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COMMODITY MARKET AND

TRADING
COMMODITY

A commodity is anything for which there is demand, but which is supplied


without qualitative differentiation across the markets.

They are things of value, of uniform quality, that are produced in large quantities
by many different producers; the items from each different producer are
considered equivalent.
GLOBAL CLASSIFICATION OF
COMMODITIES
Precious Metals
Other Metals
Agro-Based Commodities
Soft Commodities
Petrochemicals
Energy
COMMODITIES AN ALTERNATE ASSET
CLASS
Returns are independent of other asset classes
Low correlation with other asset classes
Its returns cannot be replicated with combination of other asset classes
Positively correlated with inflation whereas bonds & equities are negatively
correlated.
Have independent risk/return profile.
CORRELATION BETWEEN BSE SENSEX AND
COMMODITIES
Negative to low correlation between commodities and bse Sensex.
Good for diversification as it reduces portfolio risk.
COMMODITY MARKET

Commodity market is a place where trading in commodities takes place. These


are the markets where raw and primary products are exchanged.

These raw commodities are traded on regulated commodity exchanges, in which


they are bought and sold in standardized contracts. It is similar to an equity
market, but instead of buying or selling shares one buys or sells commodities.
TIMINGS

Agri products : 10 am to 5 pm
Other commodities : 10 am to 11.30 pm
COMMODITY EXCHANGE

An entity, usually an incorporated non-profit association, that determines and


enforces rules and procedures for the trading of commodities and related
investments, such as commodity futures.
Commodities exchange also refers to the physical centre where trading takes
place
18 existing commodity exchanges in India offering domestic contracts in 8
commodities and 2 exchanges that have permission to conduct trading in
international (USD denominated) contracts.
NATIONAL COMMODITY AND DERIVATIVES
EXCHANGE LIMITED (NCDEX)
This is an online multi-commodity exchange that was promoted in 2003 and
professionally managed by the following:
ICICI Bank Limited - ICICI Bank
Life Insurance Corporation of India LIC
NABARD
National Stock Exchange of India Limited NSE
Punjab National Bank PNB
CRISIL Limited
Indian Farmers Fertilizer Cooperative Limited
Canara Bank
MULTI COMMODITY EXCHANGE OF INDIA
LIMITED (MCX)
MCX is an independent multi commodity exchange, headquartered in Mumbai,
2003.

MCX is promoted by Financial Technologies.

It is recognized by the government for conducting the following in the area of


commodities futures and options:
facilitating online trading
clearing
settlement operations
MCX CONNECTS THE FOLLOWING

Producers and Processors


Traders
Corporate house
Regional trading centers
Importers
Exporters
Co-operatives
Industry Associations and institutions
EXAMPLES OF PRODUCTS AT MCX

Bullion
Spices
Fiber
Cereals
Plantations
pulses
Oil & Oil Seeds
Energy
Petrochemicals
Metals
MAJOR ACTORS IN COMMODITY MARKET

Speculator
A trader who enters the futures market in pursuit of profit, accepting risk in the
endeavor.
Hedger
A Trader who enters the futures market to reduce some pre-existing risk
exposure.
Broker
An Individual or firm acting as an intermediary by conveying customers trade
instructions. Account executives or floor brokers are examples of brokers.
COMMODITY TRADING

Spot trading

Spot trading is any transaction where delivery either takes place immediately, or
if there is a minimum lag, due to technical constraints, between the trade and
delivery. Commodities constitute the only spot markets which have existed nearly
throughout the history of humankind.
spot trading are also known as over the counter which have been
decreasing over the years due to risks.
EXAMPLES OF SPOT TRADING

Lets assume that Priyanka is a oil trader and buys the oil at a price of 50$ per
barrel and the oil will be delivered in due time at a future date say 15 to 30 days.
Another example of spot trading which includes over the counter will be two
parties trading in a contract which is non standard as pratiksha and sriram enter
into a gold contract whereby the price will be fixed on the spot and details of the
contract will be within the 2 parties including the price whereas earlier in the oil
contract price was open in the market.
FORWARD CONTRACT

A forward contract is an agreement between two parties (counterparties) for the


delivery of a physical asset (e.g., oil or gold) at a certain time in the future for a
certain price that is fixed at the inception of the contract.

Forward contracts can be customized to accommodate any commodity, in any


quantity, for delivery at any point in the future, at any place.
EXAMPLE OF FORWARD CONTRACT

Lets assume that aarti is a corn farmer who enters into a contract with ashwathi
who is the owner of ash flakes (brand name of her cornflakes) and she is selling
the corn to ashwathis firm at 50rs/kg in November if the price of corn is more than
50 rs/kg aarti is in profit while if the price of corn is less than 50rs/ kg then ashwathi
is in profit.
FUTURE CONTRACTS

Futures contracts are highly uniform and well-specified commitments for a


carefully described good (quantity and quality of the good) to be delivered at a
certain time and place (acceptable delivery date) and in a certain manner (method
for closing the contract) and the permissible price fluctuations are specified
(minimum and maximum daily price changes).
HEDGING

Purpose is to avoid risk of adverse market movements.


