A commodity is a part of commerce that is interchangeable with other goods of the same type. Grains, gold, meat, oil and natural gas are few traditional examples of commodities. While the commodity market is an age-old concept with many empires built on the complex trading systems facilitating commodity exchange on the golden rule of supply and demand, today we will talk about the investor commodity market.
For investors, capital markets are lucrative, where one invests in equity and debt through stocks, bonds and mutual funds. Apart from these traditional securities, investors have an option to diversify their portfolio with commodity trading. Some investors rely on commodities as their prices tend to move in opposition to stocks and they become a safe bet during market volatility.
Due to the requirement of significant time, money, and expertise in commodity trading, it is not as popular as other instruments of investment. But this is slowly changing with the increase in awareness about the commodities trade and its better returns on investment for the investors. Today, huge amounts of commodity trading happen with just a few clicks through computers online. Advancements in technology have enabled people from all backgrounds to know, trade and gain from the commodity market.
What are the key aspects of the commodity market?
- Traded Commodities are broadly categorised in energy, metal, services, minerals and agricultural, with trading options ranging from base metals like zinc and aluminium to grains, pulses, coal, and gold.
- Though commodities provide an important way to diversify the portfolio of investors, it can be a risky investment at times when the market supply and demand is impacted by unpredictable uncertainties such as unusual weather patterns, epidemics and natural or man-made disasters.
- As stated above, key principles of supply and demand are what drives the commodity market. Low supply equals higher prices, so any disruption of supply in a particular commodity can see a higher price in trade. Similarly, an oversupply of a commodity can see a lower trade price of the commodity.
- Futures contracts, options, and exchange-traded funds (ETFs) are the number of ways to start investing in the commodity market.
What are the requirements to start commodity trading?
It is important to understand the requirements and know-how of the market before jumping into it.
- Demat Account: The foremost requirement to start trading is to acquire a Demat account. This is the same account used for trading in the stock market for shares and mutual funds. A Demat account can be easily opened with the NSDL or National Securities Depository Limited. This account stores your details of all the trades and instrument holdings digitally in one place.
- Trading Account: With a trading account you can freely buy and sell commodities to other traders. This happens through commodity exchange. You will require a broker to connect to these exchanges online. Since commodity trading makes heavy use of margin funding, you may have to do any additional paperwork with the broker.
- Commodity Exchanges: Just as the shares of various companies are listed on different indices for people to trade them, commodities are listed on their respective exchanges to enable trading of the same. There are 22 exchanges currently operating in India with the Forward Markets Commission being the regulator for them and all commodity trade activity in the country. Here are a few major exchanges listed below.
- Multi Commodity Exchange of India (MCX)
- Universal Commodity Exchange
- National Multi Commodity Exchange of India
- National Commodity and Derivative Exchange (NCDEX)
- Instruments of trade: It is important to know about the contracts involved in commodity trading. Just like futures, options or derivatives trades from the equity market, there are 2 major contracts in the commodity market.
Commodity investing can be initiated through a special form of an instrument called a commodity future. These are called cash-settled contracts too. It is a contract between a buyer and seller of a certain commodity, where the former agrees to buy the commodity at a future agreed date at a pre-agreed price. Traders can gain through this contract with the right planning of future pricing against the spot price of a commodity.
For example, Silver is trading at Rs 30,000 per KG in the commodity market. An investor buys the same at Rs 31,000 for a future date after 30 days. This means that buyer will have to purchase that kilo of silver for Rs 31,000 irrespective of the pricing at the future agreed date. Now the ups and downs of the market play a major role, If the silver reaches Rs 32,000 by the future date, the buyer will purchase it at an agreed price of Rs 31,000 making Rs 1000/- profit in the transaction. This is how the profit and loss are measured and the settlement amount is booked against both parties considering spot price, target price and the current price.
Apart from future contracts, there is a delivery-based contract available, where one has to produce warehouse receipts to make a trade. On the expiry date of the contract, the actual delivery of the commodity is done as per agreed terms in the contract.
For both the settlement contracts stated above, investors can choose between cash-settled or delivery based and keep a note of the same as the type of settlement can’t be changed on the contract expiry date.
- Understand how the market works
Fresh investors in the commodity market should start reading the charts and understand how volatility works. It will be beneficial to understand how price changes happen along with their impact.
Conclusion: Though it is encouraging to see more people getting involved considering it as a good investment, one has to exercise caution given the commodity market’s high volatility and high margins. To gain from the market, one has to keep on studying it, better understand the processes to make confident and intelligent trades. It is always considered good practice to consult a broker for best guidance and judgement for healthy returns on your investment.