Commodity Market – Types of Commodities, Participants involved, Contracts & more
Know everything about Commodity Market here & also understand in details about the various commodities traded in the market, how to invest in commodities market, participants & more.
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Know about Commodity Market
A commodity market acts as an intermediary between those who wish to trade in perishable as well as non-perishable physical goods.
This type of market usually attracts those traders who aim to hold a diversified portfolio, which is not limited to just stocks and bonds.
The history of the regulated commodity market dates back to 1848 in Chicago. This need arose as a response to the need for a regular supply of agricultural products.
Since then, commodity markets have flourished and become an integral part of a country’s overall economic growth.
There have been drastic changes in the methods of trade; however, the purpose remains the same.
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What are the types of Commodities Traded in the Market
Below is a list of the most popular exchange-traded commodities:
- Precious Metals: Aluminium, copper, lead, nickel, tin, zinc, steel, sponge iron
- Energy: Crude oil, furnace oil, Natural gas
- Bullion: Gold, Silver, I-gold, Silver M
- Fiber: Cotton yarn, kapas, Cotton S staple, Cotton M staple
- Spices: Jeera, pepper, turmeric, cardamom, red chili
- Plantations: Coffee, rubber, Arecanut, Cashew kernel
- Pulses: Chana, yellow peas, Masur
- Oil and oilseeds: Castor oil, coconut oil, crude palm oil, mustard seeds, mustard oil, refined sunflower oil, refined soy oil, sesame seed, soybean, soy seeds
- Cereals: Maize, guar seeds, Sugar M-30, Potato, Gurchaku, Guargum
- Livestock: Pork, feeder cattle, live cattle
These are the most commonly traded commodities in India. Crude oil, silver, and gold were the most demanded ones.
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Types of participants in the Commodity Market
Two kinds of traders enter in the commodity market. They vary from each other on the basis of the positions they take up in the market.
The psychology of both these segments varies a lot, and their actions affect the overall market situations. These groups are:
Speculators: This constitutes a significant chunk of the people who enter the commodity market. These traders earn by predicting the direction of movement in the market.
Based on their estimations, they sign future contracts. These speculators do not desire any physical possession or long term gains.
They enter the market for short term profits and exit as soon as their motive gets fulfilled. Their profits or losses depend directly on their market estimations.
If they are able to predict the right spot prices, they can earn huge profits.
Hedgers: These include the traders who wish to get physical possession of the commodities. Their main aim for entering into futures contracts is to save themselves from market volatility and inflation affects.
They enter into contracts for the delivery of goods at a later date, at a price agreed upon today.
How to invest your money in the Commodity Market?
In India, there are four major commodity exchanges. These are:
- Multicommodity Exchange (MCX)
- National Commodities and Derivatives Exchange (NCDEX)
- Indian Commodity Exchange (ICEX)
- National Multi commodity exchange (NMCE)
With the help of their branch network spread across the country, these exchanges help facilitate the smooth trading of commodities across the country.
These exchanges are regulated by the Securities and exchange board of India (SEBI) The traders can enter for both derivative contracts as well as physical possession of goods in this market.
The institutional investors and commodity brokers enter the market intending to secure physical possession of the goods so that they can be sold in the retail markets for better prices.
The speculators, on the other hand, enter into derivative contracts that are digitized. These contracts are made with the only purpose of short term profits in the market.
In order to be able to assume any position in the market, the traders first need to open a Demat account with any of the exchanges.
They also need a trading account with the stockbrokers. With the help of these accounts, they can quickly and conveniently trade in the commodity markets from the comfort of their homes.
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Types of contracts in the Commodity Market
In the commodity market, the investors can either enter into a futures contract or an options contract.
Futures contract: This is the most common type of contract in the commodity market.
With the help of this binding derivative contract, the traders agree to buy a fixed quantity of physical goods, at a price agreed upon today, after a stipulated period of time.
All the conditions are mentioned in the contract. When such contracts are made under the supervision of an exchange, they are known as exchange-traded contracts.
However, when these are done outside the control of any regulatory body, they are known as counter exchange trading.
The people who enter into these contracts mainly include- the producers who wish to save themselves from any market fluctuations and the investors who want to earn from these price fluctuations.
An uptrend benefits the buyers, whereas a downtrend benefits the seller in the market.
Options Contract: In this type of contract, both parties are clear about the fact that they do not aim to get the physical possession of the commodity.
They just enter the market to benefit from the price fluctuations and market conditions. Based on their estimation of the price movement, they either take a put option or call option.
These are usually undertaken by speculators who enter the market with the sole aim of earning short term profits and exiting.
How price is determined in commodities exchange?
The market forces of demand and supply, both at the domestic as well as international level, play an essential role in the process of price determination in the commodities exchange.
