Commodities market, commodities trading, commodity futures. . .

These terms are not very commonly

understood by many. However, commodity markets offer as much an opportunity to investors as does the
stock market
commodity market
Commodity market is a place where trading in commodities takes place. It is similar to an equity market,
but instead of buying or selling shares one buys or sells commodities.
Different types of commodities that are traded in these markets.
World-over one will find that a market exists for almost all the commodities known to us. These
commodities can be broadly classified into the following:
Precious Metals: Gold, Silver, Platinum, etc.Other Metals: Nickel, Aluminum, Copper, etc.Agro-Based
Commodities: Wheat, Corn, Cotton, Oils, Oilseeds, etc.Soft Commodities: Coffee, Cocoa, Sugar, etc.LiveStock: Live Cattle, Pork Bellies, etc.Energy: Crude Oil, Natural Gas, Gasoline, etc.
The different segments in the commodities market?
The commodities market exists in two distinct forms, namely, the Over the Counter (OTC) market and the
exchange-based market.
Also, as in equities, there exists the spot and the derivatives segment. The spot markets are essentially
over-the-counter markets and the participation is restricted to people who are involved with that
commodity, say, the farmer, processor, wholesaler, etc. A majority of the derivative trading takes place
through exchange-based markets with standardised contracts, settlements, etc.
The characteristics of Over The Counter (OTC) commodity markets
The OTC markets are essentially spot markets and are localised for specific commodities. Almost all the
trading that takes place in these markets is delivery based.
The buyers as well as the sellers have their set of brokers who negotiate the prices for them. This can be
illustrated with the help of the following example:
A farmer, who produces castor, wishing to sell his produce would go to the local 'mandi.' There he would
contact his broker who would in turn contact the brokers representing the buyers. The buyers in this case
would be wholesalers or refiners.
In event of a deal taking place, the goods and the money would be exchanged directly between the buyer
and the seller. Thus, it can be seen that this market is restricted to only those people who are directly
involved with the commodity.
In addition to the spot transactions, forward deals also take place in these markets. However, they too
happen on a delivery basis and hence are restricted to the participants in the spot markets.
The characteristics of the Exchange Traded markets?

The exchange-traded markets are essentially only derivative markets and are similar to equity derivatives
in their working. That is, everything is standardised and a person can purchase a contract by paying only
a percentage of the contract value. A person can also go short on these exchanges.
Also, even though there is a provision for delivery most of the contracts are squared-off before expiry and
are settled in cash. As a result, one can see an active participation by people who are not associated with
the commodity.
Do the commodity exchanges facilitate delivery?
The commodity exchanges do facilitate delivery, although it has been observed world-over that only 2 per
cent of all the trades result in actual delivery.
What is the size of the commodities market as compared to the equity market?
In the developed markets the volumes on the exchange-based commodity derivates markets are about
five times more than that of the equity markets.
The current developments in this market
The government has now allowed national commodity exchanges, similar to the Bombay Stock Exchange
and the National Stock Exchange, to come up and let them deal in commodity derivatives in an electronic
trading environment. These exchanges are expected to offer a nation-wide anonymous, order-driven,
screen-based trading system for trading. The Forward Markets Commission (FMC) will regulate these
exchanges.
Consequently four commodity exchanges have been approved to commence business in this regard.
They are:
Multi Commodity Exchange of India Ltd (MCX), located at MumbaiNational Commodity and Derivatives
Exchange Ltd (NCDEX), located at MumbaiNational Board of Trade (NBOT), located at IndoreNational
Multi Commodity Exchange (NMCE), located at Ahmedabad
The oppurtunities commodity derivatives provide for investors
Futures contract in the commodities market, similar to equity derivatives segment, will facilitate the
activities of speculation, hedging and arbitrage to all class of investors.
Speculation:
It facilitates speculation by providing opportunity to people, although not involved with the commodity, to
trade on the views in the movement of commodity prices. The speculative position is taken with a small
margin amount that is paid to the exchange, and the contract can be squared-off anytime during the
trading hours.
Hedging:

For the people associated with the commodities the futures market can provide an effective hedging
mechanism against price movements.
For example an oil-seed farmer may go short in oil-seed futures, thus 'locking' his sale price and in the
process hedging against any adverse price movements.
On the other hand a processor of oil seeds may buy oil-seed futures and thus assure him a supply of oilseeds at a pre-determined price. Similarly the oil-seed processor may go short in oil futures, which may
be bought by a wholesaler of oil.
Also, there is a saying that 'gold shines when everything fails.' Thus, gold can be used as a hedging tool
against other investments.
Arbitrage:
Traders may exploit arbitrage opportunities that arise on account of different prices between the two
exchanges or between different maturities in the same underlying.