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Commodity Market

Commodity is defined as any bulk good traded on an exchange or in the cash market. One of the first forms of trade between individuals began by what is called the barter system wherein goods were traded for goods. Lack of a medium for exchange was the sole initiator of this system. People sold what they had in excess and bought what they lacked. Animals were the first few commodities to be exchanged. Some examples of commodities include grain, oats, gold, oil, beef, silver, and natural gas. These markets are the meeting places of buyers and sellers of an ever-expanding list of commodities that today includes agricultural goods, metals and petroleum, but also products such as financial instruments, foreign currencies and stock indexes that trade on a commodity exchange.

History of the commodities market

In India , the futures market for commodities evolved by the setting up of the “Bombay Cotton Trade Association Ltd.”, in 1875.A separate association by the name "Bombay Cotton Exchange Ltd” was established following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association. With the setting up of the ‘Gujarati Vyapari Mandali” in 1900, the futures trading in oilseed began. Commodities like groundnut, castor seed and cotton etc began to be exchanged. Raw jute and jute goods began to be traded in Calcutta with the establishment of the “Calcutta Hessian Exchange Ltd”. in 1919. The most notable centers for existence of futures market for wheat were the Chamber of Commerce at Hapur, which was established in 1913. Other markets were located at Amritsar , Moga, Ludhiana , Jalandhar, Fazilka, Dhuri, Barnala and Bhatinda in Punjab and Muzaffarnagar, Chandausi, Meerut , Saharanpur , Hathras, Gaziabad, Sikenderabad and Barielly in U.P. The Bullion Futures

market began in Bombay in 1990. After the economic reforms in 1991 and the trade liberalization, the Govt. of India appointed in June 1993 one more committee on Forward Markets under Chairmanship of Prof. K.N. Kabra. The Committee recommended that futures trading be introduced inbasmati rice, cotton, raw jute and jute goods, groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, safflower seed, copra and soybean, and oils and oilcakes of all of them, rice bran oil, castor oil and its oilcake, linseed, silver and onions. All over the world commodity trade forms the major backbone of the economy. In India , trading volumes in the commodity market have also seen a steady rise - to Rs 5,71,000 crore in FY05 from Rs 1,29,000 crore in FY04. In the current fiscal year, trading volumes in the commodity market have already crossed Rs 3,50,000 crore in the first four months of trading. Some of the commodities traded in India include Agricultural Commodities like Rice Wheat, Soya, Groundnut, Tea, Coffee, Jute, Rubber, Spices, Cotton, Precious Metals like Gold & Silver, Base Metals like Iron Ore, Aluminium, Nickel, Lead, Zinc and Energy Commodities like crude oil, coal. Commodities form around 50% of the Indian GDP. Though there are no institutions or banks in commodity exchanges, as yet, the market for commodities is bigger than the market for securities. Commodities market is estimated to be around Rs 44,00,000 Crores in future. Assuming a future trading multiple is about 4 times the physical market, in many countries it is much higher at around 10 times.

Benefits of Commodity Trading Exchange

The commodity markets being cyclical in nature have inherent risks involved. Due to this, banks have kept away. The exchanges have brought expertise, control, and transparency of prices. Once the commodities are deemed negotiable and transferable, warehouse receipts can be an effective tool in the hands of farmers. They can then wait for prices to soar up before selling their produce. To encourage and assist farmers to use warehouse receipts, banks like ICICI are providing up to 70 per cent loans against de-mat receipts which are obtained from the exchange against physical produce. The idea is to transfer risk from the entity to the commodity, by aligning repayment of the loan to actual use of the commodity. Thus, the need for risk management strategies in this growth phase is very essential because most companies do not have a policy for managing commodity risk. Development of scientific tools for price discovery, promotion of contract farming and better weather forecasts will help increase confidence and attract investors to commodities. Some of the other benefits of having an exchange in commodity trading are:

  • Hedging - price risk management by risk mitigation
  • Speculation - take advantage of favourable price movements
  • Leverage - pay low margin to enjoy large exposure
  • Liquidity - ease of entry and exit of market
  • Price stabilization along with balancing demand and supply position
  • Flexibility, certainty and transparency in purchasing commodities facilitate bank financing.

