A beginner’s guide to commodity markets

The wheat used to make our chapatti, the cotton we wear in our clothes, the gold used in our jewellery, the fuel that runs our cars, etc; are all traded across the world in major exchanges. Outside the equity fanatic world exists’ a small but powerful community, which earns a good amount of money by trading in these items. Earlier it was more done in need based form or barter as we can term it. But now it has taken a huge gigantic shape and size. This market is commonly referred as commodities markets.

A humble beginning – Gap between demand & supply

In India organized form of commodity trading market started in 1875, when traders came together in Bombay Cotton Trade Association. It later got converted into Bombay Cotton Exchange Ltd. Later on oilseeds, castor seeds, groundnuts, spices and materials like jute etc joined the commodities market.

With the beginning of economic liberalization, importance of organized commodity trading had gained momentum. Commodities markets are governed by the Forward Contracts (Regulation) Act, 1952. It is a division of the Ministry of Consumer Affairs, Food and Public Distribution. As early as 2002 (ten years after liberalization), there were around 20 commodity exchanges in India, trading in 42 commodities.

What is commodity market?

A commodity market is a highly volatile and risky derivative market. It deals in future pricing trends of the underlying commodities. The Commodity index constituted on NSE is not same as the commodity market. These offer immense potential to become a separate asset class for real taking investors, arbitrageurs and speculators.

Where do commodities markets invest our money?

The exchanges deal in agricultural products, metals including precious metals and energy resources. Some of commonly traded items:

Agricultural	Industrial Metals	Precious Metal	Energy
Coffee	Copper	Gold	Crude Oil
Sugar	Lead	Platinum	Natural Gas
Cocoa	Zinc	Palladium
Maize	Tin	Silver
Rough rice	Aluminium
Soybean	Nickel
Wheat
Sunflower Oil
Barley
Dal

               (Source – Kotak Commodities)

How we begin commodity trading?

1)  Choose your broker

You can begin trading in commodities by registering with brokers who are affiliated in either one of the national commodity exchange market in India:

1)   National Commodity and Derivative Exchange –

 http://www.ncdex.com/Index.aspx

2)   Multi Commodity Exchange of India Ltd - https://www.mcxindia.com/

3)   National Multi Commodity Exchange of India Ltd - http://www.nmce.com/

These exchange facilitate trading and settlement in commodity markets. Globally, to deal in precious metals we have to register or fid a broker for NYMEX, LME or COMEX. A complete list of brokers can be made on respective websites.

2)  Deposit Margin Money

Margins are of two types, the initial margin and the maintenance margin. They vary with commodities and exchanges usually the initial margin ranges from 5-10% of the contract value.

The maintenance margin is mostly lower than the initial margin. They depend on the movement achieved in the customer’s account depending on his mark to market position. If there is any profit there is an option to withdraw any extra funds from his margin account. However, if the account falls below the minimum requirement the investor needs to top up his account to the minimum. The trading can begin with as low as Rs.5000.

3)  Read about the commodity movements

Read financial newspapers for information on spot prices and for relevant news and articles on most commodities. Weather and other government policies also play a major role in these products, so keep an eye on them too. Brokers also provide research and analysis support. Beyond this for precious metals and energy resources global news are very significant impact makers.

So once the above is done, you just need to attach your bank account to the broker trading account and create a demat account for commodity trading like equity. The charges and brokerage would be made available by brokers at the time of signing of contract.

Commodity trading is most done as speculative trading so the preferred mode of settlement is cash but if you want to take delivery on expiry of contract, the exchanges do have warehouses. So, in that case you need to preserve the warehouse receipts. In case of physical delivery, you might be charged sales tax. 

Where can I go in case of any complaint or default in contract?

The FMC maintains details about the exchange administration and seek timely intervention to inspect the books of brokers. In case of any misappropriation or foul practices are found or if the exchanges themselves fail to take action, the FMC would step ahead.  If there is any default in settlement by either party in contract, then the exchanges maintain sufficient funds to protect the investor from any loss. 

So go ahead and take a plunge, in the really interesting world of commodity trading.”Aate dal ka bhav pata chal jayega”, I mean it literally.

Regards,

Saarthi Financial Planners