Spot Price + Cost of Carry

A futures Trade necessitates storing and carrying the underlying commodity until the delivery date. This
entails costs, Benefits, or both to the potential deliverer. Cost of Carry includes storage costs,
transportation costs, insurance costs, interest costs, other opportunity costs as well as benefits.

Also the actual difference between the futures price and the spot price traded on a particular day is called
as the BASIS for that particular contract month of the commodity.

Usually the Futures Price of Commodity > Spot Price (With the further months contracts priced slightly
Higher). However it is not necessary in all cases.

For most storable commodity the difference between the spot price traded on a particular day is positive
and as the contract month keeps coming nearer to the expiry date, it goes on decreasing and finally on the
day of the delivery, the Future Price is nearly the same as the spot price.

Having Know this you will have to find out the following informations for making the first trade.

10


Of course a few practices and mock trades are recommended. The initial preparation would involve like
getting to know which commodities are traded on which exchanges, who are registered members, what
are the delivery months for those commodities, what are the margin requirements, what is the volume of
activity on those commodities, etc. Much of these required initial informations you would find it in our
site.
Having collected all this informations, you are now ready for you first trade.

Your First Trade
Now let us assume that the spot price of Silver on 9
th
May 2010 is 27550/kg and the prices quoted on the
exchange are available for June, July, Oct, and Nov.
Earlier contract months wont be available as they are already expired, while the later months beyond Jan
are also not available, as they are not yet started. Note again the present Month that is May; here there
wont be much volume as it has entered into the delivery period. (Assuming that the delivery period for
the contract is from 1
st
to 15
th
of the Delivery Month). Avoid taking fresh positions in such contracts.
Instead go for the next immediate contract month that is June.

Let us say after you analysis about the market, you are bearish about the market and would like to SELL
30Kg of Silver @ 27550 for June Delivery.
Having sold in the market, we will have to wait for the market to gives us a lower level to buy back the
contract before the delivery date in June.
The obligation to take delivery by a BUYER can be removed by selling back the contract before the
delivery period.
The obligation to gave delivery by a SELLER can be removed by Buying back the contract before the
delivery period
So now you your first sample trade as follows: -
SELL 1 lot June Silver @ Rs 27550/kg
Profit or Loss
Your order was: -
SELL 1 June Silver @ 27550
Lets say after a few days the market goes down and you are able to come buy back it from the market at
27350/ kg. Then your square off trade or liquidation would be

11


BUY 1 June Silver @ 27350

Your profit and loss calculations will be as follows: -
PROFIT/<LOSS>=
(Selling Price- Buying Price) X No of Units or lots Fees
Price Factor=Contract Size/Price Quotes quantity
Now,
The PROFIT/<LOSS>=
=(27550- 27350) X 1 X 30 Fees
=RS 6000 Fees

Fees are usually charged only once during entry and exit. There is no carry forward cost involved.


12


Psychology of trading
Basics in trading psychology
Understanding the psychology of the market is crucial to make money in the market. Be it stocks, bonds,
gold or any other asset or commodity. Most of the people just get carried away by seeing increasing
number of volumes in trade turnover or by seeing a sudden jump in prices. Basically the daily market
volatility, news and the rumors about a particular commodity dominates a persons behavior while trading
in the market.
The first rule of trading in the commodities market is to think from your brains and not with your heart!
Second, whenever you do not understand the logic or reason behind sudden change in the price of gold,
stay out of trading. Third, understand the news in totality. Not all the news affects the gold price equally
and not all bad news are actually bad for gold trading.

However, effective technical analysis allows us to use trends, patterns and other indicators to evaluate the
market's current psychological state. It takes a disciplined trader to be able to watch and listen to the
market doing one thing, filter out the noise, then do the opposite - all in a controlled manor.
There are two types of traders:
1. Herd Mentality Trader - Someone who trades off fear and greed buying near tops and panic
selling out at the bottom with the masses. Basically his trading pattern replicates most of the other
participants in the market.
2. Black Sheep Trader - A trader who stand apart from the masses and trades opposite to the
"herd" during extreme levels. It will help you to trade better if you follow this one rule, Buy
when the prices are falling and everybody is moving out of the market out of fear, and sell when
people are greedy buying in the market at astronomically high prices.

Market Psychology Trading Conclusion:
Most get involved with the market because it looks like something they can quickly learn and start
making money from home. But it doesn't take long before they quickly realize there is more to trading
than meets the eye.
While trading looks easy from a glance, in actuality I think its one of the toughest jobs out there.
Why? Well, this is what you are up against:
1. You are trying to predict something that is unpredictable
2. You are trading against millions of other highly skilled traders
13


3. You are trading against automated computers with complex algorithms
4. You are trading with your hard earned money which causes fear and greed
5. You must accept losing trades as that is part of the business
6. You must trade with a proven trading strategy and follow the system
7. You must understand money management and apply it to every trade
8. You must truly love the market cause it will break you down mentally
I don't want to say you must be a contrarian, but in reality you must do the opposite of the masses during
times of extreme price behavior.
These extremes happen on a daily basis when trading intraday charts and every 4-6 weeks when looking
at daily charts. The toughest part is to pull the trigger when emotions are flying high in the market and
you are looking to do the opposite. It takes several trades before you even start to get comfortable doing
this.

14


Risks of Trading
Before becoming too excited about the substantial returns possible from commodity trading, it is a good
idea to take a long, sober look at the risks. Reward and risk are always related. It is unrealistic to expect to
be able to earn above-average investment returns without taking above-average risks as well.
Most people are naturally risk averse. Commodity trading has the reputation of being a highly risky
endeavor. It is true that a high percentage of traders eventually lose money. Many people have lost
substantial sums.
Commodity trading is the same in the sense that the individual is the one who decides how he wants to
operate. He can make large bets or small ones. One can trade commodities carefully and risk as little as
Rs 4000 or Rs 6000 on a trade. You could trade a long time this way and only lose a few thousands.
However, most people are not that patient. The unfortunates who lose big are those who can't control
themselves. They take big risks in an attempt to get rich quick. Another way to lose big is blindly to turn
your money over to others to trade such as brokers or money managers.
Anyone who is going to try speculation should be fully aware of and be comfortable with the risks
involved. Managing the risks of trading is a very important part of any trader's success. Although the risks
can be managed, they can never be eliminated. Remember that the high returns successful speculators can
earn are available only because the speculator is being paid to take risk away from others.
When a commodity trader buys a futures contract, he will lose if the price declines. His risk is
theoretically limited only by the price of the commodity going to zero. If he sells, he will lose if the price
goes up. The risk is theoretically unlimited because there is no absolute ceiling on how high the price of
the commodity can go.
For example: If you buy a gold futures contract @ Rs 18000/10 gms. You will lose your money if the
price falls below Rs 18000, till you either exit out of the contract or till the expiry of the contract.
In practice, however, the trader can offset his position when the trade is going against him to limit his
loss. While a prudent trader always has a plan to limit his losses when trades don't work, it is not possible
to guarantee a particular loss limit amount. As a practical matter, however, you can usually limit losses to
within a few thousand rupees of an intended amount. Very often losses are within Rs 1000 of the amount
you project. Only when very unusual things happen suddenly can losses balloon to thousands of rupees
more than you expected.
Other kinds of surprise situations that can cause unpredicted losses are freezes, floods, droughts,
government currency interventions and crop reports. With attention and foresight a trader can sidestep
these risky situations. The best way to control unpredictable risks is to trade conservatively so larger-than-
expected losses are still only a small percentage of the total account.
Another thing to understand about risk in trading is that you cannot avoid losses by careful planning or
brilliant strategy. Numerous losses are part of the process. Trading is a business of making and losing
money. Any trade, no matter how well thought out, has a chance of becoming a loser. Many people think
15


the best traders don't lose any money and have only winning trades. This is absolutely not true. The best
traders lose a lot of money, but they eventually make even more over time.
There is no point trading commodities if you cannot handle the psychological discomfort of making
losing trades. While people tend to take losses personally as a sign of failure, good traders shrug them off.
The best trading plans result in many losses. Because of the amount of randomness in market price action,
such losses are inevitable.

16


Basics of Commodities market
How do I choose my broker?
Several already-established equity brokers have sought membership with NCDEX and MCX. The likes of
Refco Sify Securities, SSKI (Sharekhan) and ICICIcommtrade (ICICIdirect), ISJ Comdesk (ISJ
Securities) and Sunidhi Consultancy are already offering commodity futures services. Some of them also
offer trading through Internet just like the way they offer equities. You can also get a list of more
members from the respective exchanges and decide upon the broker you want to choose from.
What is the minimum investment needed?
You can have an amount as low as Rs 5,000. All you need is money for margins payable upfront to
exchanges through brokers. The margins range from 5-10 per cent of the value of the commodity contract.
While you can start off trading at Rs 5,000 with ISJ Commtrade other brokers have different packages for
clients.
For trading in bullion, that is, gold and silver, the minimum amount required is Rs 650 and Rs 950 for on
the current price of approximately Rs 65,00 for gold for one trading unit (10 gm) and about Rs 9,500 for
silver (one kg).
The prices and trading lots in agricultural commodities vary from exchange to exchange (in kg, quintals
or tonnes), but again the minimum funds required to begin will be approximately Rs 5,000.
Do I have to give delivery or settle in cash?
You can do both. All the exchanges have both systems - cash and delivery mechanisms. The choice is
yours. If you want your contract to be cash settled, you have to indicate at the time of placing the order
that you don't intend to deliver the item.
If you plan to take or make delivery, you need to have the required warehouse receipts. The option to
settle in cash or through delivery can be changed as many times as one wants till the last day of the expiry
of the contract.
What do I need to start trading in commodity futures?
As of now you will need only one bank account. You will need a separate commodity demat account
from the National Securities Depository Ltd to trade on the NCDEX just like in stocks.
What are the other requirements at broker level?
You will have to enter into a normal account agreements with the broker. These include the procedure of
the Know Your Client format that exist in equity trading and terms of conditions of the exchanges and
broker. Besides you will need to give you details such as PAN no., bank account no, etc.
What are the brokerage and transaction charges?
17


