Commodity Market: With Special Reference to Gold & Silver

Page 1
 Acknowledgement

It would be a great pleasure for me to take this opportunity in thanking

everybody who had been of great help in the completion of my summer
project. This project has been a p l a t f o r m i n my l e a r n i n g a n d a c q ui r i n g
knowledge a b o u t t h e f i n a n c i a l s e c t o r s o a s t o h e l p me i n my f u t u r e
endeavors.

First & foremost I would like to thank Mr. Hemant Agrawal (Assistant Vice
President) for giving me an opportunity to work as a management trainee in Bonanza
Portfolio Ltd, Pune.

I wo u l d a l s o l i k e t o t h a n k M r . M o h s i n S h a i k h ( S e n i o r
R e l a t i o n s h i p M a n a g e r & my P r o je c t He a d ) f o r g i vi n g me g u i d a n c e a nd
t r a i n i n g i n u n d e r s t a n d i n g t h e commodity market and helping me to complete my
project successfully.

I also express my sincere thanks to Prof. Sonali Saripalli, who is my

internal guide f o r t h e p r o je c t . He r c o – o p e r a t i o n ma d e me wo r th y o f
b e i n g a b l e t o p u r s u e s u c h a challenging project and complete it successfully.

Gaurav Patel

Commodity Market: With Special Reference to Gold & Silver

Page 2
 Executive summary

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

The scope of this study is as follows:

 Origin of Commodities Market.
 Meaning of and Objectives of Commodity Futures.
 Pricing of Commodity Futures.
 Using commodity futures for Risk Management.
 Commodity profiles of gold & silver.

Commodity Market: With Special Reference to Gold & Silver

Page 3
 INDEX
Introduction
 Company Profile
 Objectives
 Research Methodology

Conceptual Background:
 Literature Review
 What is commodity market?
o History
o Early history of commodity markets
o India and the Commodity Market
 When did Commodity Market start in India?
 History of commodity market in India
 Present commodity market in India
o Indian commodity market structure
o Commodities Traded in India
 Derivatives
o Meaning of Derivatives:
o Using commodity futures
 Hedging:
 Speculation:
 Arbitrage:
 How the commodity market works (Working Procedure):

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

Commodity Market: With Special Reference to Gold & Silver

Page 4
 Introduction

Commodities are raw materials used to create various products. Commodities

include agricultural products such as grains, oilseeds, vegetable oils, pulses and also
meats and livestock; energy products such as crude oil and gasoline; and metals such as
gold, silver, aluminum and mild steel ingots. There are many other commodities like
polypropylene, sugar, cotton, cocoa and coffee, etc., that are also traded. A commodity is
something for which there is demand, but which is supplied without qualitative
differentiation across a given market. Characteristic of commodities is that their prices
are determined as a function of their market as a whole. Well-established physical
commodities are actively traded on various spot and derivative markets. The commodity
market has evolved significantly from the days when farmers hauled cartloads of wheat,
rice and other produce to the local market. In the 1800s, demand for standardized
contracts for trading agricultural products led to the development of commodity futures
exchanges.

Commodities (commodity) are basic raw materials and foodstuffs such as metals,
petroleum, coffee, grain etc. Commodities are traded on a commodity exchange both by
the companies that use them (e.g. chocolate manufacturers) and by speculators. Futures
contracts allow commodity producers and commodity users to bring some predictability
and stability to pricing. By buying futures contracts, they can hedge against underlying
price changes in the commodity.

Commodity exchange are the exchanges where the trading of futures and forwards
take place, basically commodity exchange are trading in future contracts on
those commodities which have some regional relevance it is not going to be as
easy as a share of a company to get listed in a different exchange.

Commodity exchanges in India are expected to contribute significantly in the

strengthening Indian economy to face the challenges of globalization. The Commodity
Exchange makes commodity money available to all as a medium of exchange, store of
wealth and unit of account.

Commodity Market: With Special Reference to Gold & Silver

Page 5
 Company Profile

Bonanza mission statement

Our mission is to be a leading, preferred service provider to our customer, and we

aim to Achieve this leadership position by building an innovative, enterprising and
technology-Driven organization which will set highest standards of service and business
ethics.

