Professional Documents
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Competition from imports: Whether or not Dominance by a few large firms: In the
domestic producers like it, the competition developed economies, a handful of companies
from imported commodities is inevitable. This share a big slice of the business pie. Typically,
four-five companies would account for, say, prices prevailing in various marketing yards
60-75 per cent of aggregate business and or mandis.
several smaller players compete for the rest.
The commodity sector will inevitably move Strong cash market: These developments will
towards such a situation. The process of result in a stronger cash market for
consolidation and dominance by a few large commodities. Initiatives are already underway
firms is already visible, however incipient. to launch electronic spot trading in farm
Take edible oil imports, for instance. Of the commodities that will help growers and
total imports of 45-50 lakh tonnes a year others not only discover prices almost real
worth over Rs 10,000 crore, five companies time, but also help capture value by taking
(of which two are MNCs) account for roughly trading positions. A strong and vibrant cash
70 per cent of business; the rest being shared market is a pre-condition for a successful and
by over 20 importers. transparent futures market.
Waning role of government: As part of the It is this emerging scenario that market
economic liberalisation process, the participants must gear themselves to face.
Government has not only freed the
commodities market of controls and Investment in India has traditionally meant
restrictions but has also, by and large, property, gold and bank deposits. The more
distanced itself from the market. The risk-taking investors choose equity trading.
interventionist role of the government is now But commodity trading forms a part of
minimal. Of course, some restrictions still conventional investment instruments. As a
remain, like those on the sugar industry. matter of fact, future trading in commodities
was banned in India in mid-1960 due to
The government's role is changing from excessive speculation. In February 2003, the
controller to facilitator. It must, however, be government revoked the ban and threw open
mentioned that "liberalisation is not licence''. futures trading in 54 commodities in bullion
and agriculture. It gave the go-ahead to four
Use of information technology: Very clearly, exchanges (The National Commodity and
IT will play a key role in bringing about greater Derivative Exchange (NCDEX), The Multi
transparency in the commodities market. The Commodity Exchange of India (MCX), The
country's strengths in IT will increasingly be National Multi Commodity Exchange of India
leveraged to connect stakeholders and link (NMCE) and The National Board of Trading in
markets. Derivatives (NBOT)) to offer online trading in
commodity derivatives products.
IT will be used for delivering price and market
information to primary producers (farmers). What makes commodity trading attractive?
E-commerce will be the modern way of doing
business. Several corporates have already * A good low-risk portfolio diversifier
begun to employ IT to derive value, ITC's e- * A highly liquid asset class, acting as a
chaupal being a remarkable initiative. The counterweight to stocks, bonds and real
agricultural produce markets (numbering estate.
nearly 7,500 across the country) will soon be * Less volatile, compared with, equities and
networked so that growers can get to know bonds.
* Investors can leverage their investments
and multiply potential earnings. World-over one will find that a market exits
* Better risk-adjusted returns. for almost all the commodities. These
* A good hedge against any downturn in commodities can be broadly classified into the
equities or bonds as there is little correlation following:
with equity and bond markets.
* High co-relation with changes in inflation. Precious Metals: Gold, Silver, Platinum etc.
* No securities transaction tax levied. Other Metals: Nickel, Aluminum, Copper etc.
Agro-Based Commodities: Wheat, Corn,
Investors' choice: Cotton, Oils, Oilseeds etc.
Soft Commodities: Coffee, Cocoa, Sugar etc.
The futures market in commodities offers Live Stock: Live Cattle, Pork Bellies etc.
both cash and delivery-based settlement. Energy: Crude Oil, Natural Gas, Gasoline etc.
Investors can choose between the two. If the
buyer chooses to take delivery of the Returns from Commodity trading:
commodity, a transferable receipt from the
warehouse where goods are stored is issued Absolute returns from stocks and bonds are
in favour of the buyer. On producing this definitely higher than pure commodities. But
receipt, the buyer can claim the commodity commodity trading carries a lower downside
from the warehouse. All open contracts not risk than other asset classes, as pricing in
intended for delivery are cash-settled. While commodity future is less volatile compared to
speculators and arbitrageurs generally prefer equities and bonds. While the average annual
cash settlement, commodity stockists and volatility is 25-30% in benchmark equity
wholesalers go for delivery. The option to indices like the BSE Sensex or NSE's Nifty, it is
square off the deal or to take delivery can be 12-18% in gold, 15-25% in silver, 10-12% in
changed before the last day of contract cotton and 5-10% in government securities.
