A commodity market is a market where raw resources or basic goods can be bought, sold, or traded. Commodities are products that can be traded on any global market.
Commodities are frequently divided into Hard and soft categories. Soft commodities are agricultural products or livestock such as soybeans, sugar, coffee, wheat, maize, and pork while hard commodities such as gold, rubber, and oil are mined or extracted.
The Multi Commodity Exchange and the National Commodity and Derivative Exchange are the two most important commodity exchanges in India. Commodity trading takes place on numerous exchanges.
There are typically two types of commodity markets:
Physical commodity markets are where raw resources and agricultural goods are traded. On futures markets, agreements are negotiated to deliver the underlying commodities at a certain price on a particular date in the future.
A commodity market is a place where goods can be bought and traded. These goods are either primary agricultural products or raw materials. Commodities are distinct from goods created by service industries or in factories employing manufacturing techniques.
Working of Commodity Markets
Producers and buyers of commodity goods can access them in a centralised, liquid market thanks to commodities markets. These market participants can ensure future demand or output by using commodity derivatives.
A wide range of commodities can be used as an alternative asset class to diversify a portfolio and some commodities such as precious metals, have been considered to be ideal inflation hedges. Some investors also turn to commodities during times of market turbulence because the prices of commodities frequently move contrary to those of stocks.
Trading in commodities used to be primarily the domain of professional traders and needed a significant amount of time, money, and knowledge.
Types of Commodity Market
Spot markets or derivative markets are the two ways that commodities are traded. The trade of physical goods for prompt delivery takes place on spot markets, sometimes known as “physical markets” or “cash markets”.
Forwards, Futures and Options are traded on derivatives markets. The spot market is the underlying asset in derivative contracts called forwards and futures. These contracts grant ownership of the underlying at some point in the future for a price agreed upon today.
Until the contracts expired, physical delivery of the commodity or other items would not take place. Hence traders regularly roll over or close out their contracts to completely avoid making or receiving delivery. The fundamental differences between forwards and futures are that the former are customizable and traded over-the-counter (OTC), while the futures are standardized and traded on exchanges.
To trade in the Indian commodity market today, you must be conversant with commodity exchange trading. Commodities are exchanged on regulated markets called commodity exchanges. Rather than taking real delivery of commodities, traders might engage in futures contracts. A promise to buy or sell a certain quantity of a commodity within a predefined price range and the expiration date is known as a futures contract.
The prominent National Commodities Exchanges in India are listed below:
- Multi Commodity Exchange of India Ltd (MCX)
- National Commodity and Derivative Exchange (NCDEX)
- Indian Commodity Exchange (ICEX)
- National Stock Exchange (NSE)
- Bombay Stock Exchange (BSE)
Timings of Commodity Market in India
Trading in the commodity derivatives market is conducted on each day of the week (except Saturdays, Sundays, and holidays declared by the Exchange in advance). The commodity derivatives segment opens regularly at 9:00 AM Typical Market Closing Time is 23:30.
Prices Set for Trading on the Commodity Market
Commodities are by-products of basic economic activities such as drilling mining, and agriculture in contrast to produced goods and services. Commodities are traded on an exchange in a similar manner to that of stocks. The goals of share trading are to determine the true pricing of commodities to speculate on profits or assess cost risk. The concept of this type of trade has been around for a while with the commodities market being established by the stock exchange in Amsterdam.
Participants of the Commodity Market
If you want to understand how India sets the prices of products you should be familiar with the participants. The action of these players has an impact on market prices. Typically, there are two types:
Hedgers – Hedgers are businesses or industries that need a lot of raw materials. They are required to purchase these for a fairly fixed cost. For instance, the construction industry requires steel. As a price hedge, industries can commit to future purchases to guarantee that their steel demand will be satisfied at the present price. Consequently, a pattern of predictable pricing emerges, which manufacturers and industries appreciate since it makes it simpler to create effective future plans.
Speculators – Speculators are individuals who do not need a product in India. They are essentially typical investors looking to profit from changes in price. Usually, when people trade commodities, they buy cheap commodities and then sell them when the price of those commodities rises.
Online pricing computation similar to online stock trading, India has seen a boom in commodity trading. Commodity prices fluctuate in a similar way to how stock prices do. The following are the main factors influencing commodity prices:
Demand and Supply – The ideas of demand and supply have an impact on commodity pricing based on trading behaviour. When there are more buyers than sellers of a given product, the price of that commodity rises, and vice versa.
