Commodity Trading

“The price of a commodity will never go to zero. When you invest in commodities futures, you’re not buying a piece of paper that says you own an intangible piece of company that can go bankrupt.”
– Jim Rogers (Businessman, Investor, Author)

A Commodity Market facilitates trading in various commodities. Similar to Stocks in Capital Market, commodities are traded as investment/trading instruments in the Commodity Market. Trading in commodities is facilitated by Multi-Commodity Exchange (MCX), National Commodity and Derivatives Exchange (NCDEX) and National Multi-Commodity Exchange (NMCE), which are all regulated by the Securities and Exchange Board of India (SEBI).

Let’s get to know more about Commodity Trading, its types, benefits and how the market operates.

Benefits of investing in Commodities are different for different people. Let’s see what they are:

  • Types of Commodities

    Commodities that are traded in the exchange can be broadly divided as follows:

    In India, the commonly traded commodities can be divided into Metals (Precious Metals: Gold, Silver etc. & Base Metals: Copper, Zinc etc.), Agro (Turmeric, Soybean, Chana, Cotton, Cardamom etc.) and Energy (Crude Oil, Natural Gas etc.). However, there are various other commodities that are traded in the Commodity Markets of other countries like USA such as Live Stock and Meat which include Pork Bellies, Live Cattle, Feeder Cattle etc.

  • Trading Process

    Similar to Equity Capital Market, Commodity Markets also operate in both Spot & Derivatives, which is to say either trading on spot or on Futures or Options (Currently only Gold trades in both Futures & Options, all other commodities trade in Futures alone). In addition to this, certain commodities also have the feature of delivery, such as Agro Commodities and Precious Metals. This is to say that the commodities that are traded based on future contracts in the market are delivered to the holder of such contracts when the contracts reach the Delivery Period, and in case of non-deliverable commodities they are cash settled.

    Commodity markets operate differently for different segments of commodities as well. Let’s have a look at how Agro Commodities are traded to get a little more clarity:

    The commodity producer engages with a broker to initiate exchange trading for his commodity. The producer may either deliver the commodity directly to the warehouse or obtain the aid of a broker in doing so. Either way, the commodities stored at the warehouse must adhere to all regulations and policies with regard to quality etc., as specified by the exchange. The Commodity Contracts are traded before it reaches the Delivery Period. A rise in price of the commodity results in profit to the investor and loss to the producer, as the producer has fixed his price when he engaged in the Futures Contract with the Exchange. Thus even if the price rises he/she will have to sell at the lower price fixed in the futures contract. Likewise, when the prices fall, the producer is at an advantage and trader is at a loss. When the Contract hits the delivery period, the Exchange marks the contracts for delivery of the commodity and the broker facilitates the delivery at the warehouse, subject to the regulations imposed by SEBI. The traders holding the contracts take or receive delivery of the commodity.

    Let’s get see how to buy a futures contract and how it benefits you.

  • Buying a Commodity Futures Contract

    Much like a buying a stock future, Commodity future is also a much more efficient way to go in the market. Assume you want to buy Gold as in investment, presuming that the price will rise in the future and selling it will make you a profit. In the conventional method, you purchase gold, store them and sell them at a profit in future. In this case you will need to ensure you purchase pure gold, you will need to securely store it, safely transport it and in addition to these risks, you will need to pay the full amount right away when you make the purchase.

    Let’s see how Commodity Futures is the smarter choice. The investor may purchase the same volume of gold by purchasing Futures Contracts in Gold through a registered broker, for which the price is fixed at the present day market price. While buying the contracts, the trader only needs to pay up a fixed percentage of the whole amount (i.e. margin) right away. The remaining amount shall need to be paid when the Contract is marked for Delivery upon its expiry. Here the trader need not pay the whole amount at once, need not indulge themselves in the risk of pure/impure gold, storing, transporting etc. and if there exists a rise in price, the trader only needs to pay the price which was fixed earlier, and is thus at a profit.

    Another added benefit of trading in futures is for traders who aren’t looking to actually buying the gold, but looking to make profits on speculations of price changes. Thus, if there is rise in price before the contract hits its expiry, the trader may opt to sell the Futures Contract and book his profits and need not take delivery nor pay the whole amount.

Start Commodity Trading Today

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