The brokerage charges range from 0.10-0.25 per cent of the contract value. Transaction charges range
between Rs 6 and Rs 10 per lakh/per contract. The brokerage will be different for different commodities.
It will also differ based on trading transactions and delivery transactions. In case of a contract resulting in
delivery, the brokerage can be 0.25 - 1 per cent of the contract value. The brokerage cannot exceed the
maximum limit specified by the exchanges.
Where do I look for information on commodities?
Daily financial newspapers carry spot prices and relevant news and articles on most commodities.
Besides, there are specialised magazines on agricultural commodities and metals available for
subscription. Brokers also provide research and analysis support.
But the information easiest to access is from websites. Though many websites are subscription-based, a
few also offer information for free. You can surf the web and narrow down you search.
Who is the regulator?
The exchanges are regulated by the Forward Markets Commission. Unlike the equity markets, brokers
don't need to register themselves with the regulator.
The FMC deals with exchange administration and will seek to inspect the books of brokers only if foul
practices are suspected or if the exchanges themselves fail to take action. In a sense, therefore, the
commodity exchanges are more self-regulating than stock exchanges. But this could change if retail
participation in commodities grows substantially.
Who are the players in commodity derivatives?
The commodities market will have three broad categories of market participants apart from brokers and
the exchange administration - hedgers, speculators and arbitrageurs. Brokers will intermediate, facilitating
hedgers and speculators.
Hedgers are essentially players with an underlying risk in a commodity - they may be either producers or
consumers who want to transfer the price-risk onto the market.
Producer-hedgers are those who want to mitigate the risk of prices declining by the time they actually
produce their commodity for sale in the market; consumer hedgers would want to do the opposite.
For example, if you are a jewellery company with export orders at fixed prices, you might want to buy
gold futures to lock into current prices. Investors and traders wanting to benefit or profit from price
variations are essentially speculators. They serve as counterparties to hedgers and accept the risk offered
by the hedgers in a bid to gain from favourable price changes.

What happens if there is any default?
Both the exchanges, NCDEX and MCX, maintain settlement guarantee funds. The exchanges have a
penalty clause in case of any default by any member. There is also a separate arbitration panel of
exchanges.
18



Are any additional margin/brokerage/charges imposed in case I want to take delivery of goods?
Yes. In case of delivery, the margin during the delivery period increases to 20-25 per cent of the contract
value. The member/ broker will levy extra charges in case of trades resulting in delivery.
Is stamp duty levied in commodity contracts? What are the stamp duty rates?
As of now, there is no stamp duty applicable for commodity futures that have contract notes generated in
electronic form. However, in case of delivery, the stamp duty will be applicable according to the
prescribed laws of the state the investor trades in. This is applicable in similar fashion as in stock market.
How much margin is applicable in the commodities market?
As in stocks, in commodities also the margin is calculated by (value at risk) VaR system. Normally it is
between 5 per cent and 10 per cent of the contract value.
The margin is different for each commodity. Just like in equities, in commodities also there is a system of
initial margin and mark-to-market margin. The margin keeps changing depending on the change in price
and volatility.
Are there circuit filters?
Yes the exchanges have circuit filters in place. The filters vary from commodity to commodity but the
maximum individual commodity circuit filter is 6 per cent. The price of any commodity that fluctuates
either way beyond its limit will immediately call for circuit breaker.

19


Gold
Since ancient times, gold has been accepted and appreciated as a commodity, an investment and an object
of guarantee. Since the development of the financial markets, investors have lost tough with this
wonderful asset called gold, which they now only acts as an asset of last resort. However, in recent years
gold has tremendous demand and interest from investors around the globe. While this outreached rally in
recent price of gold is obviously suggesting that demand surpassed the supply, which is clearly a positive
factor, there are many reasons why people and institutions around the world are once again investing in
gold. Let us look at what are the fundamental reasons behind interest in gold as an investment.
Fundamentals behind Gold price movements
1) Supply and Demand. The ultimate negotiator of any price is supply and demand. When
demand exceeds supply, prices rise and vice versa. In case of gold, its global demand is growing
much faster than its global mined supply, so the only possible economic resolution to fix this
imbalance is for the price to rise to the extent where demand equals supply. This means that the
price at which now gold trades is the maximum price investors are will to pay to buy gold.
Unlike almost every other business, gold mining is totally dependent on highly local geology.
Since gold is so scarce in the natural world, it is very difficult to find a site with enough gold to
mine economically.
Global gold mined supply is therefore very inelastic (unresponsive to price). Looking at the
complex gold mining and producing structure, it is not unlikely to see gold demand far exceeding
supply for many more years to come.

2) Long Valuation Waves. The general stock markets move in great 33-year cycles known as
Long Valuation Waves. Although stocks make horrible long-term investments during the latter
half of these Long Valuation Waves, thankfully commodities and hard assets flourish.
Commodities also move in roughly one-third-of-a-century cycles over time, but they tend to
swing 180 degrees out of phase to the equity valuation waves.
Our current commodities bull launched in 2001, just after the secular top in the general stock
markets capping a mighty equity bull lasting for half of a 33-year valuation cycle. Market history
is very emphatic in demonstrating that the 17 years after this parallel commodities bottom and
equities top should be great for commodities but very poor for equities. Since we are now about
7 years into this usually 17-year trend, this precedent suggests commodities should be strong and
equities weak for another decade or so yet.

3) Ultimate Alternative Investment. Physical gold is easy to buy, requires no maintenance, and a
great deal of wealth can be secured and stored in a relatively trivial volume. Unlike many other
major commodities, physical gold is not perishable and can be stored indefinitely. Gold has
always been the ultimate commodities investment. Some investors will buy gold to ride the
commodities bull, while others will buy gold to escape the equities bear. This distinction may
seem subtle, but it is very important. Gold is a natural destination for equity flight capital since it
is the ultimate alternative investment in world history.
20


Gold is the ultimate alternative investment because it is tangible. It is a real physical asset that
has intrinsic value in and of itself, never dependent on someone elses mere promises to pay.
Besides, central banks in various countries their currency backed by gold. Hence they always buy
and stock physical gold and maintain gold reserve and print money.

4) Negative Real Rates. When the rate of underlying true monetary inflation exceeds the nominal
interest rates available in the markets, bond investing becomes a losing proposition. Now please
realize I am talking about the true inflation rate here, which is the growth rate in broad money
supplies, not the watered-down government-reported inflation numbers.
Free markets hinge on the crucial concept of mutually beneficial transactions. The bond markets
are where savers, who consume less than they earn, meet up with debtors, who earn less than they
consume, to consummate capital transactions. True free-market prices for this money, or interest
rates, provide a reasonable return to the saver and a reasonable cost to the debtor, a mutually
beneficial transaction. Interest rates should always be set by the free markets instead of the
central banks.
As such, when central banks artificially manipulate interest rates too low, bond investors
gradually pull out of the rigged market. Since they cant beat inflation in bonds, they gradually
migrate into gold so they can at least maintain their purchasing power. Negative real rate
environments are one of the most bullish scenarios imaginable for gold investment demand, since
they drive capital out of bonds and into gold.

5) Free Market in Information. Gold is the ultimate free-market asset and currency. Todays
Information Age is witnessing the greatest free-flow of information in all of world history. Today
investors around the world can easily learn about monetary history, stock-market history, gold,
the immoral stealth tax of inflation, and countless other crucial core topics essential to long-term
wealth building. Investing in gold is the inevitable outcome of learning more about the
treacherous history of markets and money. The deeper you understand these topics, the more you
will respect and want to own gold.

6) The Rise of Asia. With China destined to become the next superpower while the West wanes,
the locus of global economic might is shifting to the Far East. As Asian investors grow wealthier,
their traditional love for gold will ultimately lead to huge amounts of capital shunted into physical
gold as they diversify their investments. Asias hard-working ethic will lead to greater general
affluence, and its aggregate gold investment consumption will utterly dwarf that of the
West. Asia is probably the single biggest gold investment demand story in world history. It
should ultimately dwarf US equity and bond flight capital and could very well lead to the biggest
gold boom the world has ever seen.

Conclusion
If gold is indeed destined to thrive in the years ahead, then fortunes will be won investing in gold and
gold stocks. The bottom line is gold fundamentals remain very bullish today.
21


And also realize that the greatest growth in gold investment demand will probably come not out of the US
or Europe, but out of a rapidly-industrializing Asia generating phenomenal amounts of wealth. This is a
global gold bull that is not dependent on the falling US dollar, valuation mean-reverting US stock
markets, or central banks. Golds universal bull market far transcends these provincial American
concerns.

22


The Technicals of Gold
Things you should look before trading in gold
Like stocks, even gold has a technical side of the causes that makes the price movements for the gold in
the market. Besides fundamental reasons, there are some technical reasons too that act as a catalyst in
price movements of gold.
There are numerous indicators and parameters one can use to look at as a part of technical analysis of
gold. But I would suggest, you stick to the following key parameters and try to understand the impact of
each on the golds price.
Current and historical global demand for gold
Foreign exchange rate
Volumes of gold futures contract traded on various exchanges
Inflation rate
Now let us try and understand each of these above factors in detail
1) Global Demand for gold: Demand for gold as an investment or a object to guarantee or back
your monetary system in the country are the prime motives that are fueling the global demand for
this asset.



