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COMMODITY OVERVIEW
Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts.
The trading of commodities consists of direct physical trading and derivatives trading. Exchange traded commodities have seen an upturn in the volume of trading since the start of the decade. This was largely a result of the growing attraction of commodities as an asset class and a proliferation of investment options which has made it easier to access this market.
Commodity includes all kinds of goods. FCRA defines "goods" as "every kind of movable property other than actionable claims, money and securities". Futures' trading is organized in such goods or commodities as are permitted by the Central Government. At present, all goods and products of agricultural (including plantation), mineral and fossil origin are allowed for futures trading under the auspices of the commodity exchanges recognized under the FCRA. The national commodity exchanges have been recognized by the Central Government for organizing trading in all permissible commodities which include precious (gold & silver) and nonferrous metals; cereals and pulses; ginned and unginned cotton; oilseeds, oils and oilcakes; raw jute and jute goods; sugar and gur; potatoes and onions; coffee and tea; rubber and spices, etc.
Commodity trading in India has a long history. In fact, commodity trading in India started much before it started in many other countries. However, years of foreign rule, droughts and periods of scarcity and Government policies caused the commodity trading in India to diminish. Commodity trading was, however, restarted in India recently. Today, apart from numerous regional exchanges, India has four national commodity exchanges namely, Multi Commodity Exchange (MCX), National Commodity and Derivatives Exchange (NCDEX), National Multi-Commodity Exchange (NMCE) and Indian Commodity Exchange (ICEX). The regulatory body is Forward Markets Commission (FMC) which was set up in 1953.
Commodities actually offer immense potential to become a separate asset class for market-savvy investors, arbitrageurs and speculators. Retail investors, who claim to understand the equity markets may find commodities an unfathomable market. But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand the risks and advantages of trading in commodities futures before taking a leap. Historically, pricing in commodities futures has been less volatile compared with equity and bonds, thus providing an efficient portfolio diversification option.
Like any other market, the one for commodity futures plays a valuable role in information pooling and risk sharing. The market mediates between buyers and sellers of commodities, and facilitates decisions related to storage and consumption of commodities. In the process, they make the underlying market more liquid.
Spot trading: Spot trading is any transaction where delivery either takes place immediately, or with a minimum lag between the trade and delivery due to technical constraints. Spot trading normally involves visual inspection of the commodity or a sample of the commodity, and is carried out in markets such as wholesale markets. Commodity markets, on the other hand, require the existence of agreed standards so that trades can be made without visual inspection.
Futures contracts: A futures contract has the same general features as a forward contract but is standardized and transacted through a futures exchange. In essence, a futures contract is a standardized forward contract in which the buyer and the seller accept the terms in regards to product, grade, quantity and location and are only free to negotiate the price.
The physical markets for commodities deal in either cash or spot contract for ready delivery and payment within 11 days, or forward (not futures) contracts for delivery of goods and/or payment of price after 11 days. These contracts are essentially party to party contracts, and are fulfilled by the seller giving delivery of goods of a specified variety of a commodity as agreed to between the parties. These contracts are mostly settled by issuing or giving deliveries. Very rarely do situations arise when unforeseen and uncontrolled circumstances prevent the buyers and sellers from receiving or taking deliveries. The contracts may then be settled mutually. Unlike the physical markets, futures markets trade in futures contracts which are (physical market), purchases and sales. Futures contacts are mostly offset before their maturity and, therefore, scarcely end in deliveries. Delivery of the commodity takes place during a future delivery period of the contract only if the option of delivery is exercised. Speculators also use these futures contracts to benefit from changes in prices and are hardly interested in either taking or receiving deliveries of goods.
Commodity futures differ from financial futures in the following ways: ·Financial derivatives are mostly cash settled whereas in case of Commodity futures physical delivery may also be given/ taken. ·Even in case of physical settlement, financial assets are not bulky and do not need special facility for storage. Due to the bulky nature of the underlying assets, physical settlement in commodity derivatives creates the need for warehousing. ·The concept of “varying quality of asset” does not really exist as far as financial underlying is concerned. However, in case of commodities, the quality of underlying asset can vary largely.
Forward contracts: A forward contract is an agreement between two parties to exchange at some fixed future date a given quantity of a commodity for a price defined today. The fixed price today is known as the forward price. Early on these forward contracts were used as a way of getting products from producer to the consumer. These typically were only for food and agricultural products.
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