Commodities Trading in India and How To Profit From Them-VRK100-Sep. 2006

Rama Krishna Vadlamudi, BOMBAY September 2006
www.scribd.com/vrk100 vrk_100@yahoo.co.in
The investment universe has, for long, consisted of stocks, bonds, fixed deposits,
mutual funds, jewellery, real estate and art. Sophisticated investors deal in
currencies or timber also. The lifting of the 30-year ban on commodity futures
trading in India has opened yet another avenue for investors. Many analysts feel
that we cannot ignore a whole asset class, that is, commodities. An analysis of
worldwide flow of capital, new materials, goods and information helps one in
understanding financial markets in a better manner. Internationally, commodity
market is many times bigger than stock market. Commodities market is the
largest non-financial market in the world. The twentieth century has seen three
periods of commodity bull markets; the periods are 1906-23, 1933-53 and 1968-
82. The present bull market had started in 1999. Commodity pundits are of the
opinion the present bull market will last for another 10 to 15 years.
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COMMODITIES TRADING IN INDIA

AND HOW TO PROFIT FROM THEM
OBJECTIVES
To have a basic understanding of commodities

To learn about the investment opportunities in
commodities in India
To understand the working of commodity
exchanges
To study the importance of risk management in
commodity derivatives
To appreciate the future of commodity derivates
The lesson is organized into the following sections:
CONTENTS PAGE
1 What are Commodities? 3

2 Why the Sudden Interest in Commodities? 5
3 How to Invest in Commodities? 8
4 What are Commodity Derivatives? 10
5 What is the need for Commodity Exchanges? 13
6 Who will Regulate Commodity Exchanges? 18
7 How to Define Commodity Risk Management? 20
8 Future of Commodity Derivatives in India? 24
9 Key Words and Tables 26
10 Reference 30
11 Additional Reading -- LME, trading strategies, Crude Oil factors of Demand & Supply 31
NB: This 31-page synopsis, prepared by Rama Krishna Vadlamudi, has

been adopted as a syllabus for a Post-Graduate Diploma in Business
Management by a leading University in India in 2006
Page 2 of 32
SECTION I
What are commodities?

DEFINITION
A commodity is a largely homogeneous product. It is a product composed of

similar or identical parts. A commodity is a physical substance, such as food, grains and
metals, which is interchangeable with another product of the same type. More generally,
a commodity is a product which trades on a commodity exchange; this would also
include foreign currencies and financial instruments and indices.
Simply put, commodities are:
things of value;
of uniform quality;
produced in large quantities by many different producers; and
the items made from different producers, but considered equivalent.
EXAMPLE
Wheat is an example of a commodity. Wheat from many different farms is pooled.

Generally, it is traded at the same price; wheat from a farm in Punjab is not differentiated
from wheat produced in another farm in Haryana. Of course, there are different varieties
of wheat. Commodities are alternatively called as “raw materials”, “natural resources”,
“hard assets”, “real things”, and “essentials”.
Major Commodities are:

Renewable Non-Renewable
(Agriculture-based)
Coffee/Tea Metals-Ferrous and Non-ferrous
Cotton/Silk/Yarn Bullion-Gold, Silver
Sugar/Wheat Coal and ores
Rubber/Pepper Oil/Petrochemicals
Paper Chemicals
Other Agricultural Cement
commodities
Page 3 of 32
ECONOMIC OUTLOOK
A commodity also has a use value, an exchange value and a price.
It has a use value because it can satisfy some human need or want, physical or
ideal.
It has an exchange value, meaning that a commodity can be traded for other
commodities, and thus gives its owner the benefit of others' labour (the labour
done to produce the purchased commodity).
Price is then the monetary expression of exchange-value
Commodities are highly liquid, in the sense, that they can be easily converted into
cash. Commodities follow the basic economic principle of supply and demand.
Commodity prices are dependent on their demand-supply position, global weather
patterns, government policies related to subsidies and taxation and international trading
norms, as guided by the World Trade Organisation (WTO).
COMMODITY CYCLE
Commodities have their cycles, in the sense, they have their periods of high
prices and low prices, depending on the demand for and supply of the commodities. Let
us briefly discuss how the cycle moves. Suppose the supply of a commodity is more
than demand. This results in low prices and losses for miners/producers. Due to low
prices, production will be cut. This period of low prices will continue for some years. After
a considerable period, the demand increases at a steady pace and demand will be more
than supply. Automatically, prices of raw material will go up. Attracted by the increase in
prices, manufacturers/miners will go for capacity expansion. This period of high prices
will last for a few years or more. Due to capacity expansion and higher output, a time will
come when supply is more than demand and the cycle will be repeated. Jim Rogers, an
expert on commodities, argues that these cycles last for 17 to 20 years. The twentieth
century saw three long period of high commodity prices (1906-23; 1933-53; 1968-82),
each lasting an average of a little more than 17 years.
As a matter of fact, commodities touch our lives every day. They are the lifeblood of
all creatures on earth. It would not be an exaggeration if we say that life forms cannot
exist without the availability of commodities.
N.B: Table I.A is given at the end of Section X detailing the major commodities that are
traded on Indian commodity exchanges.
------- END OF SECTION I -------
Page 4 of 32
SECTION II
Why the sudden interest in commodities?
COMMODITY AS AN ASSET CLASS
In the universe of an investor, there are several asset classes; they can broadly be
classified as:
Equity shares
Bonds/Fixed Income
Currencies
Real Estate
Arts and Antiques
Commodities
Investors choose one or more of the above assets to invest their savings. Depending
on their ability to absorb possible losses and their understanding of the asset classes,
investors opt for particular asset classes. Investment in India has traditionally meant
property, gold and bank deposits. The more risk-taking investors choose equity shares,
but investment in equity shares represents only less than three per cent of the overall
national savings.
DIVERSIFICATION
But commodity trading had, till a few years back, never formed part of conventional
investment instruments. As a matter of fact, future trading in commodities was banned in
India in the mid-1960s due to what the then Union Government considered as excessive
speculation. In April 2003, the Central Government removed the ban and allowed
futures trading in 54 commodities in bullion and agricultural products. It gave the go-
ahead to four exchanges to offer online trading in commodity derivative products.
But it is only after almost two years that commodity futures trading is finding
favour with Indian investors and is being seen as a separate asset class with good
growth opportunities. For diversification of portfolio beyond fixed deposits, mutual funds,
shares and property; commodity futures offer a good option for long-term investors,
speculators, hedgers and arbitrageurs. And now with global volumes in commodity
trading touching four to five times that of equities, trading in commodities cannot be
ignored by Indian investors.
Page 5 of 32
WORLD GROWTH
The 1980s and 1990s saw a bear market in commodities the world over. This
long bear market (a bear market signifies steep and continuous fall in prices) in
commodities has created a sharp reduction in capacity-and thus large supply-demand
imbalances. Quite simply, demand is increasing and supply is extremely low and
declining, and it will take years for this imbalance to improve.
As economies in Asia continue to grow, there will be a strong worldwide demand
for all commodities. China, in particular, has quickly moved from a major exporter to an
importer of commodities, consuming iron ore, copper, oil, soybeans, and other raw
materials hungrily. Historically, the prices of commodities show a negative relationship
with the price movements of stocks, bonds, and other financial instruments. When
stocks are down, commodities are up, and vice versa. A 2004 study from the Yale
School of Management’s Center for International Finance confirms that:
Since 1959, commodity futures have produced better annual returns than stocks
and bonds
Bull markets (which signify continuous rise in prices) in commodities are
accompanied by bear markets in stocks, and vice versa.
Higher commodity prices were the leading wave of high prices in general (that is,
inflation)
While investing in commodities companies is one rational way to invest in a
commodity bull market, it is not necessarily the best way. The returns of
commodities futures examined in the study were triple the returns for stocks in
companies that produced those same commodities.
BETTER RETURNS
Therefore commodities are not just a good way to diversify a portfolio of stocks
and bonds; they often offer better returns. The strong upward movement in commodities,
such as gold, silver, copper and oilseeds, present the right opportunity to trade in
commodities. Crude oil is at its highest since the beginning of the Iraq war in March
2003. Silver, copper and soybeans prices have touched new highs since 1988.
Commodities offer diversification. They are a natural hedge against inflation.
World-renowned commodities guru, Jim Rogers, in his famous book “Hot

