Capital markets have become an important part of the Indian economy. A flourishing capital market would not have been possible without exchanges such as the National Stock Exchange and the BSE. But before trade with the help of currencies had originated, trade used to take place supported by commodities. The commodity trade probably predates any other form of trade. In modern times, a large part of commodity trade takes place through exchanges that facilitate trade in commodity derivatives. Major commodity exchanges in India together clocked trade volumes worth over Rs 60 lakh crore in 2017-18.
Even though millions of deals are struck through commodity exchanges every day, they are still not as well-known as the stock exchanges. The lack of awareness about commodity trade could be a reason for low participation. Let us take a look at some of the advantages of commodity trading.
Helps in diversification
Commodities can be a potent tool for diversifying your portfolio. Commodities generally have a low or negative correlation to other asset classes such as equities and bonds. The availability of a wide variety of options too helps in achieving diversification. Commodities include everything from sugar, soya and corn to gold, silver and steel. For instance, when economic growth is uncertain equities come under pressure, but the price of gold rises due to the movement of money towards safe assets.
A large number of investors use commodities for hedging. Commodities like sugar, iron, maize or copper are a major input material for a large number of industries. Investors take an opposing position in the commodities futures market to protect against price fluctuations. You can also hedge against certain events through commodities. An oil shock may be negative for the equity markets but will lead to a surge in prices of crude oil.
Protection from inflation
In a country with high inflation, commodities can help you remain insulated. Inflation leads to the erosion in the value of the currency and hence affects the value of equity and bond holdings. However, the value of commodities like gold and silver remains intact as they have high intrinsic value.
Many people equate commodity trading with the actual movement of a large quantity of commodities, which could be difficult to sell if required. However, trading through commodity exchanges is completely different. While one can take physical delivery also, investors generally trade in commodity derivatives. Derivatives can easily be liquidated just like other financial assets like equity and bonds.
How to trade?
While the advantages of commodity trading are clear, how does one trade in commodities? You can safely trade in commodities without worrying about counterparty risks through commodity exchanges. India has multiple commodity exchanges, but MCX or the Multi Commodity Exchange is the largest. The exchange facilitates the trading, clearing and settlement of commodity futures in India. It was established in 2003 and was regulated by the Forward Markets Commission or FMC. After the merger of FMC with the Securities and Exchange Board of India, MCX currently operates under the regulatory framework of SEBI.
The MCX has different divisions for different market activities like the trading and surveillance unit, clearing and settlement unit, delivery unit and the warehousing and logistics division. Commodities of all the four major types—bullion, base metals, energy and agro commodities—can be traded through MCX. The Multi Commodity Exchange has made trading in commodity futures simple and transparent, but before starting one should know the factors that affect commodity prices in India.
The bulk of commodities traded through commodity exchanges are agricultural commodities. Weather conditions have a significant impact on the production of agricultural goods affecting the price of the commodity.
Economic and political conditions
The performance of the broader economy has a direct bearing on the demand for commodities. If the economy is robust, the consumption of commodities rises and also the price. Along with economic conditions, political events also impact commodity prices. For instance, the closure of a major mine can curtail the supply of the specific commodity and lead to a rise in prices.
The government can directly as well as indirectly influence commodity prices. The government controls the production of several commodities like coal, and also procures many commodities like wheat and rice. Any change in the procurement or production pattern can have a substantial impact on the prices.
Trading in commodities can be rewarding if done with the right strategy and through credible platforms like MCX. Commodity exchanges also ensure standardisation and help the investors get a better idea of the transaction.