If supply is more than demand, the balance residual left out is Closing Stocks, which is carried

forwarded to next year. If demand is more than supply, it is met by imports to the extent
possible or else, equilibrium prices will rise.
Seasonality: Most commodities follow a certain schedule of production cycle, which impacts
the price trend. For example, in agricultural commodities, during the harvesting season, due
to an increased supply, prices tend to come down; whereas during the sowing season, the
overall supply (availability) remains lower, which leads to an increase in prices. In precious
metals like gold and silver, during the festival season, increased demand helps prices to
remain stronger. Annexure-2 lists the sowing, harvest and arrival period of major crops which
are traded on commodity exchanges.
News: Commodity prices are very sensitive to news and rumours and any important news
related to a particular commodity can significantly affect its price in either direction in the
short term.
Geo-political developments: Commodities that have a global demand (e.g., crude oil) are
prone to price fluctuations due to political tensions in some parts of the globe and these may
lead to disruptions in supply. For example, tensions in the Middle East region may affect prices
of crude oil due to potential disturbances to production and/or to supply chains. As we have
seen recently, tensions between Russia and Ukraine also have inflated prices of natural gas
and oil.
Macroeconomic conditions: The domestic and global macroeconomic conditions can have an
impact on commodity prices. The GDP growth rate, consumption pattern, per capita income,
industrial production, employment rate, inflation rate, etc. are very important factors in
deciding the price trend of a commodity both in the short term as well as in the long term.
Currency movement: Comparative movement in the value of a currency of a country in
relation to the major global currencies is very important for prices of commodities in that
particular country. Most of the commodities globally are denominated in the US dollar (USD).
Hence, when the currency of a particular country appreciates against the USD, the price of
the commodity in that particular country becomes cheaper and vice versa.
Interest rates: Interest rates also impact the commodity prices and are the key determinants
in commodity price movements. The effect of interest rate on commodity prices is almost
instantaneous. High interest rates could reduce the market prices of commodities. High
interest rates impact the price of storable commodities through four channels: (1) by
increasing the incentive for extraction today rather than tomorrow as in the case of gold
mining, (2) by decreasing firms' desire to carry inventories, (3) by encouraging speculators to
shift their investments away from commodity contracts into treasury bills, and (4) by
appreciating the domestic currency and thereby reducing the price of internationally traded
commodities in domestic terms. All four mechanisms work to reduce the real market price of
commodities. A decrease in real interest rates has the opposite effect, lowering the cost of
carrying inventories, and raising commodity prices. Lower interest rates decrease the

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incentive to extract mine-based commodities, increase the incentives to maintain inventories,
and stimulate the demand for commodity derivatives, all of which raise the prices of basic
commodities.
Foreign Exchange rates: Increase in domestic currency value makes imports cheaper as it
reduces the INR prices of internationally traded commodities. On the other hand, a
depreciating domestic currency makes imports costlier as it increases the INR prices of
internationally traded commodities. The same is reflected in Futures prices also.
Other factors: Weather is an important factor that impacts the production of agricultural
commodities. The stock (inventory level) of certain commodities after a season is a significant
factor for the price movement of that commodity. The government’s intervention in different
ways (through implementation of a rule, programme, etc.) is another important factor that
affects commodity price. Covid-19 like situations and lock-downs also change the demand -
supply dynamics. For example, WTI Oil Futures on Nymex turned negative in April 2020 due
to the pandemic induced lock-downs.

1.8 Commodity Options and Index Futures

Commodity Derivatives segment started in India initially with Commodity Futures. Majorly
Futures are traded in Agricultural Commodities, Industrial Metals, Precious Metals and Oil. A
few of these commodity Futures expires in cash settlement while a few others lead to delivery
based settlement.
In late 2017, Commodity Options trading (on individual commodities) was started in Indian
exchanges, which initially was devolving into the underlying Commodity Futures. With the
increased awareness of market participation, in 2020, Options which expires into direct
delivery of physical commodities also were started. Commodity indices were also created,
based on which, Index Futures trading was started in 2020. In March 2022, SEBI has permitted
the exchanges to introduce options on commodity indices and has specified the product
design and risk management framework for these Index options. These segments will be dealt
in detail in subsequent chapters.

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Sample Questions
1. In ________ system, goods were exchanged between two parties with matching and opposite
needs.
(a) Barter
(b) Bullion
(c) OTC
(d) Monetary
Ans: (a)
2. ___________ are agreements between two counterparties to exchange a series of cash
payments for a stated period of time based on a certain pre-agreed arrangement.
(a) Futures
(b) Swaps
(c) Forwards
(d) Options
Ans: (b)
3. _____________ refers to the process of determining commodity price through forces of market
demand and supply.
(a) Law of one price
(b) Price determination
(c) Price discovery
(d) Arbitrary pricing
Ans: (c)
4. Arbitrage opportunities can exist between _____________.
(a) Spot and futures prices
(b) Two futures prices
(c) Futures and options prices
(d) All of the above
Ans: (d)
5. Which of the following macroeconomic factors have an impact on the commodity prices?
(a) GDP growth rate
(b) Per capita income
(c) Growth in industrial production
(d) All of the above
Ans: (d)

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