INTRODUCTION TO COMMODITY MARKET

WHAT IS A MARKET?
A MARKET IS DEFINED AS A PLACE WHERE BUYERS AND SELLERS MEET TO EXCHANGE GOODS OR SERVICES FOR A CONSIDERATION. THIS CONSIDERATION IS USUALLY MONEY .

WHAT IS A COMMODITY?
A COMMODITY IS A PRODUCT THAT HAS COMMERCIAL VALUE, WHICH CAN BE PRODUCED, BOUGHT, SOLD, AND CONSUMED. COMMODITIES ARE BASICALLY THE PRODUCTS OF THE PRIMARY SECTOR OF AN ECONOMY. THE PRIMARY SECTORS ARE USED AS INPUTS IN THE PRODUCTION OF THE SECONDARY SECTOR OF THE ECONOMY.

 WHAT IS COMMODITY MARKET? Raw or primary products are exchanged. traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts. Commodity market is an important constituent of the financial markets of any Country. It is the market where a wide range of products, viz., precious metals, base metals, crude oil, energy and soft commodities like palm oil, coffee etc. are traded. WHAT IS COMMODITY EXCHANGE? Commodity exchange is 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. It also refers to the physical centre where trading takes place.

WHAT MAKES COMMODITY MARKET ATTRACTIVE?

A good low-risk portfolio diversifier

A highly liquid asset class, acting as a counterweight to stocks, bonds and real estate.
Less volatile, compared with, equities and bonds. Investors can leverage their investments and multiply potential earnings. Better risk-adjusted returns. A good hedge against any downturn in equities or bonds as there is Little correlation with equity and bond markets. High co-relation with changes in inflation. No securities transaction tax levied.

HISTORY OF COMMODITY MARKET

Commodities future trading was evolved from need of assured continuous

supply of seasonal agricultural crops. The concept of organized trading in commodities evolved in Chicago, in 1848. But one can trace its roots in Japan. In 19th century Chicago in United States had merged as a major commercial hub. So that wheat producers from Mid-west attracted here to sell their produce to dealers & distributors. Due to lack of organized storage facilities, absence of uniform weighing & grading mechanisms producers often confined to the mercy of dealers discretion. These situations lead to need of establishing a common meeting place for farmers and dealers to transact in spot grain to deliver wheat and receive cash in return. Gradually sellers & buyers started making commitments to exchange the produce for cash in future and thus contract for futures trading evolved; Whereby the producer would agree to sell his produce to the buyer at a future delivery date at an agreed upon price.

 Trading of wheat in futures became very profitable which encouraged the entry of other commodities in futures market. This created a platform for establishment of a body to regulate and supervise these contracts and thus Chicago Board of Trade (CBOT) was established in 1848. In 1870 and 1880s the New York Coffee, Cotton and Produce Exchanges were born. Agricultural commodities were mostly traded but as long as there are buyers and sellers, any commodity can be traded. In 1872, a group of Manhattan dairy merchants got together to bring chaotic condition in New York market to a system in terms of storage, pricing, and transfer of agricultural products.

The largest commodity exchange in USA is Chicago Board of Trade, The Chicago Mercantile Exchange, the New York Mercantile Exchange, the New York Commodity Exchange and New York Coffee, sugar and cocoa Exchange. Worldwide there are major futures trading exchanges in over twenty countries including Canada, England, India, France, Singapore, Japan, Australia and New Zealand.

INDIA AND COMMODITY MARKET

The history of organized commodity derivatives in India goes back to the

nineteenth century when Cotton Trade Association started futures trading in 1875. 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). During the first half of the 20th century, there were many commodity futures exchanges, including the Calcutta Hessian Exchange Ltd. that started in 1927. Those exchanges traded in jute, pepper, potatoes, sugar, turmeric, etc. commodity futures market has been a turbulent period in Indian history. The parliament passed the Forward Contracts (Regulation) Act, 1952, which regulated contracts in Commodities all over the India. After Liberalization and Globalization in 1990, the Government set up a committee (1993) to examine the role of futures trading.

