Commodity Trading in India

1. Shields against inflation by profiting from rising prices.

1. Offers high leverage potential for magnified profits.

1. Provides diversification benefits due to low correlation with stocks.

1. Operates in a transparent market with fair price discovery.

Cons of Commodity Trading:

1. Involves risk of significant losses due to leverage.

1. Faces challenges of price volatility influenced by various factors.

1. May not always protect against inflation during economic downturns.

1. It has potential for lower returns due to its cyclical nature.

1. Carries risk of asset concentration in specific sectors.

Various Types of Commodities Traded in India

Retail traders have the choice to trade Futures and Options (f&o) of a variety of commodities. The commodities are divided into two major categories:

Soft Commodity - Agricultural products like seeds, wheat, fruits, and vegetables.

Hard Commodity - Products used in industry, such as metals, crude oil, and petrol.

These two commodities' Futures and Options (F&O) can be traded on various commodity exchanges. The National Commodity and Derivatives Exchange (NCDEX) and the Multi Commodity Exchange of India (MCX) are two of the most well-known commodity markets in India.

Types of Commodity Market

Trading in commodities usually takes place on spot markets or in derivatives markets.

Spot markets - The exchange of physical commodities for immediate delivery takes place on ‘spot markets,’ which are also referred to as ‘cash markets’ or ‘physical markets'.

Derivatives markets - There are commodity derivatives included in derivatives markets, namely, futures and forwards. While forwards can be customized and traded over the counter, futures are standardized and traded on exchanges. These derivatives contracts make use of the spot market as the underlying asset while offering the owner control of it at a point in the future for the rate decided in the present. The commodity or asset is delivered physically when the contracts become expired.

List of Commodities Traded in India

Some commodities in India's list of commodity markets are in high demand in the market. Here are a few of such commodities:

Agri Commodities

1. Soybean - Given its wide range of products, Indian soybean exports in 2022 totalled $50 million. Even though soybeans are one of the most popular commodities, factors such as the weather, biodiesel, and the demand for dollars have an impact on trade.
2. Cotton - Cotton is the most important textile fibre and natural fibre used to make clothing. India is one of the countries that produce the most of it.
3. Wheat - Wheat is a staple food in India and its export value stood at $2121 million in 2022. In addition to India's entire agri-commodity market, weather conditions and natural disasters have a big impact on wheat production and export.

Energy

1. Natural Gas - India holds the fourth-place position globally in importing natural gas. The import value of natural gas was $10.7 billion in 2021. With an overall contribution of 0.7% to the global reserve, India ranks 22nd with regard to natural gas reserves.
2. Crude Oil - India ranks among the largest importers of crude oil owing to its energy requirements. The two types of crude oils that serve as the benchmark for the commodity’s cost are West Texas Intermediate and Brent Crude Oil.

Bullion

1. Gold - Gold is one of the most expensive metals in the world. Most people hold it as a financial asset because it retains its value as a commodity despite inflationary periods.

1. Silver - Because silver has applications in numerous industries, it is in high demand. The three main sources of demand for silver in commodity trading are jewellery, investment, and industry. These three areas account for 95% of annual silver demand.

Base Metals

1. Zinc - India is a major producer of zinc due to its multiple applications in construction, electrical systems, and manufacturing. It produces 1.5 million metric tonnes of zinc annually, ranking it as the 8th largest producer in the world.
2. Aluminium - On an annual basis, India makes 2.8 million metric tonnes of aluminium. It is a favoured metal for commodity trading due to its wide range of applications.
3. Copper - Copper is a commodity trading favourite because of the high liquidity it offers.

Top Commodity Exchanges in India

Some popular commodity exchanges in India are listed below:

• Multi Commodity Exchange of India (MCX).
• Indian Commodity Exchange (ICEX).
• National Multi Commodity Exchange of India (NMCE).
• National Commodity and Derivatives Exchange (NCDEX).
• National Stock Exchange (NSE)
• Bombay Stock Exchange (BSE)

Types of Commodity Investment

Given below are the types of commodity investment in India:

Metals: This category includes a diverse range of metals such as iron, copper, aluminum, nickel, and precious metals like gold, silver, and platinum, which find applications in construction and manufacturing.

Energy goods: Commodities in this category, including natural gases and oils, are essential for both households and industries. Additionally, energy commodities like uranium, ethanol, coal, and electricity are also actively traded.

Environmental goods: This category comprises commodities related to renewable energy, carbon emissions, and white certificates.

Agricultural goods: A wide array of agricultural and livestock products is traded in commodity markets, such as sugar, cocoa, cotton, spices, grains, oilseeds, pulses, eggs, and feeder cattle, among others.

Some of the most commonly traded commodities globally include gold, silver, crude oil, Brent oil, natural gas, soybeans, cotton, wheat, corn, and coffee.