Commodities” writes: “Commodities are so pervasive that, in my view, you really cannot
be a successful investor in stocks, bonds, or currencies without understanding them.
Commodities belong in every truly diversified portfolio. Investing in commodities can be
a protection against a bear market in stocks, rampant inflation, even in major downturn
in the economy. Investing in commodities will present an enormous opportunity for the
next decade or so.”
Commodity experts argue that the world is still witnessing a rising commodity
market. They are of the opinion that the ongoing bull market in commodities is due to the
most basic principle of economics: supply and demand. They claim that the current
supply and demand balance for commodities is out of tune, indicating that a long bull
market is on the way.
Page 6 of 32
THE CHINA FACTOR
China in 2005 consumed nine per cent of world’s crude; 20 per cent of global
aluminium; at least 30 per cent of steel and 45 per cent of world’s cement. China is
giving a lot of push for infrastructure and urbanization, a section of traders believes
China will ensure that the rally in commodities does not come to an end. But there are
concerns that China may reduce consumption of commodities to slow down the
overheated economy.
At present, the Chinese economy is growing at a rate of more than 8-10 per cent per
annum. India is soon expected to be an important contributor to global commodity trade,
already having a significant say in gold, sugar and oilseeds. China is using huge
investments for Beijing Olympics to be held in 2008. Newspaper reports suggest that
China is investing more than USD 160 billion in construction and others. China and India
constitute 40% of world population. China is spending billions of dollars for 2008 Beijing
Olympics. As a result, the country is consuming millions of tons of raw materials.
HEDGING BENEFITS
Many corporates that have exposures on metals like copper, aluminum, cotton,
oilseeds, etc., will be benefit immensely by hedging their positions on the exchanges.
Present regulations do not permit Indian banks to deal in commodities, though they are
allowed to trade in bullion. Many banks in India are now dealing in gold. They are
holding gold and selling gold coins to general public through their branches. If banks are
allowed to deal in commodity futures, they will be in a better position to hedge their risks
to gold holdings. Recently, Ashok Leyland Limited has tied up with a national commodity
exchange to gain knowledge of hedging in steel. The company’s main raw material is
steel.
INDIA GROWTH STORY
Overall, India’s demand for oil and many of the key industrial metals has been on
a general upward trend over the past decade. And it is expected that this upward growth
path will continue. This growth is led by huge investments the governments are making
in roads, irrigation projects, power plants airports and others. And we have large and
growing population, which will support the demand for more agriculture commodities for
domestic consumption. More than seventy per cent of India’s population is below the
age of 35 years. It is this section of population that is driving domestic consumption.
Despite concerns about the rising interest rates and inflationary pressures, global
economic growth is likely to go up based on the huge growth in Asian countries. As a
result, demand for commodities is likely to go up and so are their prices.
------- END OF SECTION II-------
Page 7 of 32
SECTION III
How to invest in commodities?

TRADERS vs. INVESTORS
In general, traders look for short-term profits and investors put in their money for
long-term and wait for good returns. Traders concentrate on the price movements and
try to profit from a little fluctuation in prices. On the other hand, investors follow the
fundamentals of supply of and demand for a particular commodity and invest for long-
term. Before considering investment in commodities, one has to decide whether one
wants to be a trader or an investor.
Investors need to do their own research before they start investing in
commodities. They need to have a basic understanding of supply of and demand for a
particular commodity. When supply increases, the price will come down. And if supply
comes down, prices will increase. Likewise, if more people want to buy a specific
commodity (increase in demand), naturally, the price will go up. The price will move
downward if the demand for the product declines.
CRUDE OIL
Let us consider a commodity, namely, crude oil. It is well known that for the past
35 years, no major discovery of oil has been the world over. As a result of under
investment in new exploration, supply of oil the world over is limited as of now. Whereas,
global economic growth has been very strong, pushing up the demand for oil. When
supply is limited and demand has been rising, the natural outcome is increase in oil
prices. This mismatch between supply and demand (excess of demand over supply) has
been pushing up the price of crude oil. As a result, the price of crude oil is at present
quoted around USD 76 per barrel. It may be noted that it was only around USD 20 a few
years back.
A FEW QUESTIONS
Information about past trends, current inventories and future supplies of a
commodity may be gathered before one steps into commodities investment.
The following questions need to be asked before one proceeds further:

How many tons of reserves are there
Is there any chance of production areas getting affected by any troubles
What is the present total output of the commodity
Are there any new potential supplies
How long before these new sources will be available
When will the new supplies get to the market
What is this commodity most used for
Which of the current uses will continue
What alternatives are available to replace it if the prices go too high
How advances in the development of new materials will affect the commodity
The above questions will give a basic idea about the commodity’s fundamentals.
Page 8 of 32
SUBSTITUTION:
Depending on price, aluminium and tin-plated steeel substitute for each other,
especially in beverage cans. Another area where aluminium could be used more in the
future is as a replacement for zinc in die-casting. One ongoing trend has been for
producers to use more aluminium in cans at the expense of steel. Currently, 26 per cent
of world’s primary aluminium is used in transportation, according to the International
Aluminium Institute (IAI).
ETHANOL Versus OIL
As another example of alternatives, let us consider how ethanol’s demand is