INDIAN COMMODITY MARKET STRUCTURE

NATIONAL LEVEL COMMODITY EXCHANGE IN INDIA

NMCE (National Multi Commodity Exchange of India Ltd.)
NMCE is the first demutualized electronic commodity exchange of India

granted the National exchange on Govt. of India and operational since 26th Nov, 2002. Promoters of NMCE are, (CWC),(NAFED), (GAICL), (GSAMB), (NIAM) and (NOL). The Head Office of NMCE is located in Ahmedabad.
NCDEX (National Commodity & Derivates Exchange Ltd.)
NCDEX is a public limited co. incorporated on April 2003 under the

Companies Act 1956, It obtained its certificate for commencement of Business on May 9, 2003. It commenced its operational on Dec 15, 2003. Promoters shareholders are: (LIC), (NABARD) and (NSE)

 MCX (Multi Commodity Exchange of India Ltd.)

Headquarter : Mumbai, Owner : JIGNESH SHAH MCX is a demutualized nation wide electronic commodity future exchange. Set

up by Financial Technologies (India) Ltd. permanent recognition from government of India for facilitating online trading, clearing and settlement operations for future market across the country. The exchange started operation in Nov, 2003.
MCX equity partners include, NYSE Euronext,, State Bank of India and its

associated, NABARD NSE, SBI Life Insurance Co. Ltd. , Bank of India, Bank of Baroda, Union Bank of India, Corporation Bank, Canara Bank, HDFC Bank, etc. MCX is well known for bullion and metal trading platform.

 ICEX (Indian Commodity Exchange Ltd.)

ICEX is latest commodity exchange of India Started Function from 27 Nov, 09. It is jointly promoted by Indiabulls Financial Services Ltd. and MMTC Ltd. and

has Indian Potash Ltd. KRIBHCO and IFC among others, as its partners having its head office located at Gurgaon (Haryana).

REGIONAL COMMODITY EXCHANGE OF INDIA

BATINDA COMMODITY & OIL EXCHANGE LTD. THE BOMBAY COMMODITY EXCHANGE THE RAJKOT SEEDS OIL AND BULLION MERCHAT THE KANPUR COMMODITY EXCHANGE THE MEERUT AGRO COMMODITY EXCHANGE THE SPICES AND OILSEEDS EXCHANGE (SANGI) AHEMDABAD COMMODITY EXCHANGE VIJAY BEOPAR CHAMBER LTD. (MUZAFFARNAGAR) INDIA PEPPERS AND SPICE TRADE ASSOCIATION ( KOCHI ) RAJDHANI OILS AND SEEDS EXCHANGE ( DELHI ) THE CHAMBER OF COMMERCE (HAPUR) THE EAST INDIA COTTON ASSOCIATION (MUMBAI THE CENTRAL COMMERCIAL EXCHANGE ( GWALIOR ) THE EAST INDIA JUTE & HESSIAN EXCHANGE OF INDIA (KOLKATA FIRST COMMODITY EXCHANGE OF INDIA ( KOCHI ) BIKANER COMMODITY EXCHANGE LTD. ( BIKANER ) THE COFEE FUTURE EXCHANGE LTD. ( BANGALORE ) E SUGAR INDIA LTD. (MUMBAI)

QUALIFICATIONS FOR A COMMODITY

The product must not have gone through any complicated manufacturing

activity, except for certain basic processing such as mining, cropping, etc. In other words, the product must be in a basic, raw, unprocessed state. There are of course some exceptions to this rule. For example, metals, which are refined from metal ores, and sugar, which is processed from sugarcane.
The product has to be fairly standardized, which means that there cannot be

much differentiation in a product based on its quality. For example, there are different varieties of crude oil. Though these different varieties of crude oil can be treated as different commodities and traded as separate contracts, there can be a standardization off the commodities for futures contract based on the largest traded variety of crude oil. This would ensure a fair representation of the commodity for futures trading. This would also ensure adequate liquidity for the commodity futures being traded, thus ensuring price discovery mechanism.

 A major consideration while buying the product is its price. market demand

and supply for the commodity determine the commodity prices.