As you could see from the above chart, the demand fell down drastically in year 2009 after rising
for past two consecutive years, mainly due to global recession and liquidity crunch. Although the
price didnt react to this fall in the demand. Actually if you could notice, the demand picked up
and increased in 2008 over 2007. But during the same period, the price gradually reacted and
changed the direction. In fact the price remained almost flat in 2008 and only picked up at the
0.00
200.00
400.00
600.00
800.00
1,000.00
1,200.00
3200
3300
3400
3500
3600
3700
3800
3900
2007 2008 2009
Years
P
r
i
c
e

i
n

U
S
D
D
e
m
a
n
d

i
n

T
o
n
n
e
s
Global Demand for Gold and its price
Demand
Price
23


onset of 2009. Hence we can suggest one thing from the above graph that the price of gold takes
time to react to the change in its demand. There is a lag in the movement of price of gold to its
demand.

Similar findings can be noticed in the above chart representing the domestic demand for gold in India.
As you could see from the above chart the price of gold rose significantly in Q2 over Q1 of 2007. Still the
price over the same period instead of increasing, it slipped further down and rose in Q3 of 2007 and kept
on rising without honoring to the demand conditions. Again if you note, in Q1 of 2009 there was a fall in
demand for gold on QoQ basis, but still the price kept increasing and came down only when the demand
increased in next month and afterwards it followed along with the demand.
So from the above two charts, we can conclude that the price of gold at macro level does not react quickly
to the change in demand and follows a time lag.

2) Foreign exchange rate movements: As you know the physical gold is traded on international
level among countries with US dollars. Hence the currency fluctuations of the domestic currency
with respect to the US Dollar play an influential role in determining the direction of the gold price
movements. Although this factor is a minor contributor to the price movements, it has a material
impact on the trading investors in the gold futures. Let us now look how the Indian rupee
exchange rate against US dollar been in the past visa vie the gold price.

Ideally when Indian rupee depreciates against US dollar, the price for gold in the domestic market
increases and vice versa. Hence fundamentally if the price for any commodity rises, the demand
24


should fall. But again it depend to what extend does currency rate fluctuations brings fluctuations
in price of gold. If there are other factors that play a dominant role in determining the price of
gold, then currency rate fluctuations will not have much of an impact on demand for gold or
change in its domestic price.



In the above chart it is evident that in past 15 months, the domestic prices in Indian rupee almost
perfectly correlated to the international gold prices quoted in US dollars. The correlation on the
above currency exchange rate for INR/USD and Indian rupee prices for the gold comes to 72%. It
means 72% of the times change in the foreign exchange rate has brought about corresponding
change in the domestic prices for the gold. Hence it is very important to look for cues in the
foreign exchange rates to understand the variations in domestic prices it can bring. This helps in
trading in gold futures.


44.00
45.00
46.00
47.00
48.00
49.00
50.00
51.00
52.00
0.00
10,000.00
20,000.00
30,000.00
40,000.00
50,000.00
60,000.00
Domestic Gold prices Vs INR/USD
INR
INR/USD
0.00
200.00
400.00
600.00
800.00
1,000.00
1,200.00
1,400.00
0.00
10,000.00
20,000.00
30,000.00
40,000.00
50,000.00
60,000.00
INR
US$
25


It is also imperative to look from a cue in the global gold price and how well is the domestic price
synchronized with international market for gold. Here in the above chart, you could see how well
the Indian rupee gold prices are correlated with the international price of the gold traded in US
dollars. This kind of analysis will help you to find a direction of the gold futures prices by taking
cues from the international market.


3) Gold futures prices and contracts: You as an investor should track the prices of the gold
futures traded on commodities exchanges and their total volume in terms of contracts traded. It
will help you find the price lag, the direction of the price movement and the sentiments of the
trading participants in the gold futures, as in what is the consensus of people have for the gold
prices. Let us now look at what is the usually trend in the futures market with the prices and the
contracts traded.


It is evident from the above chart that the price for the gold has not been very sensitive to the total
volume being traded on the exchange. If you could see, in March 2009 when total contracts
traded increased, the price for the gold futures also increased but very little as against July 2009
sharp fall in the number of contracts traded from April 2009, the price just remained flat and did
not fall along with the contracts traded. Though there have been some spikes in the price of gold
futures, whenever there has been rise in the contracts traded like in November 2009 and in April
2010. Hence we can say that number of contracts do not have any say in determining the price of
the gold futures and you should not be worried about the a fall in contracts in the gold futures, as
the price just dont react to the decrease in the contracts traded.

4) Rising Inflation This is true for any commodity but it has more impact on the gold trading.
People consider gold as a safe metal to hedge against the rising inflation.
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
0
500000
1000000
1500000
2000000
2500000
3000000
3500000
4000000
4500000
Gold futures price and contracts traded
Contracts
(in Lots)
Price
26



As you can see from the above chart, the price of the gold in Indian market felt along with the fall in the
rate of inflation. It only picked up when inflation started to increase. Once the inflation felt below 0%, the
price for gold stayed flat as long as the inflation stayed in the negative zone. This suggests that people buy
gold when inflation is rising, hence the price rises.


-2.00%
-1.50%
-1.00%
-0.50%
0.00%
0.50%
1.00%
1.50%
42000.00
43000.00
44000.00
45000.00
46000.00
47000.00
48000.00
49000.00
50000.00
Gold
Inflation
27


Psychology in gold trading
Among gold investors, the major drivers of the gold price are well-known. From mine production and
central-bank sales to jewelry and investment demand, golds fundamentals have been and will continue to
be extensively studied. But over the past year, a curious and sometimes dominating new gold driver has
emerged.
US Stock Markets
Historically, secular gold bulls happened during secular stock bears. Over these long time frames (17
years or so), persistent stock-market weakness gradually ramped up gold investment demand. But over
the past year, weve seen something quite different from this precedent.
Rather than moving in opposition to the stock markets strategically, gold has often moved with them
tactically. On a day-to-day basis, there has actually been a high positive correlation between the stock
markets and gold! This peculiar tendency was driven by the sheer craziness of the stock panic. And even
though it is gradually abating today, gold traders can only ignore it at their own peril.
The stock markets newfound influence on gold is two-pronged. The primary way they drove gold into
an odd positive correlation with stocks was through their impact on the US dollar. Thankfully this link
will continue to fade as the post-panic normalization continues. The secondary way is through stock-
market capital chasing gold via the GLD gold ETF. As GLD grows, so will stock-market capitals impact
on gold prices.
US Dollar currency
As the fear surrounded with the stock market, investors fled with their money from stocks to the US
dollar which lead to sudden plunge in the stock market and the gold prices. This event signifies the quest
of investors for safe heaven which they consider US dollar and treasuries fulfill their needs.
Investment Demand
Gold as such is not a great investment asset. If you look at the historical performance, Gold has never
outperformed equities in long run. In fact the CAGR of gold has been poor 1% for past 300 years. The
only reason people like to invest in gold is that they consider it as a good hedging asset against inflation.
People consider it as a safe asset to invest in times of panic. Hence this particular psyche of people
influences the demand and price of gold.
Conclusion
The bottom line is the US stock markets have become a major driver of gold over the past year. And this
is not the traditional inverse secular relationship, but a positively-correlated tactical one. Intense fear in
stocks led to flight capital flooding into the US dollar. The resulting sharp dollar rally hammered gold,
causing it to plunge with stocks. And as recovering stocks led to dollar selling, gold rallied with the SPX.
As it is very unlikely for US dollar to appreciate any further, this leaves a good scope for Gold investment
in coming future.
28


Trading in Gold
There are many ways that you can profit from the up and down movements in the price of gold. One way
is to play the long side, which is where you are speculating that prices will rise in the future. Another way
is to play the short side, which is when you are speculating that prices will fall in the future. When you
are going to be trading any of the different commodities it is important to pay attention to the tick that is
taking place.
This is where as futures contract is being purchased or shorted it is reflected by a positive up tick or a
negative down tick. What you want to do is enter a position on a negative down tick if you are planning
on going long or a positive up tick on the short side, helping you to enter the futures contract at the right
time. A common strategy used to trade gold is the straddle, which is where you are going long and short
at the same time. The idea is to purchase both contracts at the same price and time frame so that you can
take advantage of the volatility to make money.
Let us now look at different scenarios and how will doing trade in Gold would make you fetch money or
at least minimize your losses.
1) When gold prices are falling

This the chart for gold price traded on a particular date lets say 12
th
may 2010. It shows the opening
price, the high price for the day, the lowest price for the day and that days closing price. From the above
chat we can see that on 12
th
may the gold traded between the range of 18250 and 18175. In such a
scenario, what should be your strategy? You should short or sell the gold futures of 100 gms at the
opening price of 18250 and close your short position before the close of the trading session or whenever
the price start moving upwards. This way you could have made Rs 750 (price quoted is for 10 gms and
your contract is for 100 gms, hence you make 75 per 10 gms) per contract.

18120
18140
18160
18180
18200
18220
18240
18260
Open Price High Price Low Price Close Price
Price
Price
29


2) When there is no direction in the price of gold
Similarly, when during the intra day trading session, when you see that there is not specific direction or
trend in the movement of price, youll have to improvise a different trading strategy.