Bonanza is a premier integrated financial services provider, and ranked

among the top five in the country in all its business segments, services over
16 million individual investors in various capacities, and provides investor
services to over 300 corporate, comprising the who is who of Corporate India.
Bonanza covers the entire spectrum of f i n a n c i a l s e r v i c e s s u c h a s S t o c k
b r o k i n g , D e p o s i t o r y P a r t i c i p a n t s , D i s t r i b u t i o n o f financial products -
mutual funds, bonds, fixed deposit, equities, Insurance Broking,
Commodities Broking, Personal Finance Advisory Services,
M e r c h a n t B a n k i n g & Corporate Finance, placement of equity, IPO’s, among others.

Bonanza – early days

The birth of Bonanza was on a modest scale in 1981. It began

w i t h t h e v i s i o n a n d enterprise of a small group of practicing Chartered Accountants
who founded the flagship c o m p a n y . B o n a n z a C o n s u l t a n t s L i m i t e d . I t
s t a r t e d w i t h c o n s u l t i n g a n d f i n a n c i a l accounting automation, and
carved inroads into the field of registry and share accounting by 1985. Since then, we
have utilized our experience and superlative expertise to go from strength to
strength…to better our services, to provide new ones, to innovate, diversify
and in the process, evolved Bonanza as one of India’s premier integrated financial service
enterprise.

Bonanza is a leading Financial Services & Brokerage House working

diligently since 1994 c a n b e d e s c r i b e d i n a s i n g l e w o r d a s a
" F i n a n c i a l P o w e r h o u s e " . W i t h a c k n o w l e d g e d industry leadership in
execution and clearing services on E x c h a n g e T r a d e d D e r i v a t i v e s a n d
c a s h m a r k e t p r o d u c t s . B o n a n z a h a s s p r e a d i t s trustworthy tentacles
all over the country with more than 1025 outlets spread across 340cities.
It provides an extensive smorgasbord of services in equity,
c o m m o d i t i e s , c u r r e n c y derivatives, wealth management, distribution of third party
products etc. Keeping in par with the modern tech-savvy world , Bonanza makes an
integrated and innovative use of technology; it also enables its clients to trade
online as well as offline and the strategic tie -ups with the latest technology
partners has earned Bonanza this prestigious place in one of the top
Commodity Market: With Special Reference to Gold & Silver
Page 6
brokerage houses in the country. Client -focused philosophy backed by
memberships of all principal Indian Stock and Commodity Exchanges makes
Bonanza s t a n d a p a r t f r o m i t s c o m p e t i t o r s a n d a p r e f e r r e d s e r v i c e
p r o v i d e r i n t h e i n d u s t r y f o r value-based services. To add to our ever-
growing achievements, a study by Dun and Bradstreet has rated Bonanza as
the SIXTH largest broking house in terms of equity terminal listings in the
country. If this is not enough, Bonanza Portfolio Ltd was recently nominated amongst
the Top 3 Retail Financial Advisors of the country in an event conducted by
CNBC-TV18and OptiMix Financial Advisor Awards 2008. Also Bonanza has been
awarded by BSE the “Major Volume driver for the year 2004-2005, 2006-2007 and 2008-
2009".

Achievements
1. Top Equity Broking House in terms of branch expansion for 2008*.
2. 3rd in terms of Number of Trading Accounts for 2008*.
3. 6th in terms of trading terminals in for two consecutiv e years 2007-
2008*.
4. 9 t h i n t e r m s o f S u b B r o k e r s f o r 2 0 0 7 *
5. Awarded by BSE 'Major Volume Driver 04 -05, 06-07, 07-08’.
6. N o m i n a t e d a m o n g t h e T o p 3 f o r t h e " B e s t F i n a n c i a l A d v i s o r
A w a r d s ' 0 8 " i n t h e c a t e g o r y o f National Distributors - Retail instituted
by CNBC-TV18 and OptiMix.

*As per the survey by DUN & BRADSTREET

Corporate tie ups

The company has Corporate Tie ups with Birla Sun life, Bajaj Allianz,
ICICI Prudential, SBI, Aviva, Kotak Mahindra and Reliance for Life Insurance and
General Insurance. In General Insurance, Bonanza provides Insurance for Motor, Health,
Travel, Housekeeper, Shopkeeper, Marine, Personal and Group Insurance.

Reasons to choose Bonanza Portfolio Ltd.

 EXPERIENCE
Bonanza Portfolio ltd has more than eight decades of trust and credibility in the
Indian stock market. In the Asia Money broker’s poll held recently, SSKI won the
‘India’s best broking house for 2004 award’. Ever since it launched Company as its retail
broking division in February 2000, it has been providing institutional-level research and broking services to
individual investors.