External Conditions – Weather and other external factors may have an impact on supply and demand. For instance, when it’s cold outdoors, the cost of heating could climb. Natural gas is therefore in great demand, which drives up the price of the product.
Eco-political factors – The politics and economy of a country affect fluctuation in prices in the commodity market. For example, OPEC (Organization of Petroleum Exporting Countries) members produce the world’s crude oil, and political or economic instability in one or more of these countries may have an effect on the price of this commodity.
Speculation – Speculators invest in commodities based on whether they think a particular commodity will be profitable or not. As a result, some commodity prices vary.
Commodity Market Regulation
The volume of daily trading across commodity market platforms has increased significantly over the past 20 years as a result of the maturing of various commodity markets around the world.
Since the establishment of MCX and NCDEX in India about two decades ago, both the volume of trading and the variety of products sold on the commodity markets has increased significantly, thanks to increased participation from retail buyers.
Nearly every country with an established system of commodities trading has regulatory authorities for the commodity market, almost along the same lines as they do for the stock market, such as the SEC in the US or SEBI in India. For instance, the Forward Markets Commission in India supervises and controls how the commodities markets operate.
The following are the functions of the Forward Markets Commission:
- To provide advice to the Central Government regarding the recognition of any association or the withdrawal of that recognition, as well as regarding any other issue relating to the enforcement of the Forward Contracts (Regulation) Act 1952. To execute the powers granted to it by or under the Act by keeping an eye on forward markets and taking any required measures in relation to them.
- To gather and, as the Commission considers it necessary, to publish information about the trading conditions for goods to which any provisions of the Act are made applicable, including information about supply, demand, and prices; and to submit to the Central Government periodic reports on the operation of forward markets relating to such goods.
- To offer general suggestions for enhancing the structure and operation of forward markets;
- To carry out the auditing of the accounts and other records of any registered or recognized association, as well as any of its members, whenever it deems it essential.
Commodity Vs Stock Market Trading
The majority of private investors find it impossible to participate in the spot or derivatives markets for commodities. In most cases, a unique brokerage account and/or specific credentials are needed in order to gain direct access to these markets. Pooled funds that traded commodities futures, like CTAs, normally only accept accredited investors because commodities are seen as an alternative asset class. Nevertheless, regular investors have indirect access to commodities through the stock market. There are numerous ETFs available now that track different commodities or commodities indexes, and stocks of mining and material firms often have a correlation with commodity prices.
These ETFs are available to investors wishing to diversify their portfolios, but for the majority of long-term investors, equities and bonds will constitute the majority of their holdings. Trading in commodities is frequently best suited for people with a higher risk tolerance and/or longer time horizon because commodity prices tend to be more volatile than those of stocks and bonds.
Advantages of Investing in a Commodity Market
Hedging Mechanism: The producers, importers, and exporters stand to gain the most from participating in the commodity market because it gives them a way of hedging price fluctuations. For instance, by selling a futures contract with a three-month expiration date, a farmer can shield himself from price volatility in wheat. A retailer, on the other hand, can safeguard themselves by purchasing a futures contract.
Fewer Manipulations: Compared to the financial markets, commodity markets deal in real, tangible goods that serve as raw materials for the manufacturing sector. Thus, unlike financial markets, commodity markets are driven by supply and demand and are less susceptible to manipulation.
Risky: Investments in commodities are risky since geopolitical events affect pricing significantly. Commodity markets are susceptible to operational failures due to systemic risk, so it is important to keep an eye on them to prevent unpleasant situations.
Leverage: Contrary to financial markets, commodity markets profit from a high level of leverage and low-margin requirements. High leverage ratios amid an economic downturn or unforeseen volatile market moves might raise losses even when they aid to improve potential profit.
Trading in commodities, and subsequently the development of the commodity market, can be dated to the beginning of human civilisation. They are merely additional kind of assets, much like stocks or bonds. The origins are different because they are more obvious. The similarity is that both contain sophisticated, complex derivatives that serve as quick money for speculators and hedging mechanisms for hedgers. The commodity market offers a platform for stakeholders to interact and take part in the final pricing of these products.