Like in the case of above chart, it is gold futures expiring on 5
th
aug 2010. It is clear from the graph, that
the gold price behavior has no specific direction in it and its volatile. As a trader, it becomes really
difficult to make money in such a market condition. Then what can be done in such a scenario? You
should use a strategy called straddle. It means you should buy and sell the futures contract at the same
price having a stop loss on both the contracts. It is always advisable to wait and observe for any patterns
or direction if you are able to spot in the price movement. Lets say after some observations, you decide
to trade in the futures contract at about 11:30 AM. You use the strangle strategy where you bought and
sold gold futures at the same price of Rs 18535 keeping a stop loss of Rs 18525 on long contract
(basically assuming that the price have bottomed out and there is not much room for price to fall further)
and Rs 18550. Now using this strategy will hedge your position and minimize your losses. When the price
moves up, you will make money on the long (the one that you bought) futures contract and at the same
time you will lose the same amount on the short futures contract. Hence your position is hedged.
Now let us calculate how much profit/loss you have mad at different point in time. At 12 noon, when the
price is at Rs18540, you made Rs 5 (18540-18535) on the long contract and lost Rs 5 (18535-18540) on
the short contract. Both the contracts are still valid as none of them have actually triggered their
respective stop losses. Now at 12:30, the gold is trading at Rs 18558. Now here your short futures
contract got executed at the stop loss price of Rs 18550 which means you made a loss of Rs 15 on the
short contract. On the other hand you have a profit of Rs 23 (18558-18535) on the long contract. Hence
you made a net profit of Rs 8. Once one of your contracts gets its stop loss triggered, it means the price
30


movement has found itself a direction and you can hang-on to another contract for a while. In this case it
requires you revise your stop loss slightly on the upside from Rs 18525 to Rs 18535 as the price has move
up in the direction. If you observe, the price again came down and reached Rs 18538 levels at about
12:45. And then it shoot up Rs 15575 about 1 pm. This is the time you get out of the contract as you have
made a profit of Rs 50 (18575-18535) on a single contract which seems to be a big fluctuation in todays
trade ( Todays high is Rs 18580 and low of Rs 18525 which is like a difference of 55). Hence by
exceeding at Rs 15575 you have made a net profit of Rs 35 (50-15).
The key to make money in this strategy is the stop loss. You have to be really smart at calculating the
appropriate stop loss for your contracts and revising the stop losses according to changing conditions.
Risk in this strategy The only risk the trader faces in this kind of strategy is that he will make loss if
one of the contracts gets executed due to triggering of stop loss and the other one obviously is till on. In
such case you could either hang on to the other contract for few more price fluctuations and then exit out
of it or if you are a risk taker, then you can either continue holding your active contract like In the case
above or can even enter into another contract (go short if you are long on the other contract) at the current
price. Thats how you can minimize your risk. Or at the end of day if none of your contracts trigger their
respective stop loss limit, you will end up making no money as your position will be perfectly covered
and hence no profit no loss for you.

31


Silver
Fundamentals of Silver
Silver has been used as a medium of exchange since ancient times. Throughout history, silver coins were,
and still are in many places, essential for internal and international trade.
Silver has been a great store of value since 2003 since it has been actually increasing in value at a much
faster rate than the stock market or bonds. There is now a small, but rapidly growing demand for silver as
a store of value. In 2007, it was about 20 to 60 million ounces, depending on if you trust the statistics of
the Silver Institute, or the CPM groups, respectively. In 2008, investment demand was up to 150 million
oz/year since the introduction of the new Silver ETF, or the raging physical demand of silver as seen by
the doubling of production of Silver Eagles by the U.S. Mint, and respective shortages of that silver
product and others such as scarce 100 oz bars.
Most of the demand for silver today is for Industrial, Healthcare, Jewelry, & photography purposes. More
than is produced each year.
That does not leave much room for investment, or monetary demand, (which is termed a "surplus" by the
groups who publish statistics on silver).
Silver is produced throughout the world but an interesting fact remains that the primary source of silver is
not the silver mines but the other sources of silver. Silver mines produce a small amount of silver that is
25% of the worlds total production and the rest of it is derived as a by-product from gold mines (15%),
copper mines (24%), lead and zinc mines (34%) and other sources. The total production of silver in the
world figures to be around 615 million ounces and Mexico is the leading silver producing country.
Now let us look at each of these segments and their potential demand for the Silver
Industry: Silver has numerous uses and applications in various industries, especially in the electrical
appliances segment. Ordinary household switches, which normally carry high electric current for
electrical appliances from irons to refrigerators, use silver. Silver is the metal of choice for switch
contacts because it does not corrode, which would result in overheating, posting a fire hazard.
Industrial demand has grown with the increasing use of electronics and electrical uses. From mirrors to
paints, and dental alloys to coins, silver is used in numerous areas. Today industrial uses account for 44%
of worldwide silver consumption.
Healthcare: Silver contains anti-bacterial properties and researchers have found that silver can be used as
a biocide. Burn units in hospitals use bandages that release silver ions that help with healing and reduce
the need for frequent dressing changes
Research shows that silver promotes the production of new cells, increasing the rate of healing in wounds
and bone. The regeneration of whole areas of lost skin is being accomplished by the use of silver
treatment.
Research indicates that silver-based purification systems are effective in disinfecting water.
32


As part of a growing trend in silver-based bandage usage, two wound dressing makers, Curad and
Johnson & Johnson, have introduced products into this growing field.
For the health care professional market, Johnson & Johnson has introduced their SILVERCEL
antimicrobial alginate dressing, providing the protection of silver and the absorption of alginate.
Jewelry and Photography:
126 million troy ounces of silver were used worldwide in 2007 for photography. Although a wide variety
of technology is available, silver-based photography is expected to dominate the market for the
foreseeable future due to its superior definition and low cost. Over 1.5 billion silver oxide-zinc batteries
are supplied to world markets yearly, including miniature-sized batteries for watches, cameras and small
electronic devices, and larger batteries for tools and commercial portable TV cameras.
India is the biggest and still an emerging market for silver jewelry market in the world. Worldwide use of
silver for jewelry markets amounts to over 163 million troy ounces in 2007.The array of large silver
pendants and other jewelry available in the market today is quite mind boggling! Silver pendants come in
a wide range of styles. The most common style incorporates one or more gemstones. The pendant can
have a single large gemstone that forms the focus of the pendant and the sterling silver setting can be
simple and elegant or intricate and ornate.
The present day standard for jewelry is Sterling silver. Sterling silver is an alloy of silver and copper,
with the silver content being at least 92.5 percent.
New Uses of Silver creating new demand: Research on silver use in fuel cells and catalysts is well
underway by the auto industry. Silver has a significant cost advantage when compared to platinum.
The electronic industry is continuing to reduce the amount of gold used in bonding wires and plating. The
industry is replacing it with silver, a cheaper and equally durable substitute.
Silver coins that are investment grade 99.9% pure are permitted to be included in Individual Retirement
Accounts
Conclusion
Silver enjoys the dual role of an important industrial as well an investment metal. Silver's role in
photography, numerous industrial applications, silverware and jewelry, and medicine, is expected to rise
as the global economy continues to rebound.
There are many potential new uses of silver, which would lead to increased silver offtake in future years.
Fuel cells, silver-based wood preservatives, and superconductivity, are some of the innovative potential
new uses for silver.
Today, millions of people throughout the world recognize silvers intrinsic value and have made it
popular as an affordable investment.
33


Although silver is relatively scarce, it is the most plentiful and least expensive of the precious metals. For
the average investor, silver can be an effective means of diversifying investment assets and preserving
wealth against the ravages of inflation.



34


Technical drivers of Silver
Like any other commodity, price of Silver is also influenced by its demand for various purposes and its
total available and potential supply. Besides this fundamental reasons, there are few more factors that
indirectly affect silvers demand and hence its price. Here are some identified factors
Foreign exchange
Oil price
Industrial output
Gold prices.
Let us first understand the basic factors i.e. demand and supply of silver and their effect of the silver
prices.
Demand and Supply and price of Silver: As the basic micro economics states, when demand is more
than the supply of any commodity, the price of that commodity should be high or should be rising and
vice versa. But it seems the story is completely different in case of the Silver.

Well as could see fro the chart, that the demand has been consistently falling short of total available
supply of silver since 2002. But still there has been consistent rise in the price of silver since 2003. Well
there has to be some reason why would price rise despite fall in demand against the supply. Well there
could possibly be only two reasons, both of them not available in the above chart. First, being there has
been growing demand for silver from the unconventional uses like industries, photography, etc. Or
secondly, there are other factors that are affecting the price of the silver to behave in this manner.
Let us try to analyze if there are any other areas or segments from where there is a rising demand for
silver.
35



Well it is clearly visible from the above chart, that the new area where there has been rising demand for
silver is the investment and hedging needs of the investors. It has been the investment demand for silver
that has single handedly pushed the price up, since 2004. The major buyers of the silver for investment
purpose are the hedge funds and investors investing in the silver ETFs.
Foreign exchange movement: Since Silver is a globally traded commodity and is mined and consumed
by different countries in the world, it is priced and traded in the US dollar on various exchanges of the
world. Hence the foreign currency movement of US dollar against your domestic currency naturally
affects the price of the silver in your country, just like any other metal commodity. But the only valuable
insight you as an investor should be looking to get out of such analysis is to find out two things about
foreign exchange movement and silver price, First the relative strength in their relationship that makes
silver price to react to the change in currency fluctuation and second is the time lag, if any for silver price
to react to the change in the foreign currency market. Let us look at historical data to answer our
questions.
36



As it is evident fro the above chart, the silver price does get influenced by the fluctuations in the Indian
rupee exchange rate. They both share a strong negative relationship with a correlation of -0.84, which
means that 84% times the silver price has changed to the change in the foreign exchange rate of rupee.
And the negative sign indicates that they have an inverse relationship, meaning that whenever the Indian
rupee depreciated, the price for silver has increased and vice versa.
Crude oil prices to Silver: Like in case of most of the commodities, Silver also shares a strong
relationship with the crude oil price movements. Oil is demanded in huge quantity, which is even bigger
than the silvers production. Hence it becomes important factor influencing the consumption of other
commodities like silver and thus the price.