growing as ethanol is used as an alternative for oil. Sugar prices had gone up after
Hurricane Katrina destroyed oil and natural gas production facilities in the Gulf of Mexico
in August 2005. Betting record oil prices would encourage demand for alternative fuels
such as sugar-based ethanol, investors started buying sugar futures driving up sugar
prices heavily. Strangely, sugar is becoming an energy product.
BRAZIL DEPENDS LESS ON OIL
Brazil’s ethanol programme is very successful. Since 1975, Brazil is the world’s
number one sugar producer. The country has made it compulsory to blend 25 per cent
ethanol in automobile fuel. Last year, Brazil devoted more than half of its 38 crore-ton
sugar cane harvest to ethanol production, according to a Sao Paulo-based research
firm. Now, automakers with operations in Brazil, such as Volkswagen, are making cars
that run purely on ethanol. Ethanol costs about 20 per cent less than petrol (gasoline).
Very soon, Brazil is likely to end its dependence on energy imports. Other sugar-
producing countries, including India, China and Thailand, are cultivating ethanol
industries of their own. However, commodity experts are cautioning that sugar prices
may fall heavily if oil prices crash.
GOLD:
Several investors take exposure to Gold though commodity mutual funds. The
gold held globally by these mutual funds amounts to 500 tons worth about USD nine
billion, making them the world’s 11th largest holder of gold.
Banks like, Corporation Bank, ICICI Bank, HDFC Bank and Indusind Bank are
nowadays selling gold coins of specified weight. MMTC is also selling gold coins, in
addition to silver coins. Buyers are attracted to buying gold coins from banks, because of
their reliability and purity of gold. Investors can also buy gold, in denominations of 100
gm and one kg, from MCX Limited through a product called “i-Gold”, which gives an
option of keeping the gold in demat form also. Investors also have the option of trading
futures through the commodity exchanges.
------- END OF SECTION III-------
Page 9 of 32
SECTION IV
What are Commodity Derivatives?

DEFINITION
Commodity derivatives are financial instruments whose value is based on, or

derived from, the prices of underlying commodities. They have been part of the market
place for a long time. A commodity futures contract is a standardized contract traded on
a commodity futures/derivatives exchange to buy and sell fixed amounts of certain
commodity at a future time for a price decided at the time of entering into the contract.
Commodity futures contracts are generally traded through a centralized auction or
computerized matching process, with all bids and offers of each contract made public.
Through this process, a prevailing market price is reached for each contract, based
primarily on the laws of supply and demand.
By definition, Commodity Futures contracts perform two important functions of

price discovery and price risk management with reference to the given commodity. It is
useful to all segments of economy. It is useful to producer because he can get an idea of
the price likely to prevail at a future point of time and therefore can decide between
various competing commodities, the best that suits him. It enables the consumer get an
idea of the price at which the commodity would be available at a future point of time. He
can do proper costing and also cover his purchases by making forward contracts. The
futures trading is very useful to the exporters as it provides an advance indication of the
price likely to prevail and thereby help the exporter in quoting a realistic price and
thereby secure export contract in a competitive market. Having entered into an export
contract, it enables him to hedge his risk by operating in futures market. Other benefits
of futures trading are:
(i) Price stabilization-in times of violent price fluctuations. Wide price movements can be
avoided because number of participants in the markets is large.
(ii) Leads to integrated price structure throughout the country.
(iii) Facilitates lengthy and complex, production and manufacturing activities.
(iv) Helps balance in supply and demand position throughout the year.
(v) Encourages competition and acts as a price barometer to farmers and other trade
functionaries.
Characteristics of futures trading
A "Futures Contract" is a highly standardized contract with certain distinct features.

Some of the important features are as under:
A future trading is necessarily organized under the auspices of a market

association/exchange so that such trading is confined to or conducted through
members of the association in accordance with the rules.
It is invariably entered into for a standard variety
The units of price quotation and trading are fixed in these contracts, parties to the
contracts not being capable of altering these units.
Page 10 of 32
The delivery periods are specified.

In futures market actual delivery of goods takes place only in a very few cases.
Transactions are mostly squared up before the due date of the contract and
contracts are settled by payment of differences without any physical delivery of
goods taking place.
Standardized Contracts:
The process of developing a standardized futures contract is very important to the

success of the product on the futures exchange platform. This is because all future
exchanges trade only in standardized contracts in an anonymous environment to
improve ideal price discovery.
A standardized contract indicates the specifications of the contract in which the buyers
and sellers will enter into. The contract should specify all the parameters regarding the
quantity, quality, and terms of trade. Commodity exchanges require the prior approval of
the FMC before a standardized contract of any commodity is launched for trading on the
exchange.
Physical delivery:
Physical delivery of the underlying commodity will be effected only when both the buyer
and seller give their consent to take and give delivery. For settlement of physical delivery
of commodities, exchanges coordinate with sellers, buyers, warehouses (approved by
exchanges) and other agencies to ensure the quality and quantity specified in the
contract are delivered on a timely basis. However, for all practical purposes, more than
95 per cent of the trades done in leading commodity futures exchanges are settled on
the basis of non-physical delivery.
COST OF CARRY
A reasonable cost of carry must determine the relationship between spot and futures
prices, thereby ensuring greater openness. Cost of carry in commodity markets will
mean interest on investment, loss on account of loss of weight or deterioration in quality,
etc. The markets provide a meeting place for people with different needs and the
openness will make for rationalization of prices.
An effective and efficient market for trading in commodity futures requires the following:
a. Volatility in the prices of the underlying commodities

b. Large numbers of buyers and sellers with diverse profiles
c. Convertibility of the underlying physical commodities
d. Efficient and liquid exchange platform
MARKET DYNAMICS: It is important for investors to have some basic understanding of

market dynamics. Participants need to know about the exchange rules, FMC regulations,
volumes, historical prices, international prices, demand and supply factors that affect the
prices of commodities.
Page 11 of 32
REVIEW
Commodity futures are traded on commodity exchanges

Investors are required to open a trading account with a broker
Investors trade in commodities approved by the FMC
Commodity future contracts are tradable standardized contracts
Each contract has a lot size and a delivery size
A settlement takes place either through squaring off one’s position or by cash
settlement or by physical delivery
Investors are required to maintain margins as per the rules
------- END OF SECTION IV-------
Page 12 of 32
SECTION V
What is the need for Commodity Exchanges?

A commodities exchange is an exchange where various commodities and derivative products
are traded. Most commodity markets across the world trade in agricultural products and other raw
materials (like wheat, barley, sugar, maize, cotton, cocoa, coffee, milk products, pork bellies, oil,
metals, etc.) and contracts based on them.
Worldwide, there are over 29 major commodity futures exchanges that trade
commodities ranging from energy, agricultural products, metals, livestock to cement in
over 15 countries including the United States, China, Japan, the United Kingdom, South
Africa, Malaysia and Brazil. The commodity exchanges trade in physical commodity
products, as well as in financial instruments. Most trading is done in futures contracts.
Spot contracts, a less widely used form of trading, call for immediate delivery of a
specified commodity and are often used to obtain the goods necessary to fulfill a futures
contract.
Methods of Trading:
Trading in futures products at futures exchanges has traditionally occurred primarily on
physical trading floors in arenas called “pits” through an auction process known as “open
outcry.” Open outcry trading is face-to-face trading, with each trader serving as his or her
own auctioneer. The traders stand in pits and make bids and offers to one another, via
shouting or flashed hand signals, to buy and sell futures contracts. Only members
owning or leasing a seat on the exchange may trade in the pit, and orders from
individual and institutional traders are sent to these members on the trading floor, usually
through a broker.
In order to expand access to their markets, most futures exchanges are now
providing electronic trading platforms, in addition to the open outcry auction. These
platforms allow customers to obtain real-time prices and volumes and to enter orders
directly into the platform’s centralized order book. This is made possible because of
advances made in development of sophisticated electronic order routing and matching
systems.
Liquidity of Markets:
Liquidity is important because it means a contract is easy to buy and sell quickly with
minimal price disturbance. Liquidity is dependent on the following:
1. The number of participants in the market
2. The number of trades, and
3. The spread between the bid price and offer price of the quotations
If liquidity is more in a particular commodity, it will attract more customers to trading
and which in turn ensures the success of a market. A neutral, transparent and relatively
anonymous trading environment is necessary for efficient functioning of a liquid market.
In addition, a successful exchange needs to be able to provide low-cost transaction
processing, advanced technology and dependable clearing and settlement systems.
Page 13 of 32
Market Participants:
An efficient market for commodity futures requires a large number of market participants
with diverse risk profiles. Market participants can be broadly divided into three
categories:
1. Hedgers: Hedgers are generally commercial producers and consumers of traded