Rationale behind hedging is that cash and future prices tend to move in tandem
and converge at the close of expiry of contracts.
Types of hedge : short term and long term
Advantage is of locking a price and margin in advance while disadvantage is it
limits opportunities if prices move favorably.
TYPES OF HEDGE

Long term Short term

Involves taking a long position in the Involves taking a shot position in the
market. future market.
Good when somebody plans to buy Good when somebody owns the asset
something in the future. and plans to sell in the future.
EXAMPLE OF SHORT TERM HEDGE

Lets assume that sharath expects to sell 10,000 kg of sugar in November and the
current spot price is 20rs/kg while the future price is 25rs/kg , so he will lock the
future price at 25rs/kg thereby mitigating the price fluctuation in sugar will be
nullified as if the price in November falls below 25rs he doesnt have to worry
about the fall in prices and he can go and party till he crashes.
EXAMPLE OF LONG TERM HEDGE

Lets assume that Arjun is a copper trader and requires copper in 2 months time
but has an inventory holding capacity of 1month. The current spot price is
200rs/kg and future price is 180rs/kg. so he will lock the price of copper at 180
rs/kg to be bought after 2months and if the price of copper by that time is 190 rs
he will be in profit of 10rs/kg and will sleep for next 2 days happily.
FUTURE CONTRACTS

At present 22 Exchanges are recognized/registered for forward/ futures trading in


commodities.

Under the Forward Contracts (Regulation) Act, 1952, forward trading in


commodities notified under section 15 of the Act can be conducted only on the
Exchanges, which are granted recognition by the Central Government
(Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public
Distribution).
OTHER FEATURES

All the commodities are not suitable for futures trading and for conducting futures
trading. For being suitable for futures trading the market for commodity should
be competitive, i.e., there should be large demand for and supply of the
commodity. The commodity should have long shelf-life and be capable of
standardization and gradation.

Price discovery is done through two popular methods. The fundamental analysis is
concerned with basic supply and demand information, such as, weather patterns,
carryover supplies, relevant policies of the Government and agricultural reports.
Technical analysis includes analysis of movement of prices in the past.
FORWARD VS FUTURES

Comparison Forward Futures


Trade on organized No Yes
exchanges
Use standardized contract No Yes
terms
Use associate clearinghouses No Yes
to guarantee contract
fulfillment
Require margin payments and No Yes
daily settlements
Close easily No Yes
Regulated by identifiable No Yes
agencies
Any quantity Yes No
SWAP

A swap is a derivative in which two counterparties exchange cash flows of one


party's financial instrument for those of the other party's financial instrument.
EXAMPLE OF SWAP

Dilip furniture's private limited is the owner of mnc in India while vasu sushi
corporation is the owner of mnc in japan and both of these companies want to
increase there business in each other countries and they need to take a loan while
loan in India for foreign companies is at 20% while in japan is at 19%.
so in order to counter interest rates dilip and vasu will take loan for
each other at 10% and 9% respectively and then they will swap the loan at
yen/rupee rate equivalently, thereby giving both companies advantage.
EXCHANGE TRADED COMMODITIES

Exchange-traded commodity is a term used for commodity exchange-traded


funds (which are funds) or commodity exchange-traded notes (which are notes).
These track the performance of an underlying commodity index including total
return indices based on a single commodity. They are similar to ETFs and traded
and settled exactly like stock funds. ETCs have market maker support with
guaranteed liquidity, enabling investors to easily invest in commodities.
They are used mainly to diversify your portfolio.
REGULATORY ISSUES

Forward Markets Commission is a regulatory body for commodity futures/


forward trade in India.
The regulation is needed to create competitive conditions. In the absence of
regulation, unscrupulous participants could use these leveraged contracts for
manipulating prices.
To ensure that the market has appropriate risk management system. In the
absence of such a system, a major default could create a chain reaction.
The financial crisis in a futures market can create systematic risk.
To ensure fairness and transparency in trading, clearing, settlement and
management of the exchange so as to protect and promote the interest of various
stakeholders.
FUNCTIONS OF FORWARDS MARKET
COMMISSION
FMC advises Central Government in respect of grant of recognition or withdrawal
of recognition of any association.
It keeps forward markets under observation and takes such action in relation to
them as it may consider necessary, in exercise of powers assign to it.
It collects & publishes information relating to trading conditions in respect of
goods including information relating to demand, supply and prices and submit to
the Government periodical reports and working of forward markets in
commodities.
It makes recommendations for improving the organization and working of
forward markets.
It undertakes inspection of books of accounts and other documents of
recognized/registered associations.
RISK FACTORS
CONCLUSION

Commodities are a distinct asset class with returns that are largely independent of
bond and equity returns.
Taking broad commodity exposure can help in portfolio and risk diversification.
Long term fundamentals of commodity companies appears bright given the
supply demand mismatch rapid industrialization of emerging economies ,
emphasis on infrastructure development in many developing economies.