Commodity Trading in India by Exchange

MCX and NCDEX are the two primary commodity exchanges in India. The types of commodities that are traded on each of these exchanges are listed below:

How does Commodity Trading work?

In India, alongside the stock markets, commodity markets offer diverse investment opportunities, especially for those prioritising stability. These markets operate through a system where information about the prices of financial securities and specific commodities is displayed. This data is sourced from dealers who post bids and offers. The Indian commodity market comprises three key segments:

Brokers: Brokers are crucial in facilitating transactions within the commodity market. They act as intermediaries, connecting buyers and sellers. Brokers assume associated risks with their capital according to contractual agreements with clients. Their role involves ensuring that trades are executed smoothly and efficiently, often providing additional services such as research and advice to their clients.

Stock Exchanges: Stock exchanges serve as centralized platforms where buyers and sellers gather to trade commodities. Exchanges like the Multi Commodity Exchange

(MCX) maintain a dynamic list of commodities, regularly updating it to reflect market supply and demand dynamics. Trading can occur directly through exchange, at brokerage firms, or online from individuals' homes. These exchanges provide a regulated environment where participants can trade with confidence, knowing that there are established rules and mechanisms to ensure fair play.

Forward Contracts: Commodities are also traded through forward contracts, which are agreements between two parties to buy or sell an asset at a future date for a price agreed upon today. Farmers and exporters/importers use these contracts to hedge against price fluctuations. By locking in prices, they can protect themselves from adverse price movements, thereby stabilizing their financial planning and operations.

Example: Investing in Gold Futures on MCX

To illustrate how commodity trading works, consider an example where you decide to invest in a gold futures contract on the MCX. You enter this contract at a specified price for a certain amount of gold. MCX requires a margin, meaning you need to pay a small percentage of the total contract value upfront to secure the contract.

Margin Requirement: The margin is a good faith deposit, ensuring you have a stake in the contract. This upfront payment is a fraction of the total contract value, allowing you to control a larger position with a relatively small initial investment. For example, if you were trading a gold contract valued at a higher amount, you might only need to deposit a small percentage of that amount as margin.

Price Movements and Profit/Loss: Once the contract is in place, the value of your position fluctuates with the market price of gold. If the price of gold rises the next day, you would see a profit. This profit is calculated based on the difference between the contract price and the current market price, and it is credited to your linked bank account. Conversely, if the price drops, you incur a loss, which is debited from your bank account. These profits and losses are realised daily, reflecting the real-time market conditions.

Leverage and Risk: Commodity trading offers significant leverage, meaning you can control a larger position than your initial margin would allow. This leverage can amplify profits but also increases risk. Commodity prices can be volatile, subject to frequent and sometimes drastic fluctuations due to various factors like geopolitical events, economic data, and natural disasters. Therefore, while leverage provides the potential for higher returns, it also comes with the risk of larger losses.

Risk Management: Given the volatility and the potential for significant financial exposure, investors need to be vigilant. Effective risk management strategies are essential. These can include setting stop-loss orders to limit potential losses, diversifying

investments across different commodities to spread risk, and staying informed about market trends and factors that could impact prices. Additionally, it is crucial to regularly review and adjust positions to align with changing market conditions and personal financial goals.

Types of Commodity Investment Traders

The types of commodity investment traders are given below:

Speculators: Speculators in commodity trading aim to forecast whether the price of commodities, such as gold, will rise or fall. If they anticipate an increase, they purchase contracts at a lower price and sell them when the price rises to secure a profit. Conversely, if they predict a price decline, they sell contracts at a higher price and repurchase them at a lower price to profit regardless of the market direction.

Hedgers: Hedgers use commodity futures to shield themselves from price fluctuations. For instance, a farmer may be concerned about potential losses if wheat prices decrease during harvest. To mitigate this risk, the farmer enters into a futures contract.

If local wheat prices decline, the profit from the futures market can offset the loss. Conversely, if wheat prices surge during harvest, the farmer might incur losses in the futures market but can capitalize on higher local market prices.

Steps to invest in a commodity

The steps to invest in a commodity or start commodity trading are given below:

Choose a reputable commodity broker: Select a reputable commodity broker registered with major commodity exchanges after conducting market research to find the most suitable option for your needs. Initiate the process of opening a trading account with the chosen broker. Provide personal identification, financial details, and any necessary documents as guided by the broker.

Complete your KYC: Complete the Know Your Customer (KYC) process by submitting required documents such as identity proof and address proof as specified by the broker.

Provide funds to your account: Deposit funds into your trading account using various payment methods offered by the broker, such as bank transfers or online payments.

Do your research: Before engaging in trading activities, perform thorough research and analysis on the commodities you intend to trade. Consider factors such as supply and demand, market trends, global events, and weather conditions that may influence commodity prices.

Taxation and compliance: Ensure compliance with taxation regulations related to commodity trading in India. Understand the potential tax implications, including capital gains tax, based on your trading activity.