Looking at the chart, it is little difficult to conclude that which direction does the silver price move on the
change in the price of oil. For the first quarter of 2009, the silver price fell whenever the oil prices went
37


up. Then from Sept 2009 onward they showed a strong positive relationship and silver price movement
replicated the move of oil prices. Overall they have a strong positive correlation of 0.85.
Industrial Production in India: Since silver is used for industrial production in various sectors and for
various products, it is evidently dependent on the industrial performance and demand outlook. The
performance of industries output is measured using index of industrial production (IIP) number which is
published on monthly basis.

From the above chart, it appears that the silver price shares a strong relationship with the IIP. They have a
strong correlation in the movement of price and the index number of 0.86. If you take a closer look at the
chart above, you will be able to find an important trend in the movement of price of silver with the IIP.
The price of silver reacts to the change in IIP in the time lag of 1 month. For example, in the months of
February and March 2009, IIP fell below 0% i.e. posted a negative output, but in the month of February
2009, price of silver increased and decreased only in Mar 2009, to react to the fall in the IIP output.
Similarly, the IIP output increased in April 2009 but silver price kept falling to react in a months lag to
the fall in IIP output. Hence there is a 1 month lag in the change in price of silver to the change in IIP
output. You as an investor can surely make use of this relationship in taking your trading positions.
Gold demand and prices: As you all know, investors never appreciated Silver as a metal for investment.
It was and is still considered as a secondary investment commodity over gold. Like crude oil, Gold also
influences the price of the silver and even the investment demand for silver.
38



As you can see from the above chart both gold and silver move in the same direction, as expected. But
silver appears relatively volatile. The correlation between gold price and silver is a whooping 0.95. It
means you can safely bet on silver based on the price movements of gold. In fact the volatility of silver
can be of great trading opportunity for taking short-term positions by looking at the gold prices.

39


Trading in Silver
In India you can trade in commodities only by using futures. There are no other derivative instruments
available in the Indian commodities market. There can be numerous trading strategies one can think of.
Let us try to look at different scenarios and understand what trading style or strategy one should adopt to
gain in each of those situations.
1) When the price of Silver is on the rise: It means the sentiments are bullish and general
consensus is that the prices for silver will rise for near future to come. In such a case you should
enter into a long futures contract of silver i.e. buy silver futures. Lets say you buy silver futures
on 3
th
june 2010 at a price of Rs 28000 with expiry of 20
th
june 2010 on NCDEX. The minimum
lot size of the silver contract is 30 kgs. You have to keep aside a minimum margin in your trading
account with the broker. The margin requirement varies from 3% to 20% depending upon the
volatility of the commodity. Lets say the margin requirement for silver is 10%. It means you will
have to keep aside Rs 84000(28000X30X0.1). Let us now see how your long futures position
look on different days and at different price.
Date EOD_Silver
price
Lot size (in
Kgs)
Profit/(loss)
4-Jun-2010 28150 30 4500.00
5-Jun-2010 27945 30 (1650.00)
20-Jun-2010 28345 30 10350.00

As you can see from the above table, on the next day of your purchase of the futures, you made a profit of
Rs 450 ((28150-28000)*30) on your investment of Rs 84000 (initial minimum margin). Similarly, on 5
th

june 2010, you incurred a loss of Rs 165 as the futures price felt below Rs 28000 (i.e. your purchase
price). As the contract expired on 20
th
june 2010, you made a total profit of Rs 1035 on your initial price
of Rs 28000. Hence your net return on investment (ROI) came to 12.3% (1035 on 84000) in 16 days. This
feature of leverage actually helped you to earn 10 times more return than you would have earned had you
actually purchased 30 kgs of silver. Because you would have invested Rs 840000 and still would have
earned same profit of Rs 10350.
2) When the price of Silver is falling: It means the sentiments are bearish and general consensus is
that the prices for silver will fall for near future to come. In such a case you should enter into a
short futures contract of silver i.e. sell silver futures. Lets say you sell silver futures on 3
th
june
2010 at a price of Rs 28000 with expiry of 20
th
june 2010 on NCDEX.



40


Date EOD_Silver
price
Lot size (in
Kgs)
Profit/(loss)
4-Jun-2010 28220 30 (6600.00)
5-Jun-2010 27945 30 1650.00
20-Jun-2010 27860 30 4200.00

As you can see, you initially made a loss of Rs 6600 on your short position in silver futures since the
price went above Rs 28000 (Remember, when you short or sell futures, it is favorable for you if the price
of silver falls below your purchase price). At the end of expiry date you had a favorable position on your
short position and earned a profit of Rs 4200, clocking you ROI of 5% in 16 days.
Before adopting any trading position, you should look at various indicators covered in the previous
chapter to determine the price movement in silver.
3) Trading strategies using technical indicators: We saw few technical factors that influence the
price of silver to some extent. We even saw the kind of relationship each of those factors share
with silver. Let us now formulate a strategy using couple of those indicators. Let us consider
foreign exchange and IIP number as the indicators for predicting silvers price.
As we have seen that silver and foreign exchange rate share a negative correlation and silver and IIP
output numbers share positive correlation. Moreover, silver moves in a one month lag to IIP numbers.
Using these factors you can take a month long futures position in silver.
Conditions for our strategy: You see rupee has been depreciating in past 2 to 3 months and there are
news that it rupee will be weak against dollar for coming few months. It is safe to take a long position in
silver futures.
Industrial production has been posting a strong performance for past 3 months. It indicates that silver
price will also go up for next month, due to one month lag to the change in IIP numbers. Hence even this
indicator is favorable in taking a long position in futures.

Thus by considering both the indicators in totality, we reach to a decision that silver price is set to
increase over a period of 1 month and thus probable trading strategy would be to go long on futures.


41


Copper
Fundamentals of Copper
Introduction
Copper is an industrial metal that is mainly used in building construction (electrical and plumbing).
Copper is an excellent conductor of electricity and is very resistant to corrosion.
Copper is often considered an accurate indicator of economic growth. An economic expansion is usually
present or beginning if demand for copper is increasing.
The largest producers of copper are Chile, Peru, South Africa, North America, and Russia. In the US,
Arizona is responsible for about 65 percent of production. The US, Russia, and Japan are the three largest
consumers of copper
Copper and copper alloys meet the challenges of modern life in many ways. Often seen in plumbing
systems and good quality roofing and cladding, they are also frequently unseen providing essential
services inside equipment in houses, offices, commercial and industrial buildings. They are amongst the
most necessary materials needed to provide the means to keep home, commerce and industry running.
Main uses of copper
Electrical Applications
Approximately 65% of copper produced is used for electrical applications. Copper has the highest
electrical conductivity of any metal, apart from silver, leading to applications in:
Power generation and transmission - generators, transformers, motors, and cables provide and
deliver electricity safely and efficiently to homes and businesses.
Electrical equipment - providing circuitry, wiring and contacts for PCs, TVs and mobile phones.
Copper has a key role to play in energy efficiency - the judicious use of 1 tonne of copper in the energy
sector makes it possible to reduce CO
2
emissions by 200 tonnes per year on average.
The top two market segments, power utilities and telecommunications, account for almost two-thirds of
the copper it consumed by this market. A key driver for power utilities is electrical distribution and
control, which includes transformers, switchgear and industrial circuit breakers, and industrial controls.
Electrical distribution and control in turn is driven by both residential and nonresidential construction
Construction
25% of all the copper produced is used in buildings - for plumbing, roofing and cladding. Copper
provides light, durable maintenance-free structures that are naturally good looking, long lasting and fully
recyclable. Copper's naturally antimicrobial properties can be exploited in hygienic surfaces for hospitals
and healthcare facilities. Copper is also used on a lager scale for residential as well as non-residential
construction purposes. As the real estate market is on the growth track, more and more demand for copper
could be expected fro this sector.
42


Transport
Trains, trams, cars and lorries all need copper and transport accounts for 7% of copper usage. The high
purity copper wire harness system carries the current from the battery throughout the vehicle to
equipment such as lights, central locking, on-board computers and satellite navigation systems. Electric
super trams in cities such as Manchester, Sheffield and Croydon, provide clean, efficient transport
powered by electric motors. The overhead contact wires are either copper-silver or copper-cadmium
alloys.
Other
The remaining 3% is used for coins, sculptures, musical instruments and cookware

43


Technicals of Copper
World demand for copper has been rising much faster than the growth in market supply that result from
new discoveries of copper and increased extraction rates of known reserves.
The world supply of and demand for copper
Most copper ore is mined or extracted as copper sulfides from large open pit mines in copper porphyry
deposits that contain 0.4 to 1.0 percent copper. Over 40 per cent of world copper supply comes from
North and South America; 31 per cent from Asia and 21 per cent from Europe. Chile is the worlds
biggest supplier of copper (it provided 35 per cent of the total in 2003 with Indonesia and the USA each
contributing 8 per cent).
Copper an example of derived demand
Because copper is malleable and ductile, there is a huge industrial demand for copper. Like most metals
the demand for it is derived in part from the final demand for products that use copper as an important
component or raw material. Nearly 50 per cent of the demand for copper comes from the construction
industry, and 17 per cent is from the electrical sector. Copper is also used extensively in heavy and light
engineering and in transport industries. From copper wire to copper plumbing, from the use of copper in
integrated circuits to its value as a corrosive resistant material in shipbuilding and as a component of
coins, cutlery and to colour glass, copper has a huge array of possible industrial uses.
The volatility of commodity prices
As we have seen, price volatility stems from a lack of responsiveness of both demand and supply in the
short term, i.e. both demand and supply are assumed to be inelastic in response to price movements.
The low price elasticity of demand for copper usually stems from a lack of close substitutes in the market.
For some products and processes, aluminum or plastic may act as a substitute to copper for some uses, but
there are costs and delays involved in switching between them.
The elasticity of supply is also low. Supply is usually unresponsive to price movements in the short term
because of the high fixed costs of developing new extraction plants which also involve lengthy lead-
times. If existing copper mining businesses are working close to their current capacity then a rise in world
demand will simple lead to a reduction in available stocks. And as stocks fall, so buyers in the market will
bid up the price either to finance immediate delivery (the spot price) or to guarantee delivery of copper in
the future (reflected in the futures price). It can take huge price swings in the market for supply and
demand to respond sufficient to bring the market back to some sort of equilibrium.
The demand for copper will continue to remain strong provided that the global industrial sectors continue
to expand production. But if price remain high then we can expect to see some shifts occurring. For a
start, copper can be recycled although the costs of doing so are often high and there are fears concerning
the negative externalities arising from the pollution created by trying to recycle used copper. These
external costs include atmospheric emissions from recycling plants and waste products dumped into
rivers. Nonetheless price theory would predict an increase in demand for scrapped copper and perhaps
a substitution effect away from copper towards aluminium. And in the medium term high prices and
44