 TECHNOLOGY

Commodity Market: With Special Reference to Gold & Silver

Page 7
 With our online trading account you can buy and sell shares in an instant from any PC with an
Internet connection. You will get access to our powerful online trading tools
that will help you take complete control over your investment in shares.

 ACCESSIBILITY
Company provides Advice, Education, Tools and Execution services for investors. These
services are accessible through our centers across the country (over 250 locations in 123 cities),
over the internet as well as over the voice.

 KNOWLEDGE
In a business where the right information at the right time can translate into direct profits, you get
access to a wide range of information on our content-rich portal, sharekhan.com. You
will also get a useful set of knowledge-based tools that will empower you to take informed
decisions.

 CONVENIENCE
You can call our Dial-N-Trade number to get investment advice and execute your
transactions. We have a dedicated call-centre to provide this service via a toll free number
from anywhere in India.

 CUSTOMERSERVICE
Our customer service team will assist you for any help that you need relating to
transactions, billing, Demat and other queries. Our customer
s e r v i c e s c a n b e contracted via a toll-free number, email or live chat on sharekhan.com.

 INVESTMENT ADVICE
Company has dedicated research teams for fundamental and technical research.
Our analyst constantly track the pulse of the market and provide timely investment advice
to you in the form of daily research emails, online chat, printed reports and SMS on your phone.

BENEFITS

 Secure Order by Voice Tool Dial-n-Trade.

 Automated Portfolio to keep track of the value of your actual purchases.
 24x7 Voice Tool access to your trading account.
 Personalized Price and Account Alerts delivered instantly to your cell phone
&email address.
 Special Personal Inbox for order and trade confirmations.
 On-line customer service via web chat.
 Anytime Ordering

Commodity Market: With Special Reference to Gold & Silver

Page 8
 Objectives

 To study the Indian Commodity Market.

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

Commodity Market: With Special Reference to Gold & Silver

Page 9
 Research Methodology

Basically, there are two tools of data collection namely:

 Primary Data
 Secondary Data

Primary Data:

Primary data is the original information gathered for a specific purpose. It is

usually collected by coming in direct contact with people. It is the raw data. The Most
important source of primary data is Telephonic Study and Questionnaire.

Secondary data:

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

Collection of Data:

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

Commodity Market: With Special Reference to Gold & Silver

Page 10
 Literature Review

While doing this project I studied the previous researches which helped me to
get a broader prospective for my project. I also referred various books and journals to
have a better understanding about the topic of my project.

For the better understanding the commodity market I referred books on

commodity market and extracted the desired contents.

With the help of moneycontrol.com and commodityonline.com I gathered the

required data. I also made use of questionnaire method of research for my project work
and acquired the complete information for my project.

Commodity Market: With Special Reference to Gold & Silver

Page 11
What is commodity market?
Commodity markets are markets where raw or primary products are exchanged.
These raw commodities are traded on regulated commodities exchanges, in which they
are bought and sold in standardized contracts.

This article focuses on the history and current debates regarding

global commodity markets. It covers physical product (food, metals and electricity)
markets but not the ways that services, including those of governments, nor investment,
nor debt, can be seen as a commodity. Articles on reinsurance markets, stock
markets, bond markets and currency markets cover those concerns separately and in more
depth. One focus of this article is the relationship between simple commodity money and
the more complex instruments offered in the commodity markets.

History
The modern commodity markets have their roots in the trading of agricultural
products. While wheat and corn, cattle and pigs, were widely traded using standard
instruments in the 19th century in the United States, other basic foodstuffs such as
soybeans were only added quite recently in most markets. For a commodity market to be
established there must be very broad consensus on the variations in the product that make
it acceptable for one purpose or another.

The economic impact of the development of commodity markets is hard to

overestimate. Through the 19th century "the exchanges became effective spokesmen for,
and innovators of, improvements in transportation, warehousing, and financing, which
paved the way to expanded interstate and international trade."

Early history of commodity markets

Historically, dating from ancient Sumerian use of sheep or goats, other peoples
using pigs, rare seashells, or other items as commodity money, people have sought ways
to standardize and trade contracts in the delivery of such items, to render trade itself more
smooth and predictable.

