Commodity Markets

Commodity market facilitates an exchange of physical goods among residents in a country. Individuals aiming to diversify their portfolio can invest in both perishable and non-perishable items, not only decreasing risk but also offering a hedge against inflation in a country.

Commodities for trade are classified into the following categories depending on their intrinsic characteristics:

Hard commodities:

Precious metals include gold, platinum, copper, and silver.

Energy sources include crude oil, natural gas, and gasoline.

Soft commodities include agricultural products such as soybeans, wheat, rice, coffee, maize, and salt.

Livestock and meat includes live cattle, pork, and feeder cattle.

In 2019, major commodity markets in India mostly traded crude oil and silver. While crude oil is one of the most significant energy sources needed by almost every business, silver is one of the most valuable metals, apart from gold, with a consistent demand.

Because crude oil is in short supply locally, about 82% is imported from OPEC and Middle Eastern nations. Similarly, silver is sold in large amounts from nations like Mexico and Peru.

Investing in commodity markets

There are four main commodities exchanges in India that oversee commodity trade.

The following exchanges exist: MCX, ICEX, and NCDEX.

National Multi-Commodity Exchange (NMCE)

The Commodity Derivatives Market Regulation (CDMRD) of the Securities and Exchange Board of India regulates countrywide exchanges, which amalgamated with the Forward Market Commission in 2015.

Commodity markets promote the trade of both physical items and derivative contracts, with institutional investors and commodity brokers seeking to profit from the resale of products in the country’s retail sector.

A derivative contract, on the other hand, does not need a physical storage of the obtained products since people may trade commodities online using digitised contracts, making the transaction more easy and hassle-free.

Investors may practice trading in commodities markets by using futures or options contracts. While a futures contract requires participants to sign a deed stating that a product will be delivered at a later period for a specified price, an options contract functions as an agreement rather than a responsibility.

Futures contracts.

Future derivative trading is most frequent in the commodities market, when sellers enter into a futures agreement with brokers/buyers to acquire a certain number of things at a set price. A downturn in market prices may assist sellers realize margin gains, whilst a rising price might help purchasers or brokers earn from trades.

If the deal is controlled by a commodities exchange, it is referred to as a future derivative contract. Over the counter exchange trade refers to any settlement between two parties that occurs without the use of an intermediary exchange.

Both exchange-traded and derivative future contracts are used by two types of investors: producers who want to decrease variations in the final product price and speculators who want to benefit from the volatility of the futures contract.

Option contracts

As of 2017, SEBI laws allow for options trading while investing in top commodities, with traders having the right but not the responsibility to purchase/sell a commodity derivative at a defined price. Individuals who engage in commodities via such agreements might benefit from market changes since neither party is obligated to buy or sell things, depending on the kind of options contract.

Relationship between the Commodity Market and Stock/Bond Market

Commodity markets have an inverse relationship with stock and bond markets, with bond and stock values falling when the average price of items rises in the economy.

During periods of growing aggregate price levels or inflation, the prices of commodities traded on the corresponding market increase dramatically. Because severe inflation has a detrimental effect on consumers, the government often attempts to alleviate the situation by raising domestic lending rates via a repo rate rise. As borrowing costs increase, investors frequently cut their speculative demand for stock market assets, causing capital sector values to collapse.

The bond market is also influenced by the increase in lending rates charged by scheduled commercial banks, as interest on respective savings tools rises. As a result, fixed coupon bonds represent a less viable investment endeavor, resulting in an excess of bonds with little demand, leading bond values to decline.

While bond and stock prices move in the opposite direction of commodity prices, investing in commodities, particularly precious metals and energy sources, may result in huge profits for investors.

Traders in the commodity market

Commodity markets are important for two types of persons depending on their activities:

Hedgers

These investors seek to decrease their exposure to market volatility by investing into a futures contract with traders. The rate at which particular commodities are exchanged in the market is unaffected by price changes. The majority of hedgers trade physical items in the commodities market because they need them for manufacturing or resale.

Speculators

Speculators are investors who want to make significant gains from commodities trading. Before entering into a futures contract, such persons make a prediction about the direction of market price movement, and based on the accuracy of the forecast, positive or negative returns may be realized, subject to spot prices.

Speculators do not want actual custody of the products sold, thus they opt for a cash settlement to avoid the complications of physical trading.

Price Determination

Commodity market prices are significantly influenced by market demand and supply, both locally and internationally. Speculative news has a significant impact on commodities prices since socioeconomic factors have a strong effect on the production capability of different enterprises.

The elements that influence commodity pricing in an economy are addressed below:

Market Demand and Supply

Market demand and supply of items traded on a commodities exchange have a significant impact on market prices. Rising demand (for whatever reason) may generate short-term price increases since supply cannot be raised promptly to compensate for increasing market demand. In general, such an increase in demand may be linked to a dismal performance prognosis for the stock market, prompting investors to seek out comparatively safer investment opportunities.

Global Scenario

Global indicators have an important effect in setting the pricing of goods accessible inside a nation. For example, any upheaval in Middle Eastern nations may have an impact on the prices at which crude oil is exported, as well as the prices at which it is exchanged locally.

In this regard, a prominent example may be cited: in the 1990s, tensions between Iraq and Kuwait caused a supply shock that affected all major nations across the globe.

External considerations

Any situation impacting the overall output of prescribed items sold on an exchange might result in price variations. For example, an increase in manufacturing costs might raise the market pricing at which a product is sold, influencing the equilibrium rate.

Furthermore, the performance of the stock and bond markets influences commodity prices, since a poor outlook on their performance tends to direct investors into commodity market assets. Commodity derivatives are often traded to mitigate stock market risks and protect portfolios during downturns.

Speculative Demand

Speculative investors seeking to benefit from market price swings may drive demand for commodity derivative investment online. Speculators forecast price movements and cancel contracts before expiry to maximize cash profits.

Individuals who do not like to accept physical delivery of the products may opt for cash settlement contracts, in which the difference between the price in spot trading and the price mentioned in the futures contract must be paid at the end of the contract’s term.

Individuals may take a long or short position in a futures contract based on market expectations. Investors who predict the price to decline in the future might establish a short position (sell the asset at a preset price on a certain date) to benefit from a reduction in the market price. Individuals who predict the price of a commodities future contract to increase in the future might choose to go long (purchase the instrument at a fixed price on a certain date) in order to sell it at higher prices later.

Nonetheless, a futures contract tends to blend with the spot price at which a commodity trades on a future date, as prices adjust automatically to the predicted level.

Market Outlook

Any unexpected volatility in the stock market might encourage investors to turn their focus to commodity trading, since the likelihood of major price fluctuations in some commodities, such as precious metals, is minimal. As a result, commodities market investments are safe in nature and serve as a buffer against inflation for risk-averse investors.

Limitations

High risk.

The commodities market is volatile because variations in producing capacity, demand, or changing social situations have a direct impact on price movements. Commodity prices are very volatile, making it difficult to forecast their movements. Unexpected market developments may result in significant losses for investors.

As a result, before trading commodities, people must understand both the internal workings of an economy and exterior aspects such as international commerce. Additionally, demand and supply trends should be considered to further limit the risk.

Limited Returns:

Commodity investments only create capital gains, unlike stock and bond markets that provide monthly payouts like dividend yields and coupon payments.

While commodities market investments may provide huge profits, they need a high level of skill. Nonetheless, people may trade items on any recognized commodity market by registering with a commodities broker.