emerging new technologies may cause an even bigger shift in demand away from copper based products.
Plastics provide lower material and installation costs for businesses. And the take off in wireless
technology and fibre optics will also have an impact.
And higher prices might also be the stimulus required for an expansion of copper ore production as
supply responds to the incentives of increased potential revenues and profits. In recent years, copper
mining production has fallen short of expectations
Growth in Emerging economies
The major driver for the demand for copper in past decade has been the emerging economies like China,
India, Brazil and so on. According to reports, the Bric nations are expected to grow at the average growth
rate of 5% till 2020. This growth will need lot of infrastructure development like constructions, real estate
and other industrial development to sustain this growth rate. Due to which there will be high demand for
copper as it is one of the basic components used in these sectors.
Over half of the global GDP contribution comes from emerging economies. The continued growth of the
world economy will fuel the growth in the demand for copper.

As you can see from the above chart, emerging economies have always outperformed the world economy
in the past decade and are likely to continue to outperform for next decade or so.



Global Demand and Supply of copper
The supply of copper has always been more than the total demand till 2009. This is largely due to
slowdown in the global economic activity, which dragged the total demand for copper. But this slow
45


down even affected the supply side as the cost of production and mining copper shoot up which made lot
of companies to delay their capacity expansion plane. Hence more or less the demand supply condition
has remained unchanged to that of pre-recession period. Although the emerging economies like China and
India are expected to recover faster from the slowdown and regain the long term growth track. Hence the
demand for copper is expected to rise faster than the supply side improvements in near term by 2015.

Copper consumption in China
Chinas demand for copper is estimated to double by 2015 to 8Mt. What is driving the demand
specifically? We know that urbanization of China is the leading contributor to this demand but the
unknown factor really is just how big the infrastructural requirement will need to be to equip this new
economy. The middle class is growing at the rate of approximately 20M people per year.
China is the worlds largest consumer of copper, consuming twice as much as the US. Over 50% of
Chinas copper consumption currently goes toward power generation and transmission and this demand is
growing above 10% every year. The demand growth is expected to continue to at least 2015 at which time
Chinese copper demand is estimated to reach 12kg/urban capita.
Chinese consumption of refined copper and, further downstream, of copper and copper alloy semi
manufactures are both growing rapidly. The countrys production of refined copper and of semi-
manufactures of copper and copper alloys (such as brass and bronze) is inadequate for its end-use
requirements, and each year there are large scale net imports of refined copper and of copper and copper
alloy semi-manufactures into China.
46



As you could see from the chart the Chinese consumption for copper has been steadily rising irrespective
of the world production. There were few hiccups in the world production during 2001 to 2004, but the
Chinese consumption kept steadily rising over the period. And it is expected that the Chinese
consumption is going to rise to 15 million tones by 2015, which matches the current world production.
And the world production for copper is expected to be at about 18 million tones by 2015, which will fall
short of the total world consumption.
LME Warehouse Stockpiles
Copper, and the rest of the major base metals, are unique among commodities in that fundamental data is
available daily. The London Metal Exchange coordinates a global network of warehouses that act as a
buffer between copper consumers and copper miners, like an emergency supply. The LME publishes
their total copper stockpiles daily, which are an extremely valuable trading tool as my business partner
Scott Wrights research has abundantly proven.
In a nutshell, most copper mined is sold directly to factories manufacturing copper products for
consumption. It does not pass through LME warehouses. But if a producer temporarily mines more
copper than it is under contract to provide, it can ship its excess to an LME warehouse. And if a
consumer temporarily needs more copper than it is receiving, it can buy directly from an LME
warehouse. Thus the LME warehouse stockpiles, while existing at the margins, offer an excellent
window into global copper supply-and-demand trends.

47


Psychology behind trading in Copper
Introduction
Although copper is not the largest base-metal market (aluminum is way bigger), nor the most valuable of
the primary base metals (nickel is worth several times more per pound), it is still arguably the most
important base metal. As the base metal of choice for investors and speculators, coppers price offers
great insights into how traders view the global economic outlook.
Every long-term investor should own the worlds best copper miners, as their stocks appreciation
potential in the coming years is vast. And every speculator ought to consider trading copper stocks, as
they tend to mirror and nicely amplify moves in the broader stock markets. In order to understand why
copper stocks are so compelling for all traders, what makes people trade in copper.
Chinese Demand
Back in early 2006, the young copper bull suddenly exploded higher on a 130% year-over-year surge in
Chinese copper demand. Real demand, not just speculation, was driving it.
If a price level can be sustained for years, there is real demand underlying it. Artificially high prices
driven purely by speculation are built on a foundation of sand and seldom last longer than weeks or
months on the outside. Global copper demand was simply growing faster than the global mined supply.
Stock market performance
The commodities and copper corrections, in normal conditions, would have ended in early September
2008. But as you know, at that fateful moment in history a bond panic was morphing into the first stock
panic seen in 101 years. Many commodities, including copper, were at their secular support lines. And
as stock-market fears ballooned to breathtaking extremes, capital fled all risky assets at a staggering pace.
Much of it flooded into the US dollar and short-term Treasuries, driving the biggest and fastest dollar
rally ever witnessed which seriously exacerbated commodities selling. The dynamic of fleeing everything
to buy dollars is exceedingly important to understand.
Economic Outlook
As a metal heavily dependent on prevailing sentiment and consensus economic outlook in the best of
times, it shouldnt be surprising that copper was hit abnormally hard in the worst of times. By the time
the dust from the panic settled in late December 2008, copper had plummeted 68.6% to $1.28 per pound!
Such an epic decline in copper was unheard of.
Now there is no doubt that the post-panic world will be different than the pre-panic one. But just because
of a stock panic, a purely psychological event, economic activity doesnt cease or become permanently
crippled. All over the world people are still building and consuming, and the global population is still
growing. Global demand for copper will remain high relative to history.

48


Chinese GDP is actually growing despite the panic! In the year ending Q2 2009 that obviously straddled
the stock panic, Chinese GDP actually grew by an amazing 7.1%! Chinese copper imports in 2009 had
risen to records in some months. Given the state of the world economy, copper demand (and hence
prices) is likely to be far closer to pre-panic levels than the panic lows going forward.
Cost of mining
Despite the panics crushing impact on copper and copper miners stocks, I still believe these equities are
the best way to play this secular copper bull. They have immense profits leverage to copper prices. If a
company can mine copper at $1 per pound, and sell it at $2, they have a $1 profit. But if copper rallies
50% to $3, the miner can still mine at $1. So its profits soar 100% to $2 per pound, leveraging coppers
own gains by 2x. And ultimately profits drive stock prices, and copper stocks arent even close to
reflecting $3 copper.

Conclusion
Despite its favorable fundamentals, copper couldnt withstand the fear maelstrom. The collateral damage
was unbelievable, as the unrelated stock panic drove coppers biggest and fastest losses ever witnessed by
far. Of course this was all an unsustainable anomaly like everything else in the panic, an extreme
condition that couldnt persist without epic fear. Given its fundamentals, this recovery should continue.


49


Sugar
Introduction
If Commercial sugar's origins date is concerned than it comes near about fourth-century. While the
Indians discovered a way to crystallize sugar, the Moors discovered a way to perfect it. With the
development of sugar mills and refineries, sugar became a successful commodity in the Muslim world. In
the 14th century, the Moors brought sugar growth and production to the Iberian Peninsula, and plantations
were set up throughout what is now known as Spain and Portugal. These regions inherited the legacy of
sugar manufacturing. Eventually, Portugal successfully brought sugar to the New World, and by the 16th
century there were more than 3,000 sugar mills throughout South America.
The refined table sugar we consider a staple was once so rare and expensive that it was referred to as
"white gold." Sugar cane, which was the first source of sugar, is a perennial grass that is grown in tropical
and subtropical areas (before the arrival of sugar cane, honey and fruit were the only common
sweeteners). Later, the development of an alternative source of sugar was discovered: beets. The sugar
derived from these two sources is 99.8% pure sucrose, which is a complex sugar composed of glucose
and fructose. Today, sugar can be found throughout the world, with over 120 countries successfully
producing it for domestic and international use.
Fundamentals of Sugar
Production
The process by which sugar is produced has changed little since the 14th century. The natural sugar that is
stored in the cane stalk or beet root is separated from the rest of the plant material. For sugar cane,
processing involves extracting the juice, creating and crystallizing thick syrup, spinning the crystals to
produce raw sugar, and sending the raw sugar to a refinery for final processing and packaging. Beet sugar
processing normally is accomplished in one continuous process without the raw sugar stage.
Sugar cane dominates as the world's primary source of sugar, covering 78% of the market, with sugar
beets following in second place. Today in Worldwide sugar production Brazil is leading the way, India a
close second and the European Union (EU) running a distant third.