There should be many competing sellers of the product will be there in the

market. Their presence is required to ensure widespread trading activity in the physical commodity market.
The product should have an adequate shelf life since the delivery of a

commodity through a futures contract is usually deferred to a later date (also known as expiry of the futures contract).

COMMODITIES TRADED IN INDIA

TYPES METAL BULLION FIBER ENERGY

COMMODITIES Aluminium, Copper, Lead, Nickel, Steel Long (Bhavnagar), Steel Long (Govindgarh), Steel Flat, Tin, Zinc. Gold, Gold HNI, Gold M, i-gold, Silver, Silver HNI, Silver M,, Silver Micro. Cotton L Staple, Cotton M Staple, Cotton S Staple, Cotton Yarn, Kapas, Jute. Brent Crude Oil, Crude Oil, Furnace Oil, Natural Gas, M. E. Sour Crude Oil, ATF, Electricity(Now delisted), Carbon Credit. Cardamom, Jeera, Pepper, Red Chilli, Turmeric, Cumin Seed, Coriander. Guargum, Guar Seed, Gurchaku, Mentha Oil, Potato (Agra), Potato (Tarkeshwar)

SPICES

PLANTATION Arecanut, Cashew Kernel, Coffee (Robusta), Rubber. OTHERS

DIFFERENT SEGMENTS OF COMMODITY MARKET

There are two major segments of Commodity Market:
OTC (over the counter):
spot markets and are restricted for specific commodities. delivery based. The buyers as well as the sellers have their set of brokers who negotiate the

prices for them. This can be clarified with the help of the following example, A farmer, who produces castor, wishing to sell his produce, would go to the local 'mandi.' There he would contact his broker who would in turn contact the brokers representing the buyers. The buyers in this case would be wholesalers or refiners. In event of a deal taking place, the goods and the money would be exchanged directly between the buyer and the seller.

 EXCHANGE-TRADED MARKET:
Exchange-traded market also known as derivatives market is the place where

commodities are traded over the exchange.

It is standardized in nature and decently regulated. An exchange acts as an

intermediary to all commodity transactions, and takes initial margin from both sides of the trade to act as a guarantee. All the commodity exchanges are overseen by Forward Market Commission.

COMMODITY FUTURE MARKET

COMMODITY FUTURES

A Commodity futures is an agreement between two parties to buy or sell a specified and standardized quantity of a commodity at a certain time in future at a price agreed upon at the time of entering into the contract on the commodity futures exchange. The need for a futures market arises mainly due to the hedging function that it can perform.

OBJECTIVE OF COMMODITY FUTURE

Hedging with the objective of transferring risk related to the possession of

physical assets through any adverse moments in price. Liquidity and Price discovery to ensure base minimum volume in trading of a commodity through market information and demand supply factors that facilitates a regular and authentic price discovery mechanism.
Maintaining buffer stock and better allocation of resources as it augments

reduction in inventory requirement and thus the exposure to risks related with price fluctuation declines. Resources can thus be diversified for investments.
Price stabilization along with balancing demand and supply position. Futures

trading leads to predictability in assessing the domestic prices, which maintains stability, thus safeguarding against any short term adverse price movements. Liquidity in Contracts of the commodities traded also ensures in maintaining the equilibrium between demand and supply.

BENIFITS OF COMMODITY FUTURE

PRICE DISCOVERY:

Based on inputs regarding specific market information, the demand and supply equilibrium, weather forecasts, expert views and comments, inflation rates, Government policies, market dynamics, hopes and fears, buyers and sellers conduct trading at futures exchanges. This transforms in to continuous price discovery mechanism.
PRICE RISK MANAGEMENT:

Hedging is the most common method of price risk management. It is strategy of offering price risk that is inherent in spot market by taking an equal but opposite position in the futures market. Futures markets are used as a mode by hedgers to protect their business from adverse price change.

 USEFUL TO PRODUCER: Commodity trade is useful to the producer because he can get an idea of the price likely to prevail on a future date and therefore can decide between various competing commodities, the best that suits him.

USEFUL TO CONSUMER:
Commodity trade is useful for the consumer because he gets an idea of the price at which the commodity would be available at a future point of time. He can do proper costing/financial planning and also cover his purchases by making forward contracts. Predictable pricing and transparency is an added advantage.

