Commodities are of various types, i.e. energy, precious metals, agriculture, metals and services. All of them are an essential part of everyday human life. A rise in crude oil price directly impacts a car driver or owner. The impact of drought on agricultural products directly influences the composition of your next meal.
Commodities are also a meaningful way to diversify a portfolio beyond the traditional stock market. It is either long term or as a parking space in unusually volatile or declining stock markets, as commodities traditionally move versus promotions.
Commodity trading isn’t a new concept. Earlier, people used to trade commodities for consumption even during the barter system, but now, the trade has financialized and has become a good vantage point for investors to earn returns.
Basics of the commodity market
Commodity trading in India has been regulated by the Securities and Exchange Board of India since 2015 when the erstwhile commodities market supervisory authority – the Forward Markets Commission – merged with it. There are more than 20 exchanges under SEBI, which offer investors the opportunity to trade commodities.
Traders can make use of commodity trading instruments provided by these exchanges to invest in commodities either through the spot market or through derivatives like futures. A future is simply a contract between a buyer and seller of a commodity that lays down the price and period of the exchange. Depending on the price volatility and movement in the market, the buyer can realize gains from a future if the price of the commodity rises beyond the price locked in the future contract.
A farmer can sell corn futures to protect himself against the risk of losing money if the price drops before harvest. Similarly, a trader might buy or sell wheat futures for delivery on a future date at a price decided now.
For example, Gold on a commodity exchange can be valued at Rs 3,000 per gram if you decide to invest in a futures contract. You will find a futures contract that expires after 30 days for Rs 3,300. Now you can buy this contract by paying part of the contract value. This part that you pay is called margin and allows you to get more product presence by spending very little.
Once you paid the margin, you agreed to buy a gram of gold from the seller after a month for Rs 3,300, regardless of its market price. If the price of gold on the market is now Rs 3,500 per gram, you have made a profit of Rs 300 per gram of gold. This is your profit from the futures contract and will be credited to your account.
How to trade
To be able to trade, however, one needs to open a Demat account with the National Securities Depository Limited (NSDL). The Demat account functions as a holding account for all your investments in a ‘dematerialised’ or electronic state. The Demat account can then be used through a broker to invest in commodities at any commodities exchange.
Some of the major commodities exchanges functional in India right now are:
- – National Commodity and Derivatives Exchange – NCDEX
- – Ace Derivatives Exchange – ACE
- – Indian Commodity Exchange – ICEX
- – National Multi Commodity Exchange – NMCE
- – The Universal Commodity Exchange – UCX
- – Multi Commodity Exchange – MCX
A commodity market works similarly to a stock market where the demand and supply of stock (commodity) determines its price. When the price of a commodity goes up, those who bought it at a lower price stand to make a profit if they sell it at that moment. However, derivatives like futures and options allow an investor to make gains on both sides of the price movement if they predict the future prices correctly.
While most people prefer to invest in just gold and silver on the market, there are many other options ranging from renewable energy to mining services. An investor needs to be aware of these commodities trading options as they offer the right level of diversification and investment opportunities to generate short and long term gains.
The available product categories are distributed as follows:
- – Agriculture: cereals, legumes such as corn, rice, wheat, etc.
- – Precious metals: gold, palladium, silver and platinum etc.
- – Energy: crude, Brent crude and renewable energy, etc.
- – Metals and minerals: aluminium, iron ore, sodium carbonate, etc.
- – Services: energy services, mining services, etc.
It is essential to keep in mind that products are often sold in batches, which means that you have to buy at least the minimum quantity and then a multiple thereof.