All you wanted to know about investing in commodities

What is commodity exchange?
Commodity exchange is an organized traders exchange in which standardized, graded products are bought and sold. Worldwide there are 48 major commodity exchanges that trade over 96 commodities.

What is commodity future?
Commodity future is a contract to buy or sell specific commodity, of a specific quality, at a specific price, for a specific future date on the exchange.

Commodity market in India:
Commodities market in India is vast, with over 30 major markets in operation alongside 7,500 small localized markets. As a result, the Indian Gross Domestic Product (GDP) is hugely dependent on agrarian commodities. Two years ago, the Government of India began an initiative to commission an effective nationwide commodity trading infrastructure. As a key element of this strategy, the Ministry of Consumer Affair, Food and Public Distribution envisioned a state-of-the-art nationwide commodity exchange, that by adopting global ‘best practices’ and technology standard, would ensure the efficiency of its members.
Major Commodities Exchange in India
:: Multi commodity exchange of India (MCX)
1. MCX is an independent and demutualized multi-commodity exchange. It was inaugurated on November 10, 2003 and is headquartered at Mumbai.

2. MCX has permanent recognition from Government of India for facilitating online trading, clearing and settlement operation for commodity futures market across the country.

:: National commodity and derivative exchange (NCDEX)
1. NCDEX is a nationwide, technology driven demutualized online commodity exchange. NCDEX was incorporated on April 23, 2003 under the companies’ act 1956. It commenced its operation on December 15, 2003.

2. NCDEX is the only commodity exchange in India promoted by national level institutions. It was promoted by ICICI Bank, Life Insurance Corporation (LIC), National Bank Of Agriculture and Rural Development (NABARD) and National Stock Exchange of India (NSE).

Major Commodities Traded at the Commodity Exchange
  1. Bullion – Gold, Silver
  2. Oil & Oilseeds – Castor Oil, Castor seed, Cotton Seed, Crude Palm Oil, Mustard/Rapeseed Oil, Groundnut oil.
  3. Spices – Jeera, Pepper, Red Chilli, Cardamom
  4. Metal – Aluminum, Copper, Nickel, Steel, Tin
  5. Fiber – Cotton, Kapas
  6. Pulses – Chana, Masoor, Tur, Urad, Yellow Peas
  7. Cereals – Rice, Wheat, Maize
  8. Energy – Crude oil, Furnace Oil
  9. Plantation – Cashew Kennel, Rubber
  10. Others – Guar seed, Mentha Oil, Potato, Suga
Advantages of Trading in Commodity Futures
  1. Diversified Investment- An investor can diversify risk by investing in commodity futures.

  2. Hedging- Investment in commodity is also useful for hedging. Commodities bear a low to negative correlation to traditional asset classes like Stock and Bond.

  3. Tremendous leverage- Investor need to invest only the margin amount, which is just a fraction of the value of the future contract as specified by the exchange.

  4. Physical delivery- Physical Delivery takes place when one buys/sell through accredited warehouse of a commodity exchange. They form an insignificant portion of total volume of trade transacted at the exchange.

  5. Extended trading hours- Commodity market are open from 10am to 11pm on week days and 10am to 2pm on Saturday.
Who is the Regulator?

The Forward Markets Commission (FMC) regulates the exchanges. Unlike the equity markets, brokers don’t need to register themselves with the regulator.

The FMC deals with exchange administration and will seek to inspect the books of brokers only if foul practices are suspected or if the exchanges themselves fail to take action. In a sense, therefore, the commodity exchanges are more self-regulating then stock exchanges.

Participants in Commodities Market
Hedgers- They face risk associated with the price of an asset. They use futures market to eliminate this price risk. For example: farmers, producers and consumers.

Speculators- They are participants who wish to bet on future movements in the prices of an asset. Futures allow them to leverage for taking bigger risks and increasing their potential for bigger gains or losses.

Arbitrageurs- They work at making profits by taking advantage between prices of the same product across different markets.( For instance, MCX-NCDEX or spot and futures market).

Investors- They work with a long-term horizon in mind. Such people can enter a particular contract and roll over to the next month contract allowing them good leverage, on payment of exchange stipulated margin.
Is stamp duty levied in commodity contracts? What are the stamp duty rates?
As of now, there is no stamp duty applicable for commodity futures that have contract notes generated in electronic form. However, in case of delivery, the stamp duty will be applicable according to the prescribed laws of the state the investor trades in.
Are there circuit filters?
Yes the exchanges have circuit filters in place. The filters vary from commodity to commodity but the maximum individual commodity circuit filter is 6 per cent. The price of any commodity that fluctuates either way beyond its limit will immediately call for circuit breaker.

Getting Started with Commodity Derivative Trading
Step 1- Choose a broker-Broker should be a member of exchange you wish to trade in.

Step 2- After choosing the Broker the investor has to sign the Member Client Agreement and fill the Client Registration Form.

Step 3- Depositing the margin-To start trading the investor has to deposit margin with his broker.
:: Margin are of 2 types
  1. Initial Margin- It varies from commodity to commodity and exchange to exchange normally it is 5 to 10% of contract size.

    Maintenance Margin- It is somewhat lower than initial margin. This is set to ensure that the balance in margin account never become negative.
If the balance in the margin account falls below the maintenance margin, the investor needs to top up the margin account up to the initial margin. Investor also has an option to withdraw excess amount from his account.
 

Step 4- The investor is given a unique client code.

Step 5- After having procured the unique client code the investor then places the order with his broker and the broker in turn passes the order to exchange.

Step 6- Investor finally receives the contract note showing detail of executed trade.

Step 7- Last but not the least –KEEP TRACK OF YOUR INVESTMENT.

 
 
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