expiry. In the case of delivery-based trades,
the margin rises to 0-25% of the contract According to study, if an investor had put his
value and the seller is required to pay sales money only in silver and bonds from 1997-
tax on the transaction. 2003, his absolute returns would above been
24%. Commodities are also good bets to
Trading in any contract month will open on hedge against inflation. Gold offers good
the twenty first day of the month, three protection against exchange rate fluctuations,
months prior to the contract month. For and, in particular, against fluctuations in the
example, the December 2004 contracts open value of the US dollar against other leading
on 21 September 2004 and the due date is the currencies. However, unlike stocks,
20-day of the delivery month. All contracts commodity prices are dependent on their
settling in cash will be settled on the following demand-supply position, global weather
day after the contract expiry date. patterns, government policies related to
Commodity trading follows a T+1 settlement subsidies and taxation and international
system, where the settlement date is the next trading norms as guided by the World Trade
working day after expiry. However, in case of Organisation (WTO).
delivery-based traders, settlement takes place
five to seven days after the expiry. Growth of commodity trading:
Tradable Commodities:
A soft interest rat regime and a weak US In June 204, the rubber dealer, registered with
dollar ahs increased the demand for the the Rubber Board, is understood to have
commodities. In a short span of over a year, entered a series of shady circular transactions
online commodity markets are witnessing with a sister firm on NMCE, creating a hefty
good growth in India. The daily volume of difference of Rs.10 per kg between cash and
trading of Rs.2500 crore at NCDEX alone has futures prices. FMC neither noticed the huge
surpassed that of Rs.2000 crore on the gap between cash and future prices nor
Bombay Stock Exchange (BSE). It registered a bothered to investigate thereby signaling a
record daily traded volume of Rs.2617 crore relaxed regulatory regime in the commodities
on 8 December 2004. Commodities like chana, market, giving way to arbitrageurs and
urad, soya bean oil, sugar, pepper, mustard speculators.
seeds and wheat contributed to the balance
trading volume. MCX, on the other hand, has NCDEX is also understood to have pressed for
achieved a peak daily turnover of Rs.1889 an amendment to the Banking Regulation Act
crore. Though the most popular commodities to allow several branches of banks to act as
for trading in India are gold, silver, soya bean intermediaries to enable farmers to insulate
and guar gum, the market is divided equally fro price fluctuations through futures trading.
between bullion and agricultural commodities Another herculean task in commodity trading
in terms of trading volumes. is that of creating awareness and providing a
transparent and user-friendly trading platform
Expecting the turnover on the three online to investors.
commodity exchanges to spurt to Rs.10000
crore per day, banks are keen to tap the Conclusion:
commodity trade-financing front. Commercial
banks are chasing the commodity industry After almost two years that commodity
with attractive lending rates between 8% and trading is finding favour with Indian investors
8.5% as against the normal lending rate and is been seen as a separate asset class with
between 11% and 14%. good growth opportunities. For
diversification of portfolio beyond shares,
Problems galore: fixed deposits and mutual funds, commodity
trading offers a good option for long-term
The biggest danger to the galloping trading investors and arbitrageurs and speculators.
business in commodities is poor supervision. And, now, with daily global volumes in
Even though the commodity futures market is commodity trading touching three times that
regulated by Forward market Commission, a of equities, trading in commodities cannot be
proper regulatory system to supervise trades ignored by Indian investors.
needs to be implemented. This is because
FMC, which functions under the Online commodity exchanges need to revamp
administrative control of the Ministry of Food certain laws governing futures in commodities
and Consumer Affairs, has no hands-on to make the markets more attractive. The
experience in monitoring electronic trading national multi-commodity exchanges have
and detecting market manipulation. For this unitedly proposed to the government that in
reason, it was caught unawares earlier this view of the growth of the commodities
year when a rubber dealer made several market, foreign institutional investors, too,
shady deals. should be given the go-ahead to invest in
commodity futures in India. Their entry will
deepen and broad base the commodity
futures market. As a matter of fact, derivative
instruments, such as futures, can help India
become a global trading hub for select
commodities.