Commodity money and commodity markets in a crude early form are believed to
have originated in Sumer where small baked clay tokens in the shape of sheep or goats
were used in trade. Sealed in clay vessels with a certain number of such tokens, with that
number written on the outside, they represented a promise to deliver that number. This
made them a form of commodity money - more than an I.O.U. but less than a guarantee
by a nation-state or bank. However, they were also known to contain promises of time
and date of delivery - this made them like a modern futures contract. Regardless of the
Commodity Market: With Special Reference to Gold & Silver
Page 12
details, it was only possible to verify the number of tokens inside by shaking the vessel or
by breaking it, at which point the number or terms written on the outside became subject
to doubt. Eventually the tokens disappeared, but the contracts remained on flat tablets.
This represented the first system of commodity accounting.

Classical civilizations built complex global markets trading gold or silver for
spices, cloth, wood and weapons, most of which had standards of quality and timeliness.
Considering the many hazards of climate, piracy, theft and abuse of military fiat by rulers
of kingdoms along the trade routes, it was a major focus of these civilizations to keep
markets open and trading in these scarce commodities. Reputation and clearing became
central concerns, and the states which could handle them most effectively became very
powerful empires, trusted by many peoples to manage and mediate trade and commerce.

India and the Commodity Market

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

History of commodity market in India

The history of organized commodity derivatives in India goes back to
the nineteenth century when Cotton Trade Association started futures
trading in 1875, about a decade after they started in Chicago. Over the time
derivatives market developed in several commodities in India. Following
Cotton, derivatives trading started in oilseed in Bombay (1900), raw jute and
jute goods in Calcutta (1912), Wheat in Hapur (1913) and Bullion in
Bombay (1920). However many feared that derivatives fuelled unnecessary
Commodity Market: With Special Reference to Gold & Silver
Page 13
speculation and were detrimental to the healthy functioning of the market
for the underlying commodities, resulting in to banning of commodity
options trading and cash settlement of commodities futures after
independence in 1952. The parliament passed the Forward Contracts
(Regulation) Act, 1952, which regulated contracts in Commodities all over
the India. The act prohibited options trading in Goods along with cash
settlement of forward trades, rendering a crushing blow to the commodity
derivatives market. Under the act only those associations/exchanges, which
are granted reorganization from the Government, are allowed to organize
forward trading in regulated commodities.

The act envisages three tire regulations:

(i) Exchange which organizes forward trading in commodities can regulate trading
on day-to-day basis;
(ii) Forward Markets Commission provides regulatory oversight under the powers
delegated to it by the central Government.
(iii) The Central Government- Department of Consumer Affairs, Ministry
of Consumer Affairs, Food and Public Distribution- is the ultimate
regulatory authority

After Liberalization and Globalization in 1990, the Government set up

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

Present commodity market in India

Today; commodity exchanges are purely speculative in nature. Before
discovering the price, they reach to the producers, end-users, and even the
retail investors, at a grassroots level. It brings a price transparency and risk
management in the vital market. By Exchange rules and by law, no one can
bid under a higher bid, and no one can offer to sell higher than someone
else’s lower offer. That keeps the market as efficient as possible, and keeps
the traders on their toes to make sure no one gets the purchase or sale before
they do. Since 2002, the commodities future market in India has experienced
an unexpected boom in terms of modern exchanges, number of commodities
Commodity Market: With Special Reference to Gold & Silver
Page 14
allowed for derivatives trading as well as the value of futures trading in
commodities, which crossed $ 1 trillion mark in 2006. In India there are 25
recognized future exchanges, of which there are four national level multi-
commodity exchanges. After a gap of almost three decades, Government of
India has allowed forward transactions in commodities through Online
Commodity Exchanges, a modification of traditional business known as
Adhat and Vayda Vyapar to facilitate better risk coverage and delivery of
commodities. The four exchanges are:
(i) National Commodity & Derivatives Exchange Limited, Mumbai
(ii) Multi Commodity Exchange of India Limited, Mumbai.
(iii) National Multi- Commodity Exchange of India Limited, Ahmadabad.
(iv) Indian Commodity Exchange Limited, Gurgaon.

