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Chandrashekhar A strong and vibrant cash market is a precondition for a successful and transparent futures market. As funds seamlessly flow from one market to the other and the Indian commodity market begins to integrate with the global market, the risk perception is beginning to heighten. Adoption of risk management or risk mitigation tools is nowsine qua non for success in businesses with exposure to commodities. A serious look at futures trading as a tool for price discovery and price risk management is inevitable. Before we examine commodities futures trading its principles and benefits it may be worthwhile to crystal gaze into the future of this market. Some features of the emerging scenario in India as far as the commodity market is concerned: Expansion of commodity trade: Very clearly, trade volumes are set to expand rapidly. Demand for a wide variety of commodities covering food, fibre, metals and energy is certain to expand. India is likely to produce many of the aforesaid commodities, as investment in production facility expands. If demand growth outstrips domestic supply growth, imports will become inevitable. The possibility exporting certain commodities also exists. In commodity production, consumption and trade, India will become an important player in the international market. This will lead to a massive expansion in commodity trade volumes over the next, say, 15-20 years. Competition from imports: Whether or not domestic producers like it, the competition from imported commodities is inevitable. This
could be true in case of food crops, metals and energy. In the short/medium-term, indigenous output will trail consumption demand because of the lagged effect of investment. To fuel growth and rein in inflation, the government and the business houses will have to resort to imports. As imports are unrestricted (Quantitative Restrictions have been abolished), there will be liberal inflow of goods from abroad. Often, imports from developed countries are lowpriced and subsidised. Such competition will result in inefficient domestic units falling by the wayside, but will eventually lead to greater efficiency among domestic producers. Role of MNCs: Multinational corporations cannot be wished away. They bring with them a certain superior knowledge of operating in developing or emerging economies. They also have deep pockets and, often, are long-term players. In the Indian commodities sector, global companies will increasingly play a role as producers, suppliers, traders and service providers. Indian producers will have to learn to face competition from MNCs. Consolidation of fragmented capacities: It is well-known that commodity producers and industrial consumers in India suffer poor scale economies because of their small size. Fragmentation of business that is resulting in scale-diseconomies and other infirmities is likely to give way to consolidation. Competition is now driving smaller players to explore opportunities for merger. Bigger companies with expansion plans follow the acquisition route. Mergers and acquisitions will lead to consolidation of fragmented businesses, albeit slowly. Dominance by a few large firms: In the developed economies, a handful of companies share a big slice of the business pie. Typically,
* Less volatile.500 across the country) will soon be networked so that growers can get to know prices prevailing in various marketing yards or mandis.four-five companies would account for. The more risk-taking investors choose equity trading. say. The National Multi Commodity Exchange of India (NMCE) and The National Board of Trading in Derivatives (NBOT)) to offer online trading in commodity derivatives products. But commodity trading forms a part of conventional investment instruments. It must. the Government has not only freed the commodities market of controls and restrictions but has also. by and large. Of the total imports of 45-50 lakh tonnes a year worth over Rs 10. Waning role of government: As part of the economic liberalisation process. Take edible oil imports. but also help capture value by taking trading positions. bonds and real estate. The commodity sector will inevitably move towards such a situation. ITC's echaupal being a remarkable initiative. IT will play a key role in bringing about greater transparency in the commodities market. * Investors can leverage their investments . distanced itself from the market. The Multi Commodity Exchange of India (MCX).000 crore. E-commerce will be the modern way of doing business. Of course. compared with. gold and bank deposits. Several corporates have already begun to employ IT to derive value. It gave the go-ahead to four exchanges (The National Commodity and Derivative Exchange (NCDEX). 60-75 per cent of aggregate business and several smaller players compete for the rest. What makes commodity trading attractive? * A good low-risk portfolio diversifier * A highly liquid asset class. Use of information technology: Very clearly. equities and bonds. the rest being shared by over 20 importers. for instance. Strong cash market: These developments will result in a stronger cash market for commodities. The process of consolidation and dominance by a few large firms is already visible. acting as a counterweight to stocks. IT will be used for delivering price and market information to primary producers (farmers). future trading in commodities was banned in India in mid-1960 due to excessive speculation. The government's role is changing from controller to facilitator. It is this emerging scenario that market participants must gear themselves to face. however. some restrictions still remain. A strong and vibrant cash market is a pre-condition for a successful and transparent futures market. The agricultural produce markets (numbering nearly 7. The country's strengths in IT will increasingly be leveraged to connect stakeholders and link markets. Investment in India has traditionally meant property. As a matter of fact. five companies (of which two are MNCs) account for roughly 70 per cent of business. Initiatives are already underway to launch electronic spot trading in farm commodities that will help growers and others not only discover prices almost real time. like those on the sugar industry. In February 2003. however incipient. be mentioned that "liberalisation is not licence''. The interventionist role of the government is now minimal. the government revoked the ban and threw open futures trading in 54 commodities in bullion and agriculture.