commodities. As commodity prices are volatile, participation in futures markets
allows hedgers to protect themselves against the risk of loss from fluctuating
prices.
2. Speculators: Speculators are traders who speculate on the direction of futures
prices with the goal of making a profit. Since speculators participate in
commodity futures for investment purposes, they usually do not accept physical
delivery of commodities and instead they settle the transactions through cash
upon the expiry of futures contracts.
3. Arbitrageurs: They are traders who buy and sell futures contracts to make money
on price differentials across markets or exchanges.
Clearing and Settlement:
Transactions settled/executed on futures exchanges are settled through a body called a

“clearing house” which acts a central counterparty to the clearing firm on each side of
the transaction. When the futures transaction has been executed in the pit or on an
electronic platform and matched, the clearing house acts as a counterparty/guarantor to
the clearing firm that represents the buyer and the clearing firm that represents the seller
in the transaction.
Industry Growth:
In 1984, total trading volumes for all contracts traded globally was 18.80 crore contracts,
while, in 2004, the total volume reached 890 crore contracts per year. This indicates an
average annual growth rate of 21% for the past 20 years. The leadership in total trading
volumes goes to the United States, which accounted for 160 crore contracts in 2004.
N.B: For details of global futures volume, please refer Tables V.A, V.B and V.C given at
the end in Section X.
Trends in the Industry:
As can be seen from above, volumes in the commodity futures market are growing
substantially every year. The increase in volumes is due to:
• Increasing awareness of the importance of risk management

• Greater price volatility in bond markets
• Greater advances in technology/computerisation for futures exchanges
• Relaxation of regulatory restrictions
• Availability easy money for trading globally
Page 14 of 32
Over the past four to five years, many investors are participating in commodity
markets across the world because of globalization. These rich investors are looking for
new investment opportunities in developing countries, like, China, India, Korea, Brazil,
Turkey and others. They are driving capital into and out of the countries in a much easier
and quicker way. Very often, this easy money is causing imbalances in supply of and
demand for industrial and agricultural commodities.
The Indian Commodities Market:
AGRICLTURAL COMMODITY MARKETS
India, being a predominantly agrarian economy, has a long history of commodity
markets. India’s agricultural commodity markets initially formed when producers and
buyers met in designated locations to engage in trade. Today, the wholesale spot
markets for agricultural commodities remain relatively unchanged; agricultural
commodities are predominantly traded in government-regulated agricultural markets, or
mandis, located in or near important towns or centres of production. All the sellers,
buyers and brokers/intermediaries meet at the mandis to buy and sell goods.
NON-AGRICULTURAL COMMODITY MARKETS
Crude oil markets in India are connected with the global oil market. Crude oil is used for
the production of a wide range of products from petrol, diesel and kerosene to ATF
(aviation turbine fuel) and asphalt, and from LPG to Naphtha and other petrochemicals.
India, which imports about 75% of its crude oil requirements, is highly exposed to global
crude oil price fluctuations.
Bullion, especially gold, occupies an important role in India. In addition to finance, many
social and cultural elements of Indian culture are associated with this rare yellow metal.
However, despite being the largest consumer of gold, India is not in a position to decide
the price of bullion on the world market owing to heavy dependence on imports and
widely scattered markets across the country.
Among the non-ferrous metals, copper is one of the largely consumed commodities
apart from aluminium in India. At present, the demand for copper is met through imports
and from mines in India. Other metals like nickel and tin are largely imported into India,
due to low domestic mine output.
ROLE OF COMMODITIES IN INDIA’S ECONOMY
Commodities play an important role in India’s economy. India has over 7,500 regulated
agricultural markets, or mandis, and the majority of nation’s agricultural production in
consumed domestically, according to the Agricultural International Marketing Network
(“AGMARKNET”). India in the world’s leading producer of several agricultural
commodities. In 2004-05, agriculture and related industries accounted for approximately
21.13% of India’s GDP of USD 62,969 crore, as stated in RBI Publication 2005. At
present, there are 24 commodity exchanges recognized by the Forward Markets
Commission (FMC) in India, covering nearly 100 commodities. In fiscal years 2003-04,
2004-05 and the nine-month period ending December 31st, 2005, the total value of
commodities traded was Rs 1,29,364 crore, Rs 5,71,760 crore and Rs 13,87,785 crore
respectively, on commodities futures exchanges in India, according to data from FMC.
Page 15 of 32
COMMODITY DERIVATES EXCHANGES IN INDIA
The history of Commodity futures markets in India dates back to 1875 when trading in
cotton contracts began under the support of the Bombay Cotton Trade Association,
considered to be India’s first organized futures market. Derivatives trading then
expanded to oilseeds, jute and food grains and by World War II, futures trading in
organized form had also commenced in other commodities such as castor seed, wheat,
rice, sugar and precious metals, like gold and silver.
In 1953, the Forward Markets Commission was established to regulate futures trading.
The growth and development of futures markets, however, was halted in the 1960s,
when futures trading was banned totally by the Government of India. From the late
1970s, selected commodities were permitted for futures trading. Futures trading
witnessed a renewed interest in the 1990s in the wake of India’s economic liberalization.
Indian Government had opened up several sectors to international competition. The
government had signed the GATT agreement, which paved the way for the birth of
WTO.
On April 1, 2003, the Government of India issued a Notification which removed the
previous regulatory restrictions to trading in commodity futures. Until this point, there
were 21 regional exchanges mainly concentrating on singly or few commodities.
Subsequently, the Indian Government authorized the establishment of national multi-
commodity exchanges to facilitate electronic trading of commodity derivatives.
At present, there are three such electronic multi-commodity national exchanges which
are recognized by the Indian Government. They are”
1. National Commodity and Derivatives Exchange Ltd (NCDEX), located in Mumbai

