Commodity trading in India is a term associated with investment. Commodity trading in India is lucrative though the investor base is small. Commodity trading in India can provide good return if it is carried out with prudence. In this post, we will discuss the concept of commodity trading in India, its benefits and strategizes.
The history of commodity trading in India goes back to 1875 when the Bombay Cotton Trade Association was established. The modern day commodity trading in India started in 2003 with the establishment of Multi Commodity Exchange of India Ltd. (MCX).
What is Commodity trading
In simple word, commodity trading is buy and sell of commodities for profit. However, commodity trading can happen beyond physical mode in different platforms as financial product. Currently, commodity trading refers to all form of dealing with commodity for financial benefits.
Commodity trading in India happens around 4 category of commodities – 1) Energy oil and natural gas, 2) Base metals (copper, aluminium, zinc, lead etc), 3) Bullion (gold and silver) and 4) Agriculture (cotton, black pepper, rubber, cardamom, oil etc.)
Different Ways for commodity trading
There are several ways for commodity trading. These include:
Direct Investment
In this approach the investor purchase the commodity like agricultural produce, gold and silver in the physical form and hold. It is sold off when price appreciation is reasonable and investor make good profit. However, direct investment has many associated issues like high transaction cost, storage, purity, theft, degradation etc.
Purchase Stocks
In this approach, an investor can buy stocks or equity shares of companies which deal in particular commodity like oil company, Jewellery Company, food processing companies etc. Since share market is affected by multiple factors, gain or losses can happens for factors which is not related to the commodity.
Commodity ETFs and Mutual Funds
There are many Exchange Traded Funds (ETF) and mutual funds based on commodities. For example, if you want exposure in gold or silver, you can invest in gold or silver ETFs. There are no purity or storage-related issues with ETFs as the units are held electronically in your demat account. However, the value of ETF fluctuate as per the market sentiments.
Commodity trading platforms
Traditionally, commodity trading in India happens in village markets or mandis, where only the farmers and middleman can participate. The same concept has now been digitised with the help of technology. The scope of the process widened with inclusion of verities of commodities and financial products.
Now anybody can participate and get benefited from commodity trading. Currently, there are 5 major commodity exchanges in India through which commodity trading are executed. Details of these exchanges are as below:
a) National Multi Commodity Exchange, established in 2002; commodities traded are Gold, aluminium, copper, mustard, rubber, jute, coffee, etc.
b) Multi Commodity Exchange of India, established in 2003; commodities traded are Metal, bullion, energy, pulses, Cereals, petrochemicals and so on.
c) National Commodity and Derivatives Exchange Ltd, established in 2003; commodities traded are Fibres, oil and seeds, crude oil, steel, copper, and so on.
d) Indian Commodity Exchange, established in 2009, commodities traded are Gold, silver, lead, copper, natural gas, soybean, and so on.
e) Universal Commodity Exchange, established in 2013; commodities traded are Chana, mustard, soybean, turmeric, and so on.
Process of commodity trading in exchanges
The process of commodity trading in India through these exchanges is similar to trading for shares in stock exchange. It requires you to
1. Open a trading account with the broker of any of the commodity exchange.
2. Link your demat and saving account with the commodity trading account.
Once you are ready with above. Next step is get familiar with how the platform work.
To carry out a trade, get hold of the list commodity traded in the exchange. Choose the commodity and take a position. For example, you expect cotton price will soar after 2 months. Therefore you want to buy cotton now with an intention to sell after two months. You have 3 options to carry out the transaction.
i) Spot contract where your saving account will be debited for the invested amount and you will be issued a certificate about ownership of the commodity and credited to your demat account. The reverse will happen if you propose to sell.
ii) Future contract where you acquire both right and obligation to buy the defined quantity at a defined price on a future date. The seller also has both right and obligation to sell as per the contract terms.
iii) Option contract, the buyer has the right but not the obligations to buy the commodity at a predetermined future price.
At the end of the contract period, the transaction has to be completed in cash and actual delivery of commodity.
The future and option contract can also be traded before the maturity period in option and future market.
Features of commodity trading in India
The major features of commodity trading In India are
a) It requires to maintain a margin of 5 to 10% of contract value of trading. These details are available on the official website of the brokerage house. Additional margin money may be required to maintain mark to market. It means with the change in price of commodity the margin may go down for which additional money may be required to level the margin.
b) Exchange create a lot size of commodity for trading. The lot size is further bifurcated into mini, micro and standard depending upon the commodity and quantity. In commodity trading the size of this lot is substantial requiring higher amount of investment.
c) Most of the commodity trading in India is on contract basis with a predetermined tenure. Therefore, investment in commodity trading is short term in nature.
Advantage and disadvantages of commodity trading
The advantage of commodity trading are
i) Diversification: The stock market is adversely affected with rise in commodity price, whereas commodity trading become favourable. Both are inversely related. Therefore a percentage of investment in commodity trading compensate any loss in the stock market.
ii) Hedging tool: Since prices of commodity tend to increase at higher than inflation rate, it always gives an edge to beat or hedge inflation. Investors can earn real return above inflation level. Enterprises can also lock prices of raw material by opting for commodity contracts.
iii) It being a short time investment in nature, the profit and loss can be booked within a short period. The investor need not hold on to long term risk of investment.
The disadvantage of commodity trading are
a) It require large amount of money to invest as the commodity lot size are substantial.
b) Investor need to understand the commodity in terms of its use, life cycle and commercial value.
c) Commodity are held by designated warehouses or authorised agents. Investor has to rely on declaration by these agencies without any personal verification.
d) The commodity market remain volatile because it is influenced by many factors like level of production, seasonal affect, economic condition, demand-supply position etc. It is a high risk investment.
Conclusion
Commodity trading in India is a good alternative investment option. However, it is advisable to trade in only with better understanding of commodity market, personal risk profile and limited exposure based on available financial resources.