Sugar etc. If the buyer chooses to take delivery of the commodity. Commodities are also good bets to hedge against inflation. While speculators and arbitrageurs generally prefer cash settlement. For example. commodity prices are dependent on their demand-supply position. it is 12-18% in gold. Cotton. the buyer can claim the commodity from the warehouse. But commodity trading carries a lower downside risk than other asset classes. 15-25% in silver. Tradable Commodities: World-over one will find that a market exits for almost all the commodities. Investors' choice: The futures market in commodities offers both cash and delivery-based settlement. as pricing in commodity future is less volatile compared to equities and bonds. Soft Commodities: Coffee. These commodities can be broadly classified into the following: Precious Metals: Gold. commodity stockists and wholesalers go for delivery. the margin rises to 0-25% of the contract value and the seller is required to pay sales tax on the transaction. Commodity trading follows a T+1 settlement system. his absolute returns would above been 24%. Gold offers good protection against exchange rate fluctuations. However. government policies related to subsidies and taxation and international trading norms as guided by the World Trade Organisation (WTO). * Better risk-adjusted returns. against fluctuations in the value of the US dollar against other leading currencies. * A good hedge against any downturn in equities or bonds as there is little correlation with equity and bond markets. Oils. * High co-relation with changes in inflation. where the settlement date is the next working day after expiry. Platinum etc. While the average annual volatility is 25-30% in benchmark equity indices like the BSE Sensex or NSE's Nifty. Cocoa. However. Silver. in case of delivery-based traders. three months prior to the contract month. the December 2004 contracts open on 21 September 2004 and the due date is the 20-day of the delivery month. In the case of delivery-based trades. 10-12% in cotton and 5-10% in government securities. unlike stocks. Copper etc. Growth of commodity trading: . a transferable receipt from the warehouse where goods are stored is issued in favour of the buyer. Trading in any contract month will open on the twenty first day of the month.and multiply potential earnings. * No securities transaction tax levied. Pork Bellies etc. All open contracts not intended for delivery are cash-settled. Returns from Commodity trading: Absolute returns from stocks and bonds are definitely higher than pure commodities. Natural Gas. Oilseeds etc. settlement takes place five to seven days after the expiry. Agro-Based Commodities: Wheat. Other Metals: Nickel. global weather patterns. Investors can choose between the two. Energy: Crude Oil. in particular. Gasoline etc. All contracts settling in cash will be settled on the following day after the contract expiry date. and. On producing this receipt. if an investor had put his money only in silver and bonds from 19972003. The option to square off the deal or to take delivery can be changed before the last day of contract expiry. Live Stock: Live Cattle. Aluminum. Corn. According to study.
soya bean and guar gum. the market is divided equally between bullion and agricultural commodities in terms of trading volumes. This is because FMC. foreign institutional investors. a proper regulatory system to supervise trades needs to be implemented.1889 crore. FMC neither noticed the huge gap between cash and future prices nor bothered to investigate thereby signaling a relaxed regulatory regime in the commodities market. banks are keen to tap the commodity trade-financing front.A soft interest rat regime and a weak US dollar ahs increased the demand for the commodities. It registered a record daily traded volume of Rs. urad. is understood to have entered a series of shady circular transactions with a sister firm on NMCE. Problems galore: The biggest danger to the galloping trading business in commodities is poor supervision.2500 crore at NCDEX alone has surpassed that of Rs. has achieved a peak daily turnover of Rs. silver. Expecting the turnover on the three online commodity exchanges to spurt to Rs. MCX. In June 204. commodity trading offers a good option for long-term investors and arbitrageurs and speculators. trading in commodities cannot be ignored by Indian investors.5% as against the normal lending rate between 11% and 14%. And.10 per kg between cash and futures prices. pepper. fixed deposits and mutual funds. mustard seeds and wheat contributed to the balance trading volume. too. For diversification of portfolio beyond shares. soya bean oil. now. which functions under the administrative control of the Ministry of Food and Consumer Affairs. Commercial banks are chasing the commodity industry with attractive lending rates between 8% and 8. For this reason.2617 crore on 8 December 2004. Commodities like chana. registered with the Rubber Board. In a short span of over a year. Another herculean task in commodity trading is that of creating awareness and providing a transparent and user-friendly trading platform to investors. creating a hefty difference of Rs. The daily volume of trading of Rs. The national multi-commodity exchanges have unitedly proposed to the government that in view of the growth of the commodities market.2000 crore on the Bombay Stock Exchange (BSE). Conclusion: After almost two years that commodity trading is finding favour with Indian investors and is been seen as a separate asset class with good growth opportunities. giving way to arbitrageurs and speculators. online commodity markets are witnessing good growth in India. Even though the commodity futures market is regulated by Forward market Commission.10000 crore per day. it was caught unawares earlier this year when a rubber dealer made several shady deals. Online commodity exchanges need to revamp certain laws governing futures in commodities to make the markets more attractive. the rubber dealer. NCDEX is also understood to have pressed for an amendment to the Banking Regulation Act to allow several branches of banks to act as intermediaries to enable farmers to insulate fro price fluctuations through futures trading. sugar. has no hands-on experience in monitoring electronic trading and detecting market manipulation. on the other hand. with daily global volumes in commodity trading touching three times that of equities. should be given the go-ahead to invest in . Though the most popular commodities for trading in India are gold.
Therefore.commodity futures in India. Commodity trading in India is poised for a big take-off in India on the back of factors like global economic recovery and increasing demand from China for commodities. can help India become a global trading hub for select commodities. Their entry will deepen and broad base the commodity futures market. derivative instruments. . Considering the huge volatility witnessed in the equity markets recently with the Sensex touching 6900 level commodities could add the required zing to investors' portfolio. it won't be long before the market sees the emergence of a completely redefined set of retail investors. such as futures. As a matter of fact.
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