2. Multi Commodity Exchange of India Limited (MCX), located in Mumbai
3. National Multi Commodity Exchange (NMCE), located in Ahmedabad.
NCDEX: From 01.04.2005 to 31.12.2005, NCDEX had 53.8 per cent of the market share
of the Indian commodities exchange industry. NCDEX commenced operations in
December 2003 and as on December 31st, 2005, it facilitated trading in over 50
commodities. Its key promoters include ICICI Bank Limited, the Life Insurance
Corporation of India and the NABARD.
MCX: From 01.04.2005 to 31.12.2005, MCX had 40.2 per cent of the market share of
the Indian commodities exchange industry. MCX commenced operations in November
2003 and as on December 31st, 2005, it facilitated trading in 58 commodities. It was
promoted by Financial Technologies India Limited. Its other investors include State Bank
of India, NABARD, NSE, Bank of Baroda and Canara Bank.
NMCE: From 01.04.2005 to 31.12.2005, NMCE had 0.6 per cent of the market share of
the Indian commodities exchange industry. NMCE commenced operations in November
2002 and as on December 31st, 2005, it facilitated trading in over 60 commodities. Its
key promoters include the Central Warehousing Corporation (CWC), the NAFED and
Punjab National Bank.
Page 16 of 32
The following table shows the volumes of the commodity exchanges in India:
Exchange No of Turnover (Rs In crore) Market

Commodities 2003-04 2004-05 1.4.05 to Share (%)*
(as on 31.12.05
31.12.05)
NCDEX 50+ 1,490 2,66,339 7,46,775 53.82
MCX 58 2,459 1,66,526 5,58,369 40.23
NMCE 60+ 23,841 13,988 8,655 0.62
Others 1,01,577 1,26,286 73.986 5.33
TOTAL 168+ 1,29,367 5,73,139 13,87,785 100.00
* from 1.4.05 to 31.12.05 Source: FMC
There are at present 24 commodity exchanges and associations recognized by the

Government of India, including the three national exchanges as stated above.
INDUSTRY GROWTH
As can be seen from the above table, two exchanges, namely, NCDEX and MCX are
dominating the Indian market in commodity futures trading, with a combined market
share of around 94 per cent. Commodities trading has experienced very high growth
since in the Indian Government allowed futures trading in commodities as per a
notification dated 01.04.2003. The total value of commodities traded in India in 2004-05
was Rs 5,71,760 crore, representing a growth of 859 per cent over the period in 2002-
2003 (Rs 66,531 crore). Commodity trading volumes had risen at a compounded annual
growth rate of over 200 per cent between 2002-03 and 2004-05. As per the Ministry of
Consumer Affairs, GOI, the total volume of commodity futures trading for the year 2005-
06 was Ra 21,34,471 crore, showing an increase of more than 270% over 2004-05.
In India, commodities like, gold, silver, chana, crude oil, guarseed and urad are
dominating the futures trading. The market share of major commodities (in value terms)
for the period from 1.4.05 to 31.12.05 is shown below:
Commodity Market share (%)

Guarseed 21.00
Silver 17.00
Gold 13.00
Chana 10.00
Crude Oil 10.00
Urad 7.00
Soy Oil 6.00
Others 16.00
TOTAL 100.00
Source: FMC
------- END OF SECTION V-------
Page 17 of 32
SECTION VI
Who will regulate the Commodity Exchanges?

REGULATORY FRAMEWORK IN INDIA
The Forward Contracts (Regulation) Act, FCRA, 1952, regulates the commodities
futures markets in India. Under this legislation, commodities futures trading is regulated
under a three-tier regulatory system which consists of the following governing bodies:
a) Department of Consumer Affairs (DCA) in the Ministry of Consumer Affairs, Food

and Public Distribution, the Government of India;
b) Forward Markets Commission, FMC; and
c) An exchange or association recognized by the Central Government on the
recommendation of FMC.
The DCA is the apex regulatory body governing all commodity exchanges in India. It
exercises overall supervision over the commodity exchanges and it has the authority to
grant or withdraw recognition of any commodity exchange.
The FCRA provides for the setting up of the FMC to implement the rules framed as per
FCRA. Most of the regulatory powers are delegated to the FMC. However, the powers
relating to the grant and withdrawal of recognition to the associations are with the
Central Government, which acts on the advice of the FMC.
FORWARD MARKETS COMMISSION (FMC)
Establishment of the FMC:
The FMC has its headquarter at Mumbai and a regional office in Kolkata. At present, the
FMC consists of four members.
Powers and functions of the FMC:
They can be summarized as below:
Provision of advice to the Central Government in respect of the recognition or the

withdrawal of recognition of any exchange
Providing advice to the Central Government about the administration of the
FCRA
To take action, if necessary, against any irregularities as per the provisions of the
FCRA
Collection and publication of information about commodity trading conditions
Submission of periodical reports to the Central Government on the working of
forward markets
Inspection of the accounts and other documents of any of the recognized
exchanges
Page 18 of 32
Organisational structure of the FMC:
The FMC is divided into different divisions as given below:
1. Commodity division
2. Enforcement division
3. Administrative division
Commodity exchanges are governed by various acts in addition to the FCRA and the
rules of the FMC. Various legislations like, Prevention of Food Adulteration Act,
Essential Commodities Act, Agricultural Produce Marketing Regulations Act, Standards
of Weights and Measures Act and Central Warehousing Corporations Act are also
applicable to commodity exchanges.
------- END OF SECTION VI-------
Page 19 of 32
SECTION VII
How to define Commodity Risk Management?

Risk can simply be defined as a chance of losing money. It is the probability of
loss. Risk is the uncertainty of outcome. Risk Management is the task of managing the
risks that a producer or a consumer takes in the course of their business. Price risk is
one of the major risks faced by producers and consumers. Price risk is the risk of
adverse movement in commodity prices. Fluctuations in prices are common. The prices
change quite often. As such, producers and consumers need to have some mechanism
to reduce their risks. Ways of reducing risk include hedging etc. By reducing or removing
the volatility in commodity prices, one can plan and budget with greater confidence. The
primary goal of commodity price risk management is to protect the economic value of a
business from the negative impact of price fluctuations, at the lowest possible costs. It is
an important concept for producers and consumers of commodities to understand and
practice. There are various reasons that give rise to changes in commodity prices.
Some of the key factors influencing commodity prices internationally are:
1. new substitutes
2. change of technology
3. international political developments
4. weather, disease and embargoes
5. dollar/euro movement
6. change in interest rates
The risk management policy or process consists of the following elements:
o Risk appreciation and identification