INDIAN COMMODITY MARKET STRUCTURE

Commodities Traded in India

Commodity Market: With Special Reference to Gold & Silver

Page 15
 Commodities Traded in India

Commodity Market: With Special Reference to Gold & Silver

Page 16
Derivatives

Another major leap in the development of commodities markets is the growth in

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

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

Commodity Market: With Special Reference to Gold & Silver

Page 17
Using commodity futures

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

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

Arbitrage:
A central idea in modern economics is the law of one price. This states that in a
competitive market, if two assets are equivalent from the point of view of risk and return,
they should sell at the same price. If the price of the same asset is different in two
markets, there will be operators who will buy in the market where the asset sells cheap
and sell in the market where it is costly. This activity termed as arbitrage, involves the
simultaneous purchase and sale of the same or essentially similar security in two different
markets for advantageously different prices. The buying cheap and selling expensive
Commodity Market: With Special Reference to Gold & Silver
Page 18
continues till prices in the two markets reach equilibrium. Hence, arbitrage helps to
equalize prices and restore market efficiency.

How the commodity market works (Working Procedure):

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

Following diagram gives a fair idea about working of the Commodity Market:

Commodity Profile

Commodity Market: With Special Reference to Gold & Silver

Page 19
Gold
For centuries, gold has meant wealth, prestige, and power, and its rarity and natural
beauty have made it precious to men and women alike. Owning gold has long been a
safeguard against disaster. Many times when paper money has failed, men have turned to
gold as the one true source of monetary wealth. Today is no different. While there have
been fluctuations in every market and decided downturns in some, the expectation are
that gold will hold its own. There is a limited amount of gold in the world, so investing in
gold is still a good way to plan for the future. Gold is homogeneous, indestructible and
fungible. These attributes set gold apart from other commodities and financial assets and
tend to make its returns insensitive to business cycle fluctuations. Gold is still bought
(and sold) by different people for a wide variety of reasons - as a use in jewellery, for
industrial applications, as an investment and so on.
Country-wise share in Gold Production, 1968 and 1999.
Country Tonnes, 1968 Share 1968 Tonnes, 1999 Share, 1999

South Africa 972 67 437 17

Australia 309 12
Canada 87 6 154 6
USA 44 3 334 13
China 154 6
Indonesia 154 6
India 51 2
Rest of the world 87 6 463 18
Total 1450 100 2571 100

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

Commodity Market: With Special Reference to Gold & Silver

Page 20
Global and domestic demand-supply dynamics
The demand for gold may be categorized under two heads - consumption demand
and investment demand. Consumption of gold differs according to type, namely
industrial applications and jewellery. The special feature of gold used in industrial and
dental applications is that some of it cannot be salvaged and thus is truly consumed. This
is unlike consumption in the form of jewellery, which remains as stock and can reappear
at future time in market in another form. Consumer demand accounts for almost 90% of
total gold demand and the demand for jewelry forms 89% of consumer demand.

In markets with poorly developed financial systems, inaccessible or insecure

banks, or where trust in the government is low, gold is attractive as a store of value. If
gold is held primarily as an investment asset, it does not need to be held in physical form.
The investor could hold gold-linked paper assets or could lend out the physical gold on
the market attaining a higher return in addition to savings on the storage costs. Japan has
the highest investment demand for gold followed closely by India. These two countries
together account for over 50% of total world demand of gold for retail investment.
Investment demand can be split broadly into two, private and public sector holdings.
There are several ways in which investors can invest in gold either directly or through
a variety of investment products, each of which lends it to specific investor preferences:
• Coins and small bars
• Gold accounts: allocated and unallocated
• Gold certificates and pool accounts
• Gold Accumulation Plan
• Gold backed bonds and structured notes
• Gold futures and options
• Gold-oriented funds

Demand
The Consumer demand for gold is more than 3400 tonnes per year making it
whopping $40 billion worth. More than 80% of the gold consumed is in the form of
jewellery, which is generally pre-dominated by women. The Indian demand to the tune of
800 tonnes per year is making it the largest market for gold followed by USA, Middle
East and China. About 80% of the Physical gold is consumed in the form of jewellery
while bars and coins occupy not higher than 10% of the gold consumed. If we include
jewellery ownership, then India is the largest repository of gold in terms of total gold
within the national boundaries.
Regarding pattern of demand, there are no authentic estimates, the available
evidence shows that about 80% is for jewellery fabrication for domestic demand, and
15% is for investor-demand (which is relatively elastic to gold-prices, real estate prices,
Commodity Market: With Special Reference to Gold & Silver
Page 21
financial markets, tax-policies, etc.). Barely 5% is for industrial uses. The demand for
gold jewellery is rooted in societal preference for a variety of reasons - religious,
ritualistic, a preferred form of wealth for women, and as a hedge against inflation. It will
be difficult to prioritize them but it may be reasonable to conclude that it is a combined
effect, and to treat any major part as exclusively a store of value or hedging instrument
would be unrealistic. It would not be realistic to assume that it is only the affluent that
creates demand for gold. There is reason to believe that a part of investment demand for
gold assets is out of black money.