Both domestic, as well as foreign forces, are considered since commodity markets operate on a global level.
The news and other international events might also affect prices. This is because the physical production and distribution of goods are affected by the country’s overall socio-economic conditions.
Factors which affect the Prices in Commodities Market
Here are the few factors which affect price in commodity markets in India.
Market demand and supply affect the overall prices of commodities in the market. In the short run, when demand rises exceptionally, the prices soar up as it is impossible to increase the supply.
This creates a negative market outlook. The investors shift to other avenues to get better gains. On the other hand, if demand falls, the excess supply leads to a fall in the prices, attracting some market participants.
The chance of severe changes is lesser in the commodity market when compared to stocks. This is because of the nature of the products traded.
When there are unforeseen fluctuations in the stock markets, the investors switch to the commodity market as a safer avenue.
There is no country that has an abundance of all commodities. Hence the need for trade arises. For example, India is a leading producer of agricultural products, whereas crude oil mainly comes from Middle Eastern countries.
When there is some internal issue in these countries, the overall supply of that specific quantity suffers. The Iraq-Kuwait border tensions in the 1990s are the perfect example to understand this.
During this time, due to their internal conflicts, the supply of oil to all the countries was majorly affected. The entire crude oil market experienced a supply shock.
Some factors like cost of production, changes in taxations, etc., which are out of the control of the business, affect the overall price of the commodity.
When the cost of production rises, the total price also increases in the market.
Many investors enter into the commodity market derivatives due to its safe nature; they wish to not only diversify their portfolio but also safeguard themselves from the risks that occur in the stock markets.
Global News and Events
The news can turn the markets upside down because the speculators consider the news as an essential cue for deciding the trend in the market.
If there is any negative news related to any commodity, the market has a negative outlook.
The speculative demand rises based on positive information, which leads to a rise in prices, as discussed above.
Benefits of the Commodity Markets
By entering in the commodities market, the traders can gain the following advantages:
Portfolio diversification: No smart investor puts all his money in a single type of investment. Commodity market contracts are much safer avenues for investing and diversifying the portfolio.
The returns are also much higher here than equity. So, even if the stock markets have a negative outlook, the investor can still earn positive portfolio returns from their investments.
Margin trading: The brokers offer lower margins in the commodity markets. This allows traders to benefit from the fact that they can use more borrowed money.
The hedgers and speculators can both benefit through this. Those commodity traders who aim for the physical delivery of goods can benefit from the lower margins when they place bulk orders.
Scope of high returns: While many commodities are known for their stability, there are some which are popular for their price fluctuations. Crude oil is one typical example.
The prices of crude oil fluctuate based on the mining problems or the overall socio-economic conditions of the major exporting countries.
This high volatility attracts the speculators who aim to benefit from the short term price movements.
Hedging: The price of precious metals like gold and silver is expected to rise over time. By entering into futures derivative contracts, the investors tend to add value to their portfolio.
The demand for such commodities is expected to increase steadily, and no major fluctuations are expected. This helps investors add value to their overall investments without taking any major risks.
Cons of the Commodity Market
While the above pointers may make you feel like the commodity market is the most lucrative investment avenue, and you should go all-in, you should consider the below-mentioned cons of this market:
High Risks: The higher the potential for profits, the higher is the risks associated. Since the market forces are not the only price determinants in the commodity market, there is a very high risk.
The volatility is a significant problem. The prices of commodities are affected by the overall society as well as the economic conditions of the countries.
Thus, a study of the global outlook is essential before entering into any commodity trades.
Limited Return Opportunities: Unlike stocks and bonds, which yield dividends and interest, respectively, there are no such returns associated with commodities.
The speculators can only benefit from the price movements. Those who wish to get the physical possession benefit from the price movements at the time of delivery.
Conclusion: Commodity Market
Undoubtedly, the commodity markets are a great investment avenue. However, in order to be able to encash this market, a level of expertise is required.
One needs to have a good understanding of the markets’ functioning before entering into any trade.
There are a majority of factors that affect the prices of the commodities, and all of them need to be carefully analyzed before trading.
Talking specifically about India, there is a lot of development scope in the commodity market, and it can act as a wheel for the overall growth and regulation of the agriculture sector.
India is a significant producer of agricultural products; however, it is still not a leading exporter of these products due to quality issues.
NCDEX is playing a major role in the regulation of quality assessments. Thereby helping improve the overall conditions of the farmers.
Also, there are many price regulations imposed, external to the market forces which disturb the overall commodity market. If the market demand and supply forces are allowed to act independently, the results might be better.
Commodity markets might look complicated, but they are an excellent way to diversify your portfolio.
Developing an understanding of this market helps you safeguard your overall capital from giving negative returns.
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