o Risk measurement
o Risk control
RISK MANAGEMENT TOOLS
1. Commodity Swaps: Commodity swaps can either swap a fixed and a floating
price for the underlying commodity, or can swap two different commodities. They
offer growers and consumers a fixed or floating price per unit of measurement
that covers the majority of their price risk. All swaps are cash settled at maturity
and do not involve physical delivery of the underlying commodity. Swaps can be
used to lock in a fixed price per unit of measurement, or if one is currently
receiving a fixed cash flow, one can swap this for a floating cash flow.
2. Options: Commodity options offer growers and consumers the right, but not the
obligation to deal at a specified rate in the future. Options may be bought or sold,
puts or calls, along with varieties of unusual (exotic) options.
3. Call option: A call option gives the buyer of the option the right but not the
obligation to buy the underlying commodity at a future point in time (the expiry
date) at a pre-defined price (the strike rate). Upon expiry, the holder (purchaser)
of the option will decide to exercise the option if the price is favourable, or allow
Page 20 of 32
the option to lapse worthless where it is optimal for the holder to deal in the
cash/spot market. The seller of a call option receives a premium at the beginning
of the transaction. The seller of an option has an obligation to effect settlement. It
is only the option buyer who has the ‘option’ to settle. The premium is the cost to
the buyer for this ‘option’ and is compensation to the seller who has an obligation
to effect settlement.
4. Put option: A put option gives the buyer of the option the right but not the
obligation to sell the underlying commodity at a future point in time (the expiry
date) at a pre-defined price (the strike rate). Upon expiry, the holder (purchaser)
of the option will decide to exercise the option if the price is favourable, or allow
the option to lapse worthless where it is optimal for the holder to deal in the
cash/spot market. The seller of a put option receives a premium at the beginning
of the transaction. The seller of the option has an obligation to effect settlement.
It is only the option buyer who has the ‘option’ to settle. The premium is the cost
to the buyer for this ‘option’ and is compensation to the seller who has an
obligation to effect settlement.
Trading strategy:
The risk of loss in commodity futures trading is substantial. Traders should, therefore,
carefully consider whether such trading is suitable for them in the light of their financial
conditions and temperament. A trader needs to be aware of the following risks before
trading:
1. A trader may sustain a total loss of initial margin funds that are deposited with the
broker in the commodity futures market
2. Under certain market conditions, one may find it difficult or impossible to liquidate
a position
3. Placing contingent orders, such as “stop-loss” etc., will not necessarily limit one’s
losses, since market conditions may make it impossible to execute such orders
4. Traders use borrowed money (leverage) through a system of margins from
brokers. With less money, traders can take higher positions and gain greater
profits. But at the same time this high leverage can work against them when the
prices move in opposite direction to their trading positions.
The above is only a brief list and there are several other risks. One should therefore
carefully study and become familiar with all aspects of futures trading.
Risk Management is very important to commodities trading.
By utilizing Commodity Risk Management, one can:
Plan and budget with greater accuracy

Control costs
Manage margins more effectively
Create certainty around fluctuating commodity prices
Take advantage of a strategic view of commodity prices
Customize solutions developed for specific areas
Page 21 of 32
MARKET SAFEGUARDS AND RISK MANAGEMENT
Several commodities exchanges use a lot of risk management and surveillance

techniques to minimize instances of possibility of default by members. Usually, the
exchanges adopt the following market safeguards and risk management tools:
a) Minimum Net worth requirement: Before becoming a member of the

exchange, it is compulsory for all members to have and maintain a minimum
net worth. The exchanges review this net worth every year.
b) Margin requirements: The exchanges require all members to a pay a security
deposit at the time of registration which serves as an initial margin. As when
members wish to increase their trading volumes, they are obligated to bring
additional amounts/margins to support their increased trades. The exchanges
monitor the margin requirements as and when the trades occur on a real-time
basis. With the approval of the FMC, commodity exchanges determine the
margins for each commodity based on its historic volatility. If members fail to
comply with margin requirements, exchanges have got the powers to
suspend such members. Margin requirements are necessary to reduce the
risk of daily price fluctuations in commodities.
c) Mark to Market loss monitoring: The trading platforms of some exchanges
track losses incurred by each member on a real-time basis. The exchanges
transmit alerts to each member whenever the loss reaches a particular limit.
The members will further be advised to bring in additional margin or close
their trades.
d) Circuit filter limitations: In order to safeguard against fluctuations in prices due
to market volatility, exchanges enforce the daily circuit filter limit for each
commodity imposed by the FMC. The circuit filter specifies the maximum and
minimum price range within which a contract can be traded.
e) Settlement Guarantee Fund (SGF): Commodity exchanges maintain a
settlement guarantee fund which consists of the security deposits made by
each member. Whenever a member fails to meet his/her settlement
obligations (for trade transactions done by them) to the exchanges, the
exchanges utilize the SGF to cover the member’s obligations to the
exchanges. If the settlement dues are greater than the SGF, the member is
required to immediately deposit additional amounts/margins with the
exchange, failing which the member is declared a defaulter.
CRASH OF COMMODITY PRICES IN MAY 2006
The world over, commodity prices fell by more 20 per cent in May 2006 owing to fears
about rise in interest rates and the fear of a slowdown in world economic growth.
Commodity prices, in general, fall when economic growth slows down. In India too,
commodity prices crashed in line with international prices. In response to the falling
prices in May 2006, exchanges had taken certain measures like, increasing margins in
base metals, etc.
Page 22 of 32
FMC TIGHTENS RISK MANAGEMENT NORMS
After the crash of commodity prices in May/June 2006, the Forwards Market
Commission, the regulator of commodity trading, had taken of measures to tighten risk
management norms. These steps were taken with a view to controlling excessive
speculation in wheat and pulses after analyzing the price trends, volume of trading and
open interest positions. Some of the measures are detailed below:
Increased the cooling off period from 15 minutes to 30 minutes once the price
hits the four per cent circuit filter (four per cent up or down over the previous
day’s close)
Imposed five per cent additional margin on chana in July 2006
Prices of wheat, sugar, rice, pulses can only rise or fall by six per cent in a day
Wheat futures can move by just 50 paise/kg daily, while sugar can fluctuate by
Rs 1.20/kg at current levels
In futures like coffee and cotton, prices cannot fluctuate beyond 7.5 per cent,
while in oilseeds and oils like soya and crude palm they can move by upto 10 per
cent
FMC started directly auditing brokers trading on major commodity exchanges to
ensure complete compliance with trading laws
------- END OF SECTION VII-------
Page 23 of 32
SECTION VIII
Future of Commodity Derivatives in India

It may be mentioned that in May 2006, prices of several commodities, the world
over, had fallen by more than 20 per cent due to fears about interest rate increases and
the consequent economic slowdown. If central banks, like US Federal Reserve,
European Central Bank, Bank of England and Bank of Japan, continue their present
policy of increasing interest rates, it is likely to affect global economic growth.
Consequently, the volumes in commodities futures market may suffer due to the
subsequent fall in demand for commodities.
However, there are several things that are driving the commodities futures
trading in India. Some growth drivers for the industry are discussed below:
GROWTH DRIVERS IN THE INDUSTRY