Rural India continues to absorb more than 70% of the gold consumed in India and it
has its own role to fuel the barter economy of the agriculture community. The yellow
metal used to play an important role in marriage and religious festivals in India. In the
Hindu, Jain and Sikh community, where women did not inherit landed property whereas
gold and silver jewellery was, and still is, a major component of the gifts given to a
woman at the time of marriage. The changeover hands of gold at the time of marriage are
from few grams to kgs. The gold also occupies a significant position in the temple system
where gold is used to prepare idol and devotees offer gold in the temple. These temples
are run in trust and gold with the trust rarely comes into re-circulation. The existing
social and cultural system continues to cause net gold buyer market and the government
policies have to take note of the root cause of gold demand, which lies in the social and
cultural system of India. The annual consumption of gold, which was estimated at 65
tonnes in 1982, has increased to more than 700 tonnes in late 90s. Although it is likely
that, with prosperity and enlightenment, there may be deceleration in demand,
particularly in urban areas, it would be made good by growing demand on account of
prosperity in rural areas. In the near future, therefore, the annual demand will continue to
be over 600 tonnes per year.

Supply
Indian gold holding, which are predominantly private, is estimated to be in the
range of 10000-13000 tonnes. One fourth of world gold production is consumed in India
and more than 60% of Indian consumption is met through imports. The domestic
production of the gold is very limited which is around 9 tonnes in 2002 resulting in more
dependence on imported gold. The availability of recycled gold is price sensitive and as
such the dominance of the gold supply through import is in existence. The fabricated old
gold scraps is price elastic and was estimated to be near 450 tonnes in 2002. It rose
almost more than 40% compared to the previous year because of rise in gold price by
more than 15%.
The demand-supply for gold in India can be summed up thus:
1. Demand for gold has an autonomous character. Supply follows demand.
2. Demand exhibits income elasticity, particularly in the rural and semi-urban areas.
3. Price differential creates import demand, particularly illegal import prior to the
Commodity Market: With Special Reference to Gold & Silver
Page 22
 commencement of liberalization in 1990.

Price trends and factors that influence prices

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

History of derivatives markets in Gold

Gold futures trading debuted at the Winnipeg Commodity Exchange (Comex) in

Canada in November 1972. Delivery was also available in gold certificates issued by
Bank of Nova Scotia and the Canadian Imperial Bank of Commerce. The gold
contracts became so popular that by 1974 there was as many as 10,00,000 contracts
floating in the market. The futures trading in gold started in other countries too. This
included the following:
• The London gold futures exchange started operations in the early 1980s.
• The Sydney futures exchange in Australia began functioning with a contract in
1978. This exchange had a relationship with the Comex where participants could
take open positions in one exchange and liquidate them in the other.
• The Singapore International Monetary Exchange (Simex) was set up in 1983 by
way of an alliance between the Gold Exchange of Singapore and the International
Monetary Market (TMM) of Chicago.
• The Tokyo Commodity Exchange (Tocom), which launched a contract in 1982,
was one of the few commodity exchanges to successfully launch gold futures.
Trading volume on the Tocom peaked with seven million contracts.
• On December 31, 1974, the Commodity Exchange, the Chicago Board of Trade,
the Chicago Mercantile Exchange and the Mid-America Commodity Exchange
introduced gold futures contracts.
• The Chinese exchange, Shanghai Gold Exchange was officially opened on 30
October 2002.
Commodity Market: With Special Reference to Gold & Silver
Page 23
 • Mumbai's first multi-commodity exchange, the National Commodities and
Derivatives Exchange, NCDEX launched in 2003 by a consortium of ICICI Bank
Limited, Life Insurance Corporation, National Bank for Agriculture and Rural
Development and National Stock Exchange of India Limited, introduces gold
futures contracts.
Gold has a very active derivative market compared with other commodities. Gold
accounts for 45 per cent of the world’s commercial banks commodity derivatives
portfolio.

