India’s economy is growing at a fast pace. With more than 6% year-on-year growth in the GDP, the financial markets in the country are ripe for investors to make good returns on their money. Thus, with the rise in financial awareness, investors are looking for attractive options to invest their money and make handsome returns.
Apart from the basic tools such as a savings account or fixed deposits, more and more investors are now moving towards capital markets where they invest in equity or debt of various companies. Capital markets provide an opportunity to earn higher returns while building long-term wealth for these investors. But, the commodity market is catching up too.
In India, commodity trading isn’t too well known because of the lack of investor education about it but it’s fast becoming a hotbed of a lot of investment. Investors looking for diversification and stable returns are investing in commodities through commodity exchanges.
Investing in commodities such as gold or wheat provides the right kind of diversification to a portfolio and also hedges some risk as commodity prices have been observed to be less volatile than other instruments like stocks.
Basics of the commodity market
The Securities and Exchange Board of India governs the commodity trading activity in India since 2015 when the Forward Markets Commission merged with it. Forward Markets Commission was the erstwhile regulator of the commodities market. As of now, India has 22 commodity exchanges where investors can buy and sell commodities or related instruments.
Some of the major Indian commodity exchanges are:
- National Commodityand Derivatives Exchange – NCDEX
- National Multi CommodityExchange – NMCE
- Ace Derivatives Exchange – ACE
- Indian CommodityExchange – ICEX
- The Universal CommodityExchange – UCX
- Multi CommodityExchange – MCX
All exchanges offer commodity trading but one needs a Demat account which can be opened with a service such as the National Securities Depository Limited (NSDL). The functions of a Demat account include holding your securities (commodities and contracts, in this case) in an electronic or ‘dematerialised’ form for easy retrieval and reconciliation.
Once you have a Demat account, you will need access to a broker’s trading terminals to be able to place and execute orders for commodities on the exchanges.
Steps to trade
As an investor, you can buy and sell a whole variety of commodities on the exchanges. The range available to trade is as varied from gold to renewable energy.
Following are some of the categories of commodities that are available for trade:
- Agriculture: grains, pulses such as corn, rice, wheat etc
- Precious metals: gold, palladium, silver and platinum etc
- Energy: crude oil, Brent Crude and renewable energy etc
- Metals and minerals: aluminium, iron ore, soda ash etc
- Services: energy services, mining services etc
Through an exchange, one can place an order for any of these and the price of these commodities fluctuates through the day depending on the demand, supply and volumes of trades in that particular commodity.
Commodity trading instruments
One of the best ways to trade in commodities is through a futures contract. A future commodities contract is an agreement between a buyer and a seller where they both agree to exchange a certain quantity of a commodity for a pre-agreed price at a pre-decided date in the future.
It is important to remember that the price and date are not allowed to be altered once the futures contract is in place.
The gains from the contract will be based on the future movement of the price of the commodity.
Let’s look at an example to understand this better.
For instance, consider that gold is priced at Rs 72,000 per 10 grams right now. And an investor decides to buy a futures contract for the same which expires after 30 days and it is priced at Rs 73,000. Now, the buyer has agreed to buy 10 grams of gold at Rs 73,000 after 30 days from the seller of the futures contract irrespective of its market price on that day.
If the market price of gold on the day of the expiry of the contract is Rs 75,000, the buyer of the contract will gain on his investment as he could now technically buy gold at Rs 72,000 from his futures contract and sell it for Rs 75,000 in the open market. Hence, this is a profit for him which will be credited to his account.
Types of contracts
However, not all futures contracts are the same. These contracts in the commodity markets can be either:
- Cash-settlement futures or
- Delivery based contracts
While the example given above was of a cash-settled futures contract where no actual exchange of physical gold took place but a delivery-based contract will require the physical commodity to be exchanged between the two parties.
Those entering into a futures contract must indicate their preference for the settlement type because it can’t be changed once the contract period has expired.
Commodity markets in India offer a lot of variety in terms of the commodities that can be traded as well as the exchanges which offer a lot of depth to the market. Investors can find a broker which guides them through this journey as a deep understanding of all financial products is necessary to invest your money well.