 AN OPTION FOR HIGH NET WORTH INVESTORS:

With the rapid spread of derivatives trading in commodities, the commodities route too has become an option for high net worth and savvy investors to consider in their overall asset allocation.
COMMODITY DERIVATIVES MARKET ARE TRANSPARENT:

In the sense that the manipulation of prices of a commodity is extremely difficult due to globalization of economies, thereby providing for prices benchmarked across different countries and continents. For example, gold, silver, crude oil, natural gas, etc. are international commodities, whose prices in India are indicative of the global situation.

COMMODITY MARKET ECOSYSTEM

Buyers/Sellers or Consumers/Producers: Farmers, manufacturers,

wholesalers, distributors, farmers co-operatives, APMC mandis, traders, state civil supplies corporations, importers, exporters, merchandisers, oil refining companies, oil producing companies, etc. testing and certifying companies, valuers, etc.

Logistics Companies: Storage and transport companies/operators, quality

Markets and Exchanges: Spot markets (mandis, bazaars, etc.) and

commodity exchanges (national level and regional level)

Support agencies: Depositories/de-materializing agencies, central and state

warehousing corporations, and private sector warehousing companies

Lending Agencies: Banks, financial institutions

PARTICIPANTS OF COMMODITY MARKET

Participants who trade in the derivatives market can be classified under the following three broad categories:
HEDGERS SPECULATORS ARBITRAGERS

 HEDGERS
A Hedger can be Farmers, manufacturers, importers and exporter. A hedger buys or sells in the futures market to secure the future price of a

commodity intended to be sold at a later date in the cash market.

Helps protect against price risks.
The commodity contract, however, provides a definite price certainty for both

parties, which reduces the risks associated with price volatility.

Hedging can also be used as a means to lock in an acceptable price margin

between the cost of the raw material and the retail cost of the final product sold.

 SPECULATORS:
Do not aim to minimize risk but rather to benefit from the inherently risky

nature of the commodity market. They aim to profit from the very price change that hedgers are protecting themselves against. A hedger would want to minimize their risk no matter what they're investing in, while speculators want to increase their risk and therefore maximize their profits. In the commodity market, a speculator buying a contract low in order to sell high in the future would most likely be buying that contract from a hedger selling a contract low in anticipation of declining prices in the future. Unlike the hedger, the speculator does not actually seek to own the commodity in question. Rather, he or she will enter the market seeking profits by off setting rising and declining prices through the buying and selling of contracts.

 ARBITRAGERS:
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 continues till prices in the two markets reach equilibrium. Hence, arbitrage helps to equalize prices and restore market efficiency. Since the cash and futures price tend to move in the same direction as they both react to the same supply/demand factors, the difference between the underlying price and futures price is called as basis. Basis is more stable and predictable than the movement of the prices of the underlying or the Futures price. Thus, arbitrageur would predict the basis and accordingly take positions in the cash and future markets.

WORKING OF COMMODITY MARKET

There are two type of trade in commodities:
SPOT TRADING:

Spot Trading is the one in which one pays cash and carries away the goods.
FUTURE TRADING:

The underpinning for futures is the warehouse receipt. A person deposits certain amount of say, good X in a warehouse. 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. 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.

INTERESTING FACTS
Commodities in which future contracts are successful are commodities those

are not protected through government policies; (Example: Gold/ Silver/ Cotton/ Jute) and trade constituents of these commodities are not complaining too. This should act as an eye-opener to the policy makers to leave pricing and price risk management to the market forces rather than to administered mechanisms alone. Any economy grows when the constituents willingly accept the risk for better returns; if risks are not compensated with adequate or more returns, economic activity will come into a standstill. Worldwide, Derivatives volumes of non-US exchanges in the last decade, has been increasing as compared to the US Exchanges. Commodities are less volatile compared to equity market, but more volatile as compared to G-Sec's. The basic idea of Commodity markets is to encourage farmers to choose cropping pattern based on future and not past prices. Commodities Exchanges are working with banks to provide liquidity to retail investors against holdings such as bullion, cotton or any edible oil, much like loan against shares.