Role of Commodity Markets in India
The Indian financial market offers numerous ways, apart from equity, to invest, diversify and ensure a positively healthy portfolio. One such method is commodity trading. The commodity market in India is over 100 years old but was officially established through a legal trading mechanism in the year 2003. As every country relies on raw materials to grow, the commodities markets have a special place in driving a country’s economy and allowing investors to profit along the way.
What is the commodity market?
Similar to trading company shares in the Stock markets, commodities are bought and sold in the commodities markets in India. This financial market is widely utilised by producers, manufacturers, and wholesale traders as a price discovery mechanism for various goods and commodities.
Much like with the stock market, there are dedicated commodity exchanges that enable the market participants to buy and sell commodities online easily. In fact, three primary commodity exchanges are currently operational in India - the MCX (Multi Commodity Exchange) , National Commodity and Derivatives Exchange (NCDEX), and Indian Commodity Exchange (ICEX)
What are the different types of traded commodities?
Although there are thousands of commodities that you can trade in commodity markets in India, they have been categorised in certain sectors. Below is a list of sectors along with their commonly traded commodities:
| Commodity sectors | Constituents |
|---|---|
| Agriculture | Grains: Rice, Basmati rice, wheat, maize, jeera. Oil and oilseeds: Castor seeds, soy seeds, castor oil, refined soy oil, soy meal, crude palm oil, groundnut oil, mustard seed, cottonseed, etc. Spices: Pepper, red chili, jeera, turmeric, and cardamom. Pulses: Chana, urad, yellow peas, tur dal. |
| Metals and materials | Base metals: Aluminum, copper, nickel, zinc, tin. Bulk commodities: Iron ore, coking coal, bauxite, steel. Others: Soda ash, chemicals, rare earth metals. |
| Precious metals and materials | Gold, silver, platinum, and palladium. |
| Energy | Crude oil, natural gas, Brent crude, thermal coal, alternate energy. |
| Services | Oil services, mining services, and others. |
How to trade in the Commodities market?
You can trade in the commodities market through the following two contracts:
- Forwards Contracts: This contract is an agreement between two parties to sell or buy a certain commodity at a fixed price in the future. This contract hedges the risk for the buyer against price fluctuations, and the seller can get a guaranteed price for his product at a specified date.
- Futures Contract: Futures contract is an agreement between two parties who agree to buy or sell a particular asset at a specified date and at a predetermined price. The payment and delivery of the asset are made at a future date, termed the delivery date. The buyer in the futures contract is known to hold a long position and the seller in the futures contract is said to be having a short position.
Importance of Commodities Market in India
The commodities market in India holds value for the country’s economy and people who earn a living through commodities and investors. The important features of the commodities market include:
Price Discovery: The commodities market in India allows a transparent way to discover the real price of the commodities such as pulses, spices, cotton etc. The market ensures that they don’t sell their commodities to intermediaries at a cheap rate and incur huge losses in the process.
Superior Quality: The commodities market has strict policies related to the quality of the commodities that are traded on the exchanges. The policies result in a superior quality of commodities throughout India and benefit both the supplier and the end customers.
Better hedging against losses: Farmers and extractors of various commodities find an ideal way through the commodities market to mitigate their losses. They can sell commodities futures and options to ensure they get a predetermined price for their commodity irrespective of price fluctuation.
Diversification: For investors, trading in the commodities market in India offers a great way to diversify their portfolios. As commodities have an inverse relationship with equities and bonds’ prices, investing in commodities can safeguard an investor’s capital if the equities and bonds market fall.
Leverage: Trading in commodities futures involves the use of leverage through margin, which is maintained with the broker. Hence, one large transaction can be executed with a smaller amount of cash in hand.
Role of commodities market In India
Realizing the importance of the commodities market in India, the role of the commodities market in India is pivotal to the country’s growth and safeguarding the interest of its citizens. The market plays its role through the following factors:
Food Security: The commodities market in India play a crucial role in ensuring that the suppliers of commodities are protected against falling prices. They can utilise the commodities futures contracts to lock in a price that they think is apt for their products. It ensures that there will be an adequate supply of commodities throughout the country.
Better agriculture infrastructure: Within the commodities market, farmers suffer at the hands of inadequate post-harvest infrastructure. Even though they produce a high quantity of commodities, the lack of adequate warehousing, transport etc., forces them to suffer losses. Commodities market offers profits to farmers, brokers, intermediaries and customers. Thus, attracting investments in the agriculture sector in the hope of better long term profits.
An organised platform:Before the commodities market, the farmers or the suppliers of commodities only relied on middlemen to sell their products. It forced them to take whatever amount the middlemen offered. However, today, the commodity market ensures that they can utilise an organised platform to trade their commodities and realise an adequate price.
A new asset class: The role of the commodities market is not limited to farmers or suppliers but extends to offer a new asset class for investors seeking profits. By trading in commodities, they can hedge against losses from other asset classes, diversify their portfolio, while helping in the overall growth of the commodity sector in India.
Mitigates Volatility: This is one of the most important roles of the commodity market in India. It helps protect the originator of the risk and results in the overall distribution of the risk exposure. For example, a jeweller can sell a gold futures contract to avoid any rise in the gold prices in the upcoming months. However, the same futures contract can be bought by an investor with the intention that the gold prices will rise in the future. Through the contract, the risk gets distributed and mitigates a high level of volatility.
The role of the commodity market in India is the most important one in all as it directly affects the economy’s growth and positively influences the agriculture sector. For further assistance on how to trade commodities, you can consult IIFL’s financial experts to gain valuable insights and start your commodity trading journey successfully.