The sugar industry is unique among various commodities because as much as 70-80% of all sugar
produced is actually consumed in its country of origin. This has led to an international sugar marketplace
rife with subsidies and unfair market pricing
Sugarcane and sugar production in India typically follow a 6 to 8 year cycle, wherein 3 to 4 years of
higher production are followed by 2 to 3 years of lower production. After two consecutive years of
declining sugar production (2007/08 and 2008/09), production surged in 2009/10, and is set to gain
strongly in the upcoming 2010/11.


50


Consumption:
Sugar consumption in 2010/11 is forecast to increase to 24.5 million tons on forecast improved domestic
supplies and strong demand fueled by a growing population and continued economic growth. Bulk
consumers such as bakeries, makers of candy and local sweets, and soft-drink manufacturers account for
about 60 percent of mill sugar demand. Most of the khandsari sugar is consumed by local sweets
manufacturers. Gur is mostly consumed in rural areas for household consumption and feed use.
Prices
Despite various measures taken by the Government of India (GOI) to control sugar prices, sugar prices
escalated during calendar year 2009 on fears of short domestic supplies and strong international sugar
prices. Sugar prices have eased significantly from February 2010 on improved expectations of domestic
production in 2009/10 and forecast higher production in 2010/11.

Factors affecting Sugar Demand
1. The key health concerns of sugar consumption are diabetes, obesity and tooth decay. Industrialized
nations have made it a priority to solve these health problems, and may require the continued substitution
of sugar or its elimination altogether.
2. India is one of the largest sugar players in the world. Sugar is subsidized in many regions, through
production and high tariffs on imports. It is highly regulated by government policies, thus any shift in
policy could topple the price.
3. Weather plays a key factor for both sugar cane and sugar beets. Sugar cane thrives in warmer tropical
climates, while sugar beets prefer cooler climates such as Japan. Although sugar beets are consistently
used as an alternative source for sugar production, frost damage and the lack of processing capacity can
play a significant role in determining their availability.
4. Like all sugar producing countries, India has a protectionist policy in place for sugar prices. While
producers enjoy higher sugar prices, it forces consumers to look to alternatives, a situation that has led to
a significant number of companies switching to corn syrup. A growing movement among sugar cane and
sugar beet producers is demanding a free market for sugar production.
Sugar production is subsidized and tarrified all over the world. The real price of sugar is actually
unknown. In a truly competitive trading environment, sugar prices might be significantly less. Subtle
clues surrounding its export and consumption must be watched in order to determine the market's
direction.
Demand in India
Indians by nature have a sweet tooth and sugar is a prime requirement in every household. Almost 75% of
the sugar available in the open market is consumed by bulk consumers like bakeries, candy makers, sweet
makers and soft drink manufacturers. Khandsari sugar is less refined and is typically consumed by sweet
51


makers. Gur, an unrefined form of lumpy brown sugar, is mostly consumed in rural areas, with some
quantities illegally diverted for alcohol production.
Greater urbanization and rising standard of living have sparked of a rising trend in usage of Sugar.
Industrial consumption for sugar is also growing rapidly particularly from the food processing sector and
sugar based bulk consumers such as soft drink and ice cream manufacture
World outlook for Sugar
World sugar production for the 2010/11 marketing year is forecast at 164 million tons, raw value, up12
million from the revised 2009/10 estimate. Consumption is forecast at a record 158 million tons, up 4
million from a year earlier. Exports are forecast at record 54 million tons, up 3 million.
Brazil, India, Thailand, and China account for 53 percent of 2010/11 forecast world production; and
Brazil, Guatemala, Thailand, and Australia account for 73 percent of 2010/11 forecast world exports.


52


Technicals of Sugar
1) Ethanol commercialization
More than 50% of world ethanol production stems from sugar.

Producing ethanol from sugar is more
efficient than producing ethanol from corn (the ratio of required input energy is one to two). Brazil is the
leader in this production process, using 60% of its sugar canes for ethanol. Commercialization of the
sugar-ethanol production process raises the demand for sugar, leading to increases in sugar prices.
Whether this commercialization occurs or not depends on oil prices. When oil prices rise, then biofuels
become more attractive, elevating the demand for ethanol. For example, in the first half of 2008, sugar
prices increased by 22% in response to rising oil prices.
[



1. Perceived health effects of sugar decreases sugar demand
Public health concerns regarding obesity, heart disease and diabetes, decreases the demand for sugar-
based products. As a result, consumers turn towards sugar-free foods as well as sugar substitutes such as
high fructose corn starch. From 2005 to 2009, revenues of the artificial sweetener industry grew by
around 8%.





53


2. Basic macroeconomic trends also drive sugar supply and demand
Macroeconomic trends that affect the prices of sugar include world-wide income and population growth.
When more people are able to afford sugar-based foods, the demand for sugar rises, driving up sugar
prices. Important regions of such growth are Asia, North Africa and the Middle East. Sugar consumption
in developing countries has grown at around 1.8% per year. The price and availability of substitutes in
developing countries also affect sugar prices. Sugar substitutes include high-fructose corn syrup, starch
and artificial sweeteners.
3. Government policies inflate prices
Sugar is subsidized in many regions, through production and high tariffs on imports. It is highly
regulated by government policies, thus any shift in policy could topple the price.


54


Glossary
Arbitrage
The simultaneous purchase and sale of similar commodities in different
markets to take advantage of a price discrepancy.

Basis
Basis: The difference between the spot or cash price of a commodity and the price of the nearest futures
contract for the same or a related commodity. Basis is usually computed in relation to the futures
contract next to expire and may reflect different time periods, product forms, qualities, or locations.
CASH FUTURES = BASIS.


Bear Market (Bear/Bearish)
A market in which prices are declining. A market participant who
believes prices will move lower is called a bear.A news item is
considered bearish if it is expected to result in lower prices.


Bid
An expression of willingness to buy a commodity at a given price; the
opposite of Offer.

Broker
A company or individual that executes futures and options orders on
behalf of financial and commercial institutions and/or the general public.


Bull Market (Bull/Bullish)
A market in which prices are rising. A market participant who believes
prices will move higher is called a bull.A news item is considered
bullish if it is expected to result in higher prices.


Carrying Broker
A member of a futures exchange, usually a clearinghouse member,
through which another firm, broker or customer chooses to clear all or
some trades.


Cash Commodity
The actual physical commodity as distinguished from the futures contract
based on the physical commodity. Also referred to as Actuals.
55




Cash Market
A place where people buy and sell the actual commodities (i.e., grain
elevator, bank, etc.).
See also Forward (Cash) Contract and Spot.


Cash Settlement
A method of settling certain futures or options contracts whereby the
market participants settle in cash (payment of money rather than delivery
of the commodity).

Charting
The use of graphs and charts in the technical analysis of futures markets
to plot price movements, volume, open interest or other statistical
indicators of price movement.
See also Technical Analysis.


Churning
Excessive trading that results in the broker deriving a profit from
commissions while disregarding the best interests of the customers.

Circuit Breaker
A system of trading halts and price limits on equities and derivatives
markets designed to provide a cooling-off period during large, intraday
market declines or rises.

Clearinghouse
A corporation or separate division of a futures exchange that is responsible
for settling trading accounts, collecting and maintaining margin
monies, regulating delivery and reporting trade data. The clearinghouse
becomes the buyer to each seller (and the seller to each buyer) and
assumes responsibility for protecting buyers and sellers from financial
loss by assuring performance on each contract.


Clearing Member
A member of an exchange clearinghouse responsible for the financial
commitments of its customers.All trades of a non-clearing member must
be registered and eventually settled through a clearing member.

56



Closing Price
See Settlement Price.


Closing Range
A range of prices at which futures transactions took place during the
close of the market.


Commission
A fee charged by a broker to a customer for executing a transaction.


Commission House
See Futures Commission Merchant.


Commodity Exchange Act (CEA)
The federal act that provides for federal regulation of futures trading.


Commodity Futures Trading Commission (CFTC)
The federal regulatory agency established in 1974 that administers the
Commodity Exchange Act.The CFTC monitors the futures and options on
futures markets in the United States.


Commodity Pool
An enterprise in which funds contributed by a number of persons are
combined for the purpose of trading futures or options contracts.The
concept is similar to a mutual fund in the securities industry. Also
referred to as a Pool.


Commodity Pool Operator (CPO)
An individual or organization which operates or solicits funds for a
commodity pool.A CPO may be required to be registered with the CFTC.


Commodity Trading Advisor (CTA)
A person who, for compensation or profit, directly or indirectly advises
others as to the advisability of buying or selling futures or commodity
57


options. Providing advice includes exercising trading authority over a
customers account. A CTA may be required to be registered with
the CFTC.


Confirmation Statement
A statement sent by a Futures Commission Merchant to a customer when
a futures or options position has been initiated.The statement shows the
price and the number of contracts bought or sold. Sometimes combined
with a Purchase and Sale Statement.


Contract Market
A board of trade designated by the CFTC to trade futures or options
contracts on a particular commodity. Commonly used to mean any
exchange on which futures are traded.Also referred to as an Exchange.


Contract Month
The month in which delivery is to be made in accordance with the terms
of the futures contract.Also referred to as Delivery Month.


Convergence
The tendency for prices of physical commodities and futures to approach
one another, usually during the delivery month.


Cross-Hedging
Hedging a cash commodity using a different but related futures contract
when there is no futures contract for the cash commodity being hedged
and the cash and futures market follow similar price trends (e.g., using
soybean meal futures to hedge fish meal).

Current Delivery Month
The futures contract which matures and becomes deliverable during the present month. Also called Spot
Month.

Day Order
An order that if not executed expires automatically at the end of the
trading session on the day it was entered.


58


Day Trader
A speculator who will normally initiate and offset a position within a
single trading session.


Default
The failure to perform on a futures contract as required by exchange
rules, such as a failure to meet a margin call or to make or take delivery.