Commodity Derivatives

Commodity Exchange is a platform where different types of market participants trade in wide spectrum of commodity derivatives. In other words, prices of contracts can be determined at present for goods to be delivered in future. This helps people to avoid wide fluctuations in the prices of the commodities. The Government issued notifications on 1.4.2003 permitting futures trading in the commodities, with the issue of these notifications futures trading is not prohibited in any commodity. Options trading in commodity are, however presently prohibited.

Pricing of commodities

Price forecasting of commodity involves analyzing commodity under using two methodologies i.e. Fundamental and Technical. Fundamental analysis of any commodity involves knowing facts such as production and consumption, import and export, distance between consuming center to producing center, cost of transportation, means of transportation, usual trade practice, cultivation period, impact of weather and technology on crop cultivation, scope and potential of production and consumption for particular commodity and its rivalry with other similar kind of commodity that may in turn may be near substitute for it. The relationship between cash price and futures price can be explained in terms of cost of carry. Cost of storage, cost of insurance and cost of financing constitute cost of carry. Cost of carry is an important element in determining pricing relationship between spot and futures prices as well as between prices of futures contracts of different expiry months. When there is expected shortage of physical commodity in the future then additional cost of holding the commodity is added to the spot price besides cost of carry, which is termed as Convenience Yield.

Latest introductions in the Commodities Market

According to the latest circular, demat account facilities have been opened for the members of MCX.The members were informed about the facility of converting the physical warehouse receipts into the electronic (demat) form and also the requirements of opening the demat accounts both by the members and their clients. The Exchange has advised the members to open the Clearing member (CM Pool) accounts with both the depositories. The government has changed the regulations in the commodity exchange. From an earlier policy of allowing corporate to hedge only a fraction of their physical market exposure, corporates can now almost double their participation in commodity exchanges.Extra limit on hedging will apply to domestic as well as international traders, who are trading from India . Apart from corporate this will also encourage participation from speculators, thanks to a possible deepening of the market in the coming days. Speculators will get more flexibility to cover up their open positions. Corporates until now could only trade within an upper ceiling fixed by the regulator and exchanges. Under the new system a corporate can now trade twice its earlier permissible limit if it can substantiate that the extra trading is used to hedge the price risk. Another development is that the APMC market at Navi Mumbai has become the first agri-commodity market to go live with the electronic price & information dissemination system. On June 14,2005 , National Spot Exchange for Agriculture Produce (NSEAP) and Multi Commodity Exchange of India Ltd. (MCX) launched India 's first ever ‘Commodity Suchana Kendra' a knowledge centre of commodities from spot and futures market price & information on fundamentals. The aim is to link the markets electronically in phases to create a “Common Indian Market” as being envisioned by the Union Government. The Commodity Suchna Kendra will display spot and futures commodity prices and also India 's first composite Commodity Futures Index ‘MCX-COMDEX.' computed & displayed on a real-time basis. NSEAP plans to set up ‘Commodity Suchna Kendras' at all APMC markets which would link all the agriculture physical market players over a period of time. It would also help in linking the support infrastructure from a single point access, thereby enabling the users to get all the assistance normally required for buying, selling, storing, transporting and payment of commodities.

This is the first phase of implementation where NSEAP is interlinking all key APMC markets electronically. In the second stage, the network established by NSEAP and MCX will be used by farmers, co-operatives and intermediaries in the APMC's for trading in commodities. Commodity specific grades, quality standards and delivery & settlement mechanism shall be laid down by NSEAP. The initiative by NSEAP will integrate the fragmented markets, create a new distribution channel for procurement & sale and enhance consumer-producer interaction with minimum intermediation, thereby truly integrating the rural India -The Next Green Revolution. Electronically networking the producers & consumers of agriculture commodities will help in creating a common nationwide market. In the long run it will enable and empower the farmers to sell their produce at better rates and directly use the intermediary network of NSEAP. The future for commodity market is bright. It is noteworthy that the commodity and equity markets have been moving in tandem, bucking the global market trend. The growth of a sizeable section of the middle class with increasing disposable incomes has led to a hike in consumer spend in India . Although there could be a correction in equity markets due to a slowdown in flows from foreign funds and high crude prices, the trend for commodities still appears healthy. Since the commodity cycle is normally for 10-15 years, the consensus is that strong demand for commodities will comfortably continue for another 10 years. The strong local demand for metals is expected to grow the commodities market and industry by about 7 to 8 per cent, while high purchasing power will boost consumer spending, whereas with crude price nearing record levels, there are fears that the equity market could crack in the near term


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