Analysis of prices of gold in India in last 5 years

YEAR GOLD RATE VALUE TRADED(in lakhs)

2007 10800 74786092.36

2008 12500 184054386.35

2009 14500 207797608.29

2010 18500 248477853.35

2011 26400 384270982.58

Commodity Market: With Special Reference to Gold & Silver

Page 24
Silver
The dictionary describes it as a white metallic element, sonorous, ductile, very
malleable and capable of high degree of polish. It also has the highest thermal and
electrical conductivity of any substance. Silver is somewhat harder than gold and is
second only to gold in malleability and ductility. Silver remains one of the most
prominent candidates in the metals complex as far as futures' trading is concerned.
Thanks to its unique volatility, silver has remained a hot favorite speculative vehicle for
the small time traders. Though futures trading were banned in India since late sixties,
parallel futures markets are still very active in Delhi and Indore. Speculative interest in
the white metal is so intense that it is believed that combined volume of Indian punters
represent almost 40 percent of volume traded at New York Commodity Exchange. Delhi,
Rajasthan, MP and UP are the active pockets for the silver futures. Until recently, Rajkot
and Mathura were conducting futures but now players have diverted toward comex trade.
Most of the world's silver is mined in the US, Australia, Mexico, Peru, and
Canada. Cash markets remain highly unorganized in the silver and impurity and
excessive speculation remain key issue for the trade. Taking cue from gold, government
of India is planning to introduce hallmarking in silver which is likely to address quality
and credibility of Indian silverware and jeweler industry. The unique properties of silver
restrict its substitution in most applications.

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

Demand

Demand for silver is built on three main pillars; industrial and decorative uses,
photography and jewelry & silverware. Together, these three categories represent more
than 95 percent of annual silver consumption. In recent years, the main world demand for
silver is no longer monetary, but industrial. With the growing use of silver in
Commodity Market: With Special Reference to Gold & Silver
Page 25
photography and electronics, industrial demand for silver accounts for roughly 85% of
the total demand for silver. Jewelry and silverware is the second largest component, with
more demand from the flatware industry than from the jewelry industry in recent years.
India, the largest consumer of silver, is gearing up to start hallmarking of the white
precious metal by April. India annually consumes around 4,000 tonnes of silver, with the
rural areas accounting for the bulk of the sales. India's demand for silver increased by
177 per cent over the past 10 years as compared to 517 tonnes in 1991. According to
GFMS, India has emerged as the third largest industrial user of silver in the world after
the US and Japan.

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

Factors influencing prices of the silver

The prices of silver, like that of other commodities, are dictated by forces of
demand and supply and consumption. Besides, a host of social, economic and political
factors have powerful bearing on silver prices. As in the case of gold prices, political
tensions, the threat affects the price of silver too. When trading and movement of silver is
restricted, within or outside national boundaries, prices move in accordance with demand
and supply conditions prevalent in mat environment Price of silver is also influenced by
Commodity Market: With Special Reference to Gold & Silver
Page 26
changes in factors such as inflation (real or perceived), changing values of paper
currencies, and fluctuations in deficits and interest rates, etc. Although prices and
incomes are important factors, they are also influenced by factors such as tastes,
technological change and market liberalization.
Approximately 70 percent of the silver mined in the western hemisphere is mined as a
byproduct of other metal products, such as gold, copper, nickel, lead, and zinc. As such,
the price of these metals greatly affects the supply of silver mined in any year. As die
price of die omer metal products increases, die increased profit margin to mine operations
stimulate greater production of die omer metals, and as a result, die production of silver
increases in tandem. Because silver is a precious metal, its price is determined by die
supply and demand ratio at any given moment. As is the case with other precious metals,
there is a limited amount of silver in the world. It is not a product mat can be
manufactured en masse, and, mere fore is subject to issues such as weamer and politics
mat may affect silver mining operations.

Historical background of Silver markets

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

Commodity Market: With Special Reference to Gold & Silver

Page 27
 Analysis of prices of Silver in India in last 5 years

YEAR SILVER RATE QUANTITY VALUE

TRADED(in thousands) TRADED(in lakhs)

2007 18960 306790.07 KGS 57424526.09

2008 17800 393747.525 KGS 83980721.19

2009 26850 431439.545 KGS 103092321.07

2010 46300 599843.995 KGS 194143239.53

2011 51350 1013923.254 KGS 246117507.12

Commodity Market: With Special Reference to Gold & Silver

Page 28