1. Indian economic growth: India is currently one of the fastest growing
economies in the world and is expected to be the third larges economy by 2050
according to Goldman Sachs’ Research Report: “BRICS”-A Path to 2050”. The
growth in the overall economy in India is expected to drive the demand for
commodities and an increase in physical market volumes may increase hedging
requirements driving derivative volumes. Based on the experience of the
developed markets, it is expected that the volumes of commodities derivatives
being traded may increase in line with the consumption of physical commodities.
2. New Initiatives: In April 2003, the Indian Government removed the restrictions
on commodities futures trading. And the Government had taken a lot of new
initiatives, like, establishment of national, multi-commodity exchanges and others
to modernize the commodity futures market.
3. Options Trading: In developed markets, the volumes in options are
approximately one-fourth or one-third of futures volumes. But, in India, options
trading is not allowed in commodities markets as of now. The Government of
India may soon allow trading in options contracts on commodities, which is likely
to increase volumes and overall growth of the Indian commodity market. In fact, a
bill is being tabled in the Parliament for bring out changes in the Forwards
Contract (Regulation) Act. One of the important amendments proposed in the bill
is the introduction of options trading in commodities.
4. New Commodities: Under current regulations, the FMC must approve of all
commodities that can be traded on exchanges in India. If the FMC allows futures
trading in some more commodities, the volumes in commodities market may
increase.
5. More Participants: New participants are expected to enter the trading markets
as exchanges become more accessible, the availability of market information
increases and awareness regarding benefits of hedging more widespread. It is
expected that the new participants will include, for example:
Farmers, seeking to hedge against their farm output price fluctuations;
Equity investors, seeking to diversify their equity portfolio;
Manufacturers, seeking to hedge against raw material price risks;
Hedge funds seeking to capitalize on price differentials; and
Banks seeking to hedge their risk against collateral.
Page 24 of 32
FUTURE POTENTIAL
The future potential of commodity derivative trading appears to be good. Futures

market size (both commodities and securities) relative to Gross Domestic Product (GDP
at current prices) in the US is about 90%, in China about 85%, and in Brazil about 200%.
Commodities derivatives trade value relative to GDP (at current price) in India was 5.81
% in 2003-04, 20.14% in 2004-05 and it has gone up to 66 % during 2005-06. The
commodity futures trade has taken a big leap in the past two years. Likely participation
of Banks, Mutual Funds and Foreign Institutional Investors along with introduction of
options trading after amendments to FCR Act, 1952, will boost the commodity futures
trading further in the coming years.
------- END OF SECTION VIII-------
Page 25 of 32
SECTION IX
Key Words and Tables

KEY WORDS
1. APMC: Agricultural Produce Market Committee

2. Backwardation: A condition in financial markets in which the forward or futures
price is less than the spot price.
3. CBoT: Chicago Board of Trade
4. Commodity/Commodities: Distinct contracts traded on commodity exchange
5. A contango is just opposite of backwardation. A contango is a condition in
financial market in which the forward or futures price is more than the spot price.
6. GATT: General Agreement on Tariffs and Trade (former name of WTO)
7. GDP: Gross Domestic Product (national income)
8. Hedge Fund: A collective investment fund which takes large, and often
leveraged, risk with the aim of producing a high return on capital
9. LME: London Metal Exchange
10. MCX: Multi Commodity Exchange of India Limited
11. MMTC: Minerals and Metals Trading Corporation Limited
12. MTM: Mark to Market
13. NABARD: National Bank for Agriculture and Rural Development
14. NAFED: National Agricultural Cooperative Marketing Federation of India Limited
15. NBHC: National Bulk Handling Corporation
16. NCDEX: National Commodity and Derivatives Exchange Limited
17. NMCE: National Multi Commodity Exchange
18. NSEAP: National Spot Exchange for Agriculture Produce (National Spot
Exchange Limited)
19. NYBOT: New York Board of Trade
20. SGF: Settlement Guarantee Fund
21. SQUARING OFF: Squaring off is taking a contrary position to the initial stance,
which means in the case of an original buy contract an investor would have to
take a sell contract
22. TOCOM: Tokyo Commodity Exchange
23. WTO: World Trade Organisation
Page 26 of 32
TABLES
TABLE I.A: TRADAEABLE COMMODITIES
The following are some of the commodities that are traded in Indian commodity
derivatives markets:
Agricultural Commodities Metals and bullion
Coffee Aluminium
Cashew/almond/walnut Gold
Castor seed Mild Steel ingots
Chana Nickel
Chilli Silver
Crude palmolein Sponge iron
Guarseed Zinc
Gur Tin
Jeera (cumin seed) Copper
Jute Steel long
Mentha oil Brass
Sugar Lead
Pepper
Soyabean
Soymeal
Tur dal
Turmeric Oil and others
Urad (blackgram)
Wheat Brent crude oil
Maize Furnace oil
Yellow peas Natural Gas
Rice Cement
Kapas Paraffin wax
Potato Soda ash
Rubber Calcium carbonate
Note: The above list is only illustrative, but not exhaustive. In fact, there are more than
160 commodities that are traded in Indian commodity exchanges at present.
TABLE V.A: GLOBAL DERIVATIVES VOLUME
The following chart indicates the volumes of futures and options contracts in terms of
number of contracts traded globally:
Page 27 of 32
GLOBAL FUTURES VOLUME (in crores)
Jan-Dec 2003 Jan-Dec 2004 % Change

US Futures 104.30 132.40 26.95
Non-US Futures 195.24 216.35 9.75
Total Futures volume 299.54 348.75 16.43
GLOBAL OPTIONS VOLUME (in crores)

US Options 112.96 147.12 30.06
Non-US Options 401.26 390.78 -2.76
Total options volume 514.22 537.90 4.45
Grand Total 813.76 886.65 8.96

Source: Futures Industry Association
TABLE V.B: GLOBAL COMMODITY DERIVATIVES VOLUME
The following chart gives volume of commodity derivatives traded globally:
AGRICULTURAL, METALS & ENERGIES (in crores)

Agricultural 28.61 30.19 5.52
Metals 15.49 16.60 7.17
Energies 21.75 24.35 11.95
Total volume 65.85 71.12 8.00
TABLE V.C: COMMODITIES TRADABLE ON WORLD’S EXCHANGES

The top ten commodity futures exchanges in order of volume of futures contracts traded
during Jan-Dec 2005 are given in the table below:
Rank Name of Futures Exchange Country of Volume

Location (in crore) *
1 New York Mercantile Exchange, NYMEX United States 16.66
2 Dalian Commodity Exchange, DCE China 9.92
3 Chicago Board of Trade, CBoT United States 7.68
4 London Metal Exchange, LME United Kingdom 7.04
5 Tokyo Commodity Exchange, TOCOM Japan 6.18
6 Intercontinental Exchange, ICE United Kingdom 4.19
7 Shanghai Futures Exchange, SHFE China 3.38
8 Zhengzhou Commodity Exchange, ZCE China 2.85
9 Tokyo Grain Exchange, TGE Japan 2.56
10 New York Board of Trade, NYBOT United States 2.45
Page 28 of 32
* Volume is expressed in terms of number of contracts traded. This data is for a single-sided
trade. Source: Futures Industry Association
The following table details the top ten commodity exchanges according to sector type:
Energy ICE, NYMEX, SHFE and TOCOM

Metals CBoT, LME, NYMEX, SHFE and TOCOM
Electricity NYMEX
Grains and Oilseeds CBoT, DCE, NYBOT, TGE and ZCE
Softs NYBOT, TGE and ZCE
------- END OF SECTION IX-------
Page 29 of 32
SECTION X
References
Websites offer lot of information. Business newspapers like, Business Line, Business
Standard, Economic Times, Financial express provide lot of information and daily quotes
are given in detail.
• “Hot Commodities” by Jim Rogers