Deferred Delivery Month
The distant delivery months in which futures trading is taking place, as
distinguished from the nearby futures delivery month.


Delivery
The transfer of the cash commodity from the seller of a futures contract
to the buyer of a futures contract. Each futures exchange has specific
procedures for delivery of a cash commodity. Some futures contracts,
such as stock index contracts, are cash settled.


Derivative
A financial instrument, traded on or off an exchange, the price of which is
directly dependent upon the value of one or more underlying securities,
equity indices, debt instruments, commodities, other derivative instruments,
or any agreed upon pricing index or arrangement. Derivatives involve the
trading of rights or obligations based on the underlying product but do not
directly transfer that product.They are generally used to hedge risk.



Disclosure Document
The statement that some CPOs must provide to customers. It describes
trading strategy, fees, performance, etc.


Discount
(1) The amount a price would be reduced to purchase a commodity of
lesser grade; (2) sometimes used to refer to the price differences
between futures of different delivery months, as in the phrase July is
trading at a discount to May, indicating that the price of the July future
is lower than that of May; (3) applied to cash grain prices that are below
the futures price.
59




Discretionary Account
An arrangement by which the owner of the account gives written power
of attorney to someone else, usually the broker or a Commodity Trading
Advisor, to buy and sell without prior approval of the account owner.
Also referred to as a Managed Account.


Electronic Order
An order placed electronically (without the use of a broker) either via the
Internet or an electronic trading system.


Electronic Trading Systems
Systems that allow participating exchanges to list their products for
trading electronically. These systems may replace, supplement or run
along side of the open outcry trading.


Expiration Date
Generally the last date on which an option may be exercised. It is not
uncommon for an option to expire on a specified date during the month
prior to the delivery month for the underlying futures contracts.


Extrinsic Value
See Time Value.


First Notice Day
The first day on which notice of intent to deliver a commodity in fulfillment
of an expiring futures contract can be given to the clearinghouse by
a seller and assigned by the clearinghouse to a buyer.Varies from contract
to contract. 1) The value of a futures trading account if all open positions
were offset at the current market price; 2) an ownership interest in a
company, such as stock.


Floor Broker
An individual who executes orders on the trading floor of an exchange
for any other person.

60



Floor Trader
An individual who is a member of an exchange and trades for his own
account on the floor of the exchange.


Forward (Cash) Contract
A contract which requires a seller to agree to deliver a specified cash
commodity to a buyer sometime in the future, where the parties expect
delivery to occur.All terms of the contract may be customized, in contrast
to futures contracts whose terms are standardized.


Fully Disclosed
An account carried by a Futures Commission Merchant in the name of an
individual customer; the opposite of an Omnibus Account.


Fundamental Analysis
A method of anticipating future price movement using supply and
demand information.


Futures Commission Merchant (FCM)
An individual or organization which solicits or accepts orders to buy or
sell futures contracts or commodity options and accepts money or other
assets from customers in connection with such orders.An FCM must be
registered with the CFTC.


Futures Contract
A legally binding agreement to buy or sell a commodity or financial
instrument at a later date. Futures contracts are normally standardized
according to the quality, quantity, delivery time and location for each
commodity, with price as the only variable.

Guaranteed Introducing Broker
A Guaranteed Introducing Broker is an IB that has a written agreement
with a Futures Commission Merchant that obligates the FCM to assume
financial and disciplinary responsibility for the performance of the
Guaranteed Introducing Broker in connection with futures and options
customers. A Guaranteed Introducing Broker is not subject to minimum
financial requirements.
61



Hedging
The practice of offsetting the price risk inherent in any cash market
position by taking an opposite position in the futures market. A long
hedge involves buying futures contracts to protect against possible
increasing prices of commodities. A short hedge involves selling futures
contracts to protect against possible declining prices of commodities.


High
The highest price of the day for a particular futures or options on futures
contract.


Initial Margin
The amount a futures market participant must deposit into a margin
account at the time an order is placed to buy or sell a futures contract.
See also Margin.


Intrinsic Value
The amount by which an option is in-the-money.


Last Trading Day
The last day on which trading may occur in a given futures or option.


Leverage
The ability to control large dollar amounts of a commodity with a
comparatively small amount of capital.


Limit
See Position Limit, Price Limit, Variable Limit.


Liquidate
To sell a previously purchased futures or options contract or to buy back
a previously sold futures or options position. Also referred to as Offset.


Liquidity (Liquid Market)
62


A characteristic of a security or commodity market with enough units outstanding
and enough buyers and sellers to allow large transactions without
a substantial change in price.


Long
One who has bought futures contracts or options on futures contracts or
owns a cash commodity.


Low
The lowest price of the day for a particular futures or options on futures
contract.


Maintenance Margin
A set minimum amount (per outstanding futures contract) that a customer
must maintain in his margin account to retain the futures position.
See also Margin.



Margin
An amount of money deposited by both buyers and sellers of futures
contracts and by sellers of options contracts to ensure performance of the
terms of the contract (the making or taking delivery of the commodity or
the cancellation of the position by a subsequent offsetting trade). Margin
in commodities is not a down payment, as in securities, but rather a
performance bond.
See also Initial Margin, Maintenance Margin and Variation Margin.


Margin Call
A call from a clearinghouse to a clearing member, or from a broker or firm
to a customer, to bring margin deposits up to a required minimum level.


Mark-to-Market
To debit or credit on a daily basis a margin account based on the close of
that days trading session. In this way, buyers and sellers are protected
against the possibility of contract default.


63


Market Order
An order to buy or sell a futures or options contract at whatever price is
obtainable when the order reaches the trading floor.


National Futures Association (NFA)
Authorized by Congress in 1974 and designated by the CFTC in 1982 as
a registered futures association, NFA is the industrywide self-regulatory
organization of the futures industry.


Nearby Delivery Month
The futures contract month closest to expiration. Also referred to as the
Spot Month.


Net Asset Value
The value of each unit of participation in a commodity pool. Basically
a calculation of assets minus liabilities plus or minus the value of open
positions when marked to the market, divided by the total number of
outstanding units.


Net Performance
An increase or decrease in net asset value exclusive of additions,
withdrawals and redemptions.


Offer
An indication of willingness to sell a futures contract at a given price; the
opposite of Bid.



Open
The period at the beginning of the trading session officially designated
by the exchange during which all transactions are considered made at
the open.


Open Interest
The total number of futures or options contracts of a given commodity
that have not yet been offset by an opposite futures or option transaction
64


nor fulfilled by delivery of the commodity or option exercise. Each open
transaction has a buyer and a seller, but for calculation of open interest,
only one side of the contract is counted.


Open Outcry
A method of public auction for making bids and offers in the trading pits
of futures exchanges.



Opening Range
The range of prices at which buy and sell transactions took place during
the opening of the market.

Over-the-Counter Market (OTC)
A market where products such as stocks, foreign currencies and other
cash items are bought and sold by telephone, Internet and other electronic
means of communication rather than on a designated futures exchange.


Position Limit
The maximum number of speculative futures contracts one can hold as
determined by the CFTC and/or the exchange where the contract is traded.
See also Price Limit, Variation Limit.


Position Trader
A trader who either buys or sells contracts and holds them for an extended
period of time, as distinguished from a day trader.


Price Discovery
The determination of the price of a commodity by the market process.


Price Limit
The maximum advance or decline, from the previous day's settlement
price, permitted for a futures contract in one trading session.Also referred
to as Maximum Price Fluctuation.
See also Position Limit, Variation Limit.


65


Quotation
The actual price or the bid or ask price of either cash commodities or
futures or options contracts at a particular time.


Range
The difference between the high and low price of a commodity during
a given trading session,week, month, year, etc.


Regulations (CFTC)
The regulations adopted and enforced by the CFTC in order to administer
the Commodity Exchange Act.


Reparations
The term is used in conjunction with the CFTCs customer claims procedure
to recover civil damages.


Reportable Positions
The number of open contracts specified by the CFTC when a firm or
individual must begin reporting total positions by delivery month to the
authorized exchange and/or the CFTC.


Settlement Price
The last price paid for a futures contract on any trading day. Settlement
prices are used to determine open trade equity, margin calls and invoice
prices for deliveries.Also referred to as Closing Price.


Short
One who has sold futures contracts or plans to purchase a cash commodity.


Speculator
A market participant who tries to profit from buying and selling futures
and options contracts by anticipating future price movements.
Speculators assume market price risk and add liquidity and capital to the
futures markets.


66


Spot
Usually refers to a cash market for a physical commodity where the parties
generally expect immediate delivery of the actual commodity.


Spot Month
See Nearby Delivery Month.


Spreading
The buying and selling of two different delivery months or related
commodities in the expectation that a profit will be made when the
position is offset.


Stop Order
An order that becomes a market order when the futures contract reaches
a particular price level. A sell stop is placed below the market, a buy stop
is placed above the market.


Technical Analysis
An approach to analysis of futures markets which examines patterns of
price change, rates of change, and changes in volume of trading, open
interest and other statistical indicators.
See also Charting.


Tick
The smallest increment of price movement for a futures contract. Also
referred to as Minimum Price Fluctuation.


Underlying Futures Contract
The specific futures contract that the option conveys the right to buy
(in case of a call) or sell (in the case of a put).


Variable Limit
A price system that allows for larger than normal allowable price movements
under certain conditions. In periods of extreme volatility, some exchanges
permit trading at price levels that exceed regular daily price limits.
See also Position Limit, Price Limit.
67




Variation Margin
Additional margin required to be deposited by a clearing member firm to
the clearinghouse during periods of great market volatility or in the case
of high-risk accounts.


Volatility
A measurement of the change in price over a given time period.


Volume
The number of purchases and sales of futures contracts made during a
specified period of time, often the total transactions for one trading day.