Commodities are the resources or raw materials that are used to manufacture refined goods.
Unlike finished goods, commodities are standardised, meaning that two separate units of a commodity in equal measure are identical irrespective of their origin or production. Thus, they are also interchangeable. Much like stock trading, wherein you can buy and sell shares of companies, with commodity trading you can do the same with commodity products. This trading happens on certain exchanges, and the aim is to generate profit from the changes in the commodity market through purchase and sale of the commodities. Trading commodities has evolved as a practice over the years. Moreover, the range of commodities in the market today is incredibly diverse. Let us look at the commodity exchanges in India and the different types of commodities traded in the commodity derivatives market.
Major Commodity Exchanges in India:
- Multi Commodity Exchange of India
- National Multi Commodity Exchange of India
- Indian Commodity Exchange
- National Commodity and Derivatives Exchange
Types of Commodity Market:
Typically, commodity trading occurs either in derivatives markets or spot markets.
- Spot markets are also known as “cash markets” or “physical markets” where traders exchange physical commodities, and that too for immediate delivery.
- Derivatives markets involve two types of commodity derivatives: futures and forwards; these derivatives contracts use the spot market as the underlying asset and give the owner control of the same at a point in the future for a price that is agreed upon in the present. When the contracts expire, the commodity or asset is delivered physically. The main difference between forwards and futures is that forwards can be customized and traded over the counter, whereas futures are traded on exchanges and are standardized.
The most traded commodities:
On the exchanges, you can trade in hard as well as soft commodities. Hard commodities include crude oil, metals, etc. and soft commodities generally have a shelf life and include agricultural commodities like wheat, soybean, corn, cotton, etc.
Globally, the most-traded commodities include gold, silver, crude oil, Brent oil, natural gas, soybean, cotton, wheat, corn, and coffee. Here is some insight into a few of these commodities
Crude oil is one of the most sought-after commodities. With several byproducts such as petroleum and diesel, the demand for crude oil is increasing every day, especially due to the boom in demand for automobiles. The high demand has even led to the eruption of geopolitical tensions all over the world. OPEC is a consortium of the nations that produce oil, and some of the top oil-producing countries are Saudi Arabia, USA and Russia.
Gold has always been an anchor for most people. When we see the price value of the US dollar fall, we start buying more gold for security and when the price value of the dollar goes up, gold prices tend to fall; they share an inverse relationship.
Soybean is also one of the top commodities, but is often impacted by factors like weather, demand for dollars and demand for biodiesel.
Types of commodities traded in India (Multi Commodity Exchange of India – MCX):
- Bullion: Gold, Silver
- Agricultural commodities: Black pepper, castor seed, crude palm oil, cardamom, cotton, mentha oil, rubber, Palmolein
- Energy:Natural gas, Crude oil
- Base Metals: Brass, Aluminum, Lead, Copper, Zinc, Nickel
Types of commodities traded in India (National Commodity and Derivatives Exchange – NCDEX):
- Cereals and pulses: Maize kharif/south, Maize rabi, Barley,Wheat, Chana, Moong, Paddy (basmati)
- Soft: Sugar
- Fibres: Kappa’s, Cotton, Guar seed, Guar gum
- Spices: Pepper, Jeera, Turmeric, Coriander
- Oil and Oil seeds: Castor seed, Soybean, Mustard seed, Cotton seed oil cake, Refined soy oil, Crude palm oil
Participants of commodity market:
Speculators drive the commodity market, along with hedgers. By constantly analyzing the prices of commodities they are able to forecast future price movements. For instance, if the prediction is that the prices will move higher, they will buy commodity futures contracts and when the prices do actually seem to move higher, they can sell the aforementioned contracts at a higher price than what they bought it for. Similarly, if the predictions indicate a fall in prices, they sell the contracts and buy them back at an even lower price, thus making profits.
Manufacturers and producers typically hedge their risk with the help of the commodity futures market. For example, if prices fluctuate and fall during harvest, farmers will have to face a loss. To hedge the risk of this happening, farmers can take up a futures contract. So, when the prices fall in the local market, the farmers can compensate for the loss by making profits in the futures market. Inversely, if there is a loss in the futures market, it can be compensated for by making gains in the local market.
What are the benefits of trading in commodities?
Transparency in trading transactions:
Since commodity trading takes place on the exchanges, there is no price manipulation by either buyers or sellers; there is total transparency. If the prices quoted by either party match, an exchange is executed. Price discovery of the commodities happens without manipulation, and this is one of the major plus points of online trading platforms. The lower margins in commodity futures are an incentive for small trades to utilise this sector for hedging risks and finding higher leverage.
Trading happens on exchanges with total transparency, therefore there is little to no danger of counterparty risk. The exchanges enforce proper risk management protocol in order to protect the investors.
Commodity prices are influenced by several factors which should be researched thoroughly in order to employ effective trading strategies. Having a solid understanding of the demand-supply chain is essential too. Additionally, note that with higher leverage, the risk of commodity trading rises too. So if you are a beginner, it is wise to consult research experts and monitor the market constantly.
Armed with the vital knowledge on the types of commodity trading, types of commodities and price movements, your commodity trading journey will be smooth-sailing.