• Kabra Committee Report
• www.mcxindia.com
• www.ncdex.com
• www.kitco.com
• www.cboe.com
• www.icicidirect.com
• www.lme.com
• www.nymex.com
• www.fmc.gov.in
National Stock Exchange in association with NCDEX offers NCFM, an online

examination for commodity derivates. It is very cheap and costs around Rs 1,000. For
full details, one can visit website: www.nseindia.com
------- END OF SECTION X-------
Page 30 of 32
SECTION XI
ADDITIONAL READING
Trading Strategies on LME:
Electronic Trading on London Metal Exchange is showing huge growth. In 2003,

the LME introduced its electronic trading system called Select. This is in addition to the
open outcry trading system.
For base metals, as with any other commodity, traders watch for changes in
supply and demand. The LME monitors stockpiles of metals across a global network of
registered warehouses. At 9 pm, daily reports from the exchange on inventory levels
may indicate whether demand is growing or slowing. The LME inventory of zinc plunged
around 40 per cent in 2005, while the metal’s price increased more than 60 per cent
during the same time period. The price of gold rose around 30 per cent in 2005 and
platinum gained 18 per cent during the same period.
Commodity prices and volumes are benefiting from increased investor interest in
the asset class. Some investors, such as hedge funds, choose to buy and sell individual
metals directly. Others opt for a wider exposure by tracking indexes such as the
Goldman Sachs Commodity Index that follow the performance of a range commodities.
COPPER:
ICRA says copper industry is likely to register 7-8 per cent growth over the next
two years. While demand for copper from telecom sector is coming down, the same is
going up for winding wires and power cables. Telecom industry constitutes 35-40 per
cent of the total copper demand but its appetite for copper is declining as fixed lines are
giving way to wireless communications. Copper lines are being replaced by optical fibre
cables. India’s per capita copper consumption rose by 5.9 per cent in FY 2005 to 0.27
metric tonnes and is estimated to have grown by six per cent during FY 2006 to 0.29 mt.
CRUDE OIL: DEMAND-SUPPLY GAP:
Factors pulling down demand Factors boosting demand
Economic recessions and demand Project delays due to constraints such as

destruction due to high oil prices unfavourable weather conditions,
environmental restrictions, availability of
Peace in Iraq and West Asia rigs and experienced workers
opening the way to more Accelerating declines of existing oilfields
investments (Kuwait, Mexico and Russia)
New discovery of oil fields Political uncertainties leading to production
cuts (Nigeria, Venezuela, Mexico, Bolivia,
Iran, Irag
Page 31 of 32
ONION:
Onion prices had gone down to a lowly 10 paise per kilogram in April 2006 in
Maharashtra as a result of a bumper crop.
Poor basic facilities of warehousing, transportation, distribution, etc.

Tea Prices-Kenyan drought- India low yields –high cost of productions-Kenya, Indonesia
and Sri Lanka are having less cost of production.
Steep increase in oil-stimulated oil market-biodiesel jatropha
Supply chain is the backbone for commodities. Earlier it was not possible to manage
the inventory. Now, with IT backbone, bar coding and RFID revolutionized the
distribution of several thousands of items through 100s of outlets. ----entire food chain.
MSPs distort
Cotton subsidies in the USA. Distress to farmers in India.
Government of India is proposing to bring in amendments to the Forward

Contracts (Regulation) Act, 1952. The amendments pertain to:
o Permit hedging against weather

o Pave the way for introduction of options trading
o Set up Forward Markets Appellate Tribunal
o Enhance the powers of the FMC
o Increase penal provisions
o Lead to corporatisation and demutualisation of the existing commodity
exchanges
o Provide for setting up of a separate Clearing Corporation
RECENT DEVELOPMENTS
In commodities markets, several interesting developments had taken place in the last
few months. Prices of wheat and pulses had gone up steeply recently. This has caused
some concern to the Central Government authorities. There have been some
suggestions that the rise is prices is due to excessive speculation in exchanges. There
are also reports that the Central Government authorities and some state governments
are thinking of banning futures trading in certain essential commodities. They want to
bring back the restrictive provisions of Essential Commodities Act. If such restrictive
measures are brought back, we may see a steep decline in the volumes of commodity
trading in India. The final word on the subject is yet to be known as of now.
------- END OF THE SYNOPSIS-------
Page 32 of 32

Commodities Trading in India and How To Profit From Them-VRK100-Sep. 2006

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Rama Krishna Vadlamudi, BOMBAY September 2006

THE BEST OF MY STUFF ON Reads

1. Income Tax Slabs 2009-10 for Salaried Class 3 105

TOTAL READS running toward 26,700!

COMMODITIES TRADING IN INDIA

To have a basic understanding of commodities

The lesson is organized into the following sections:

1 What are Commodities? 3

NB: This 31-page synopsis, prepared by Rama Krishna Vadlamudi, has

What are commodities?

A commodity is a largely homogeneous product. It is a product composed of

Simply put, commodities are:

produced in large quantities by many different producers; and

the items made from different producers, but considered equivalent.

Wheat is an example of a commodity. Wheat from many different farms is pooled.

Major Commodities are:

A commodity also has a use value, an exchange value and a price.

------- END OF SECTION I -------

Why the sudden interest in commodities?

COMMODITY AS AN ASSET CLASS

World-renowned commodities guru, Jim Rogers, in his famous book “Hot

THE CHINA FACTOR

INDIA GROWTH STORY

------- END OF SECTION II-------

How to invest in commodities?

The following questions need to be asked before one proceeds further:

ETHANOL Versus OIL

As another example of alternatives, let us consider how ethanol’s demand is

BRAZIL DEPENDS LESS ON OIL

------- END OF SECTION III-------

What are Commodity Derivatives?

Commodity derivatives are financial instruments whose value is based on, or

By definition, Commodity Futures contracts perform two important functions of

Characteristics of futures trading

A "Futures Contract" is a highly standardized contract with certain distinct features.

A future trading is necessarily organized under the auspices of a market

The delivery periods are specified.

The process of developing a standardized futures contract is very important to the

a. Volatility in the prices of the underlying commodities

MARKET DYNAMICS: It is important for investors to have some basic understanding of

Commodity futures are traded on commodity exchanges

------- END OF SECTION IV-------

What is the need for Commodity Exchanges?

1. Hedgers: Hedgers are generally commercial producers and consumers of traded

Clearing and Settlement:

Transactions settled/executed on futures exchanges are settled through a body called a

Trends in the Industry:

• Increasing awareness of the importance of risk management

COMMODITY DERIVATES EXCHANGES IN INDIA

1. National Commodity and Derivatives Exchange Ltd (NCDEX), located in Mumbai

Exchange No of Turnover (Rs In crore) Market

There are at present 24 commodity exchanges and associations recognized by the

Commodity Market share (%)

------- END OF SECTION V-------

Who will regulate the Commodity Exchanges?

a) Department of Consumer Affairs (DCA) in the Ministry of Consumer Affairs, Food

FORWARD MARKETS COMMISSION (FMC)

Establishment of the FMC:

Powers and functions of the FMC:

They can be summarized as below:

 Provision of advice to the Central Government in respect of the recognition or the

Organisational structure of the FMC:

The FMC is divided into different divisions as given below:

Provision of advice to the Central Government in respect of the recognition or the