What are the ways to invest in a commodity?

Based on the types of commodities, you can choose in what types you would be interested in investing. Typically, there are four ways in which you can invest in commodities of your choice:

Derivative contracts: You can use the derivative contract to invest in a commodity.

Direct investment: You can invest directly in a commodity of your choice.

Buying commodity shares: You can purchase shares of the companies which produces commodities,

Commodity ETFs: You can purchase exchange-traded funds (ETFs) of the commodities of your choice.

Benefits of Trading in Commodities

The benefits of commodity trading are listed below:

Transparency in trading - Since commodity trading occurs on exchanges, there is complete transparency; neither buyers nor sellers can manipulate prices. A transaction is carried out if the prices offered by both parties coincide. One of the key benefits of online trading platforms is that the price discovery of the commodities occurs without manipulation. Because of the lower margins in commodity futures, small trades are encouraged to use this market to reduce risk and increase leverage.

Diversified investment portfolio - A well-designed asset allocation strategy is referred to as a diversified investment portfolio. The diversification of the investment portfolio is made easier by commodities. If you are interested in investing in stocks and bonds, you can invest in raw materials.

Risk management - Because trading takes place on exchanges that are completely transparent, counterparty risk is rarely an issue. The exchanges implement appropriate risk management procedures for safeguarding the investors.

Returns are profitable - If there is a high level of liquidity, commodities as investments become riskier. This implies that businesses may experience both significant profits and losses.

Trading with Reduced Margin - A margin deposit with the broker can range from 5 to 10% of the total contract value. Compared to other asset classes, this is lower. You can invest and take larger positions with lower capital because of low margins.

Hedge against inflation - Commodity prices can rise as a result of inflation. Commodities perform well when inflation is high, but they are also more volatile than other investment types.

Disadvantages of Commodity Trading

High Volatility: Commodity markets are known for their high price volatility, driven by fluctuations in supply and demand. This volatility can lead to significant price swings, offering the potential for higher returns but also increasing the risk of substantial losses.

Not necessarily immune to inflation: Contrary to the belief that commodities provide a hedge against inflation, they are not always immune to economic downturns. During periods of economic crisis, factors such as increasing inflation, unemployment, and reduced demand can negatively impact commodity prices.

Asset concentration: While commodities are considered a diversification tool, many commodities investments options focus on specific industries, leading to asset concentration within a particular segment of the market.

Leverage: While leverage can magnify profits in commodity trading, it also poses significant risks, especially for inexperienced traders. With leverage, traders can control large positions with a small margin. However, even a slight price movement against their position can result in substantial losses.

Low returns for buy-and-hold investors: Commodity trading often requires substantial investments to generate significant returns. However, historical data, such as the Bloomberg Commodity Index, indicates that even relatively secure government bonds have historically outperformed commodity investments. This is partly due to the cyclical nature of commodity markets, which may not favor buy-and-hold strategies.

How to Ensure You Choose a Suitable Broker?

Choosing the right commodity partner broker is a critical step in ensuring success in commodity trading. Here is a detailed breakdown of the process:

Research Potential Brokers: Begin by thoroughly researching the available commodity partner brokers. Look into their backgrounds, reviews, and reputation within the industry. This step helps you identify brokers with a solid track record and trustworthy reputation.

Assess Reliability: Evaluate the reliability of each broker. Look for information on their history of service, any regulatory actions, and feedback from other traders. A reliable broker is essential for ensuring the safety and security of your investments.

Evaluate Research Support: Consider the level of research support provided by each broker. This includes access to research reports, market analysis, and expert insights. A broker that offers comprehensive research resources can help you make informed trading decisions.

Review Trading Platforms: Examine the trading platforms offered by each broker. Look for platforms that are user-friendly, reliable, and equipped with essential features such as real-time market data, advanced charting tools, and order execution capabilities. The trading platform plays a crucial role in your overall trading experience.

Compare Brokerage Fees: Compare brokerage fees and commissions charged by different brokers. While low fees are desirable, it's essential to consider the overall value provided by the broker, including the quality of service and support.

Assess Customer Support: Prioritize brokers with responsive and accessible customer support. Test their customer service channels, such as phone, email, and live chat, to gauge their responsiveness and willingness to assist clients.

Conduct Due Diligence: Conduct thorough due diligence before finalizing your decision. This may involve contacting the broker directly, reading client testimonials, and consulting independent reviews. Ensure that the broker is transparent and forthcoming with information ab

Consider Additional Factors: Consider additional factors such as platform charges, account minimums, and regulatory compliance. These factors can vary between brokers and may influence your decision.

Make an Informed Decision: Based on your research and evaluation, choose the commodity partner broker that best aligns with your trading goals, preferences, and risk tolerance. Selecting the right broker is crucial for maximizing your chances of success in commodity trading.