January 2014 31

MBA Education & Careers

Eco Fundas for youEco Fundas for youEco Fundas for youEco Fundas for youEco Fundas for you

What is Commodity Trading?What is Commodity Trading?What is Commodity Trading?What is Commodity Trading?What is Commodity Trading?PROMOD JOSEPH

MBA, VIRGINIA TECH.

Any goods that are unbranded and are commonly

traded in the market are called commodities.

Globally, the commodity trade market is about three

times the size of equity trade market. In India, the commodities

market is still in a nascent stage and is going to be the next big

thing for investors. The expected growth rate of commodity

market is over 25 per cent annually over the next five years.

The volume of business of the country’s 24 commodity

exchanges, including three national exchanges, has, in the last

few years, run into several lakhs of crores of rupees per annum.

The main difference between a commodity exchange and stock

exchange is as follows: A commodity exchange deals in non-

financial commodities, be they agricultural commodities like

cotton and wheat, and non-agro commodities like aluminum,

and oil, whereas a stock exchange deals in financial products

like stocks and government securities.

Commodity markets are quite like equity markets. The

commodity market also has two constituents i.e. spot market

and derivative market. In case of a spot market, the

commodities are bought and sold for immediate delivery while

in the case of a commodities derivative market, various

financial instruments are traded on the exchanges.

Commodity future is a derivative instrument for the future

delivery of a commodity on a fixed date at a particular price.

For example, if an investor purchases a palm oil future, he is

entering into a contract to buy a fixed quantity of palm oil at a

future date. The future date is called the contract expiry date.

The fixed quantity is called the contract size. Such a contract

is called a Forward Contract. These futures can be bought

and sold on the commodity exchanges.

Futures Contract is a type of forward contract. Futures are

exchange-traded contracts to sell or buy physical commodities

for delivery on a specified future date at an agreed price. Futures

trading, which provide for greater transparency in prices, are

used generally for protection (hedging) against adverse price

fluctuations in basic commodities.

TTTTTypes of Commoditiesypes of Commoditiesypes of Commoditiesypes of Commoditiesypes of Commodities

The commodity exchanges facilitate an online platform for

trading on futures contracts in a wide range of

commodities, by following the best-global practices of

professionalism and transparency. The items traded on the

commodity exchanges include agricultural commodities like

wheat, rice, tea, jute, spices, soya, groundnut, coffee, rubber,

cotton; precious metals - gold and silver; base metals - iron

ore, lead, aluminium, nickel, zinc, etc., and energy commodities

- crude oil and coal. Over 100 commodities are traded in the

national exchanges.

The Forward Markets Commission (FMC) is the regulatory

body for commodity trading in futures / forward trade in India.

FMC, set up in 1953, has its headquarters in Mumbai and is

overseen by the Ministry of Consumer Affairs and Public

Distribution.

History of Commodity THistory of Commodity THistory of Commodity THistory of Commodity THistory of Commodity Trading in Indiarading in Indiarading in Indiarading in Indiarading in India

India has a long history of futures trading in commodities.

At one time, there were as many as 110 regional exchanges

conducting forward trade in various commodities. That was

the time, when the equity market was a poor cousin of this

market as there were not many companies whose shares could

be traded. However, in the late 1950s and early 1960s, India

saw a period of endemic shortages in many essential

commodities. This resulted in inflationary pressures on prices

of such commodities, which along with government regulations

in this area, resulted in the decline of this market since the

mid-1960s. Futures trading came to be prohibited in most of

the important commodities and many traders migrated to the

securities market.

The interest in commodity futures trading has revived since

early 1990s. Though the futures trading is not new to India as

32 January 2014

MBA Education & Careers

ECO FUNDAS FOR YOU What is Commodity Trading?

mentioned above, we have missed more than three decades

within which tremendous strides have been made in the field

worldwide.

Commodity ExchangCommodity ExchangCommodity ExchangCommodity ExchangCommodity Exchanges in Indiaes in Indiaes in Indiaes in Indiaes in India

There are 24 commodity exchanges in India, including three

national exchanges. The objective of establishing national

exchanges is to ensure that the commodity exchanges operate

at a national level, trade in all commodities with economies of

scale and adopt best practices in exchange management like

demutualisation (i.e., they are not owned or managed by

member brokers), automation, and settlement guarantee.

An individual, partnership firm, private limited company,

public limited company, co-operative societies are eligible to

become members of the following national exchanges subject

to the conditions for the membership.

(a) National Commodity & Derivatives ExchangeLimited (NCDEX) is an online multicommodity exchange

promoted by ICICI Bank, LIC, NABARD, and NSE. NCDEX,

the only commodity exchange in the country promoted by

national level institutions, is located in Mumbai and offers

facilities to its members in about 91 cities throughout India.

This is India’s biggest commodity exchange with a over 50

per cent share of the national commodities market.

(b) Multi Commodity Exchange (MCX), which started

operations in 2003, is promoted by Financial Technologies

(India) Ltd., SBI, NABARD, NSE, HDFC Bank, State Bank

of Indore, State Bank of Hyderabad, State Bank of Saurashtra,

SBI Life Insurance Co. Ltd., Union Bank of India, Bank of

India, Bank of Baroda, Canara Bank, and Corporation Bank.

It is headquartered in Mumbai.

(c) National Multi Commodity Exchange of India(NMCE) is unique as it is promoted by commodity-relevant

public institutions, viz., Central Warehousing Corporation

(CWC), National Agricultural Cooperative Marketing

Federation of India (NAFED), Gujarat Agro-Industries

Corporation Limited (GAICL), Gujarat State Agricultural

Marketing Board (GSAMB), National Institute of Agricultural

Marketing (NIAM), and Neptune Overseas Limited (NOL).

Commodity vs StocksCommodity vs StocksCommodity vs StocksCommodity vs StocksCommodity vs StocksWith stocks, you need to put up the full amount of the

stock value to buy the stock. With commodities, you

control commodity futures contracts with a margin deposit

which is usually between 5% - 10% of the value of the

commodity.

While there are thousands of stocks traded at an exchange,

the number of commodities are just over a hundred.

Stock prices often move slowly. Frequently, stock prices

may linger in a narrow trading range (sometimes for years)

causing your financial resources to be unproductively used.

Commodities frequently have fast price movement,

providing increased profit potential.

If you own stock, you get taxed twice. Once when the

company pays corporate tax on its earned income; and

again, when you pay personal taxes on dividends or capital

gains from your shares. The real tax can be very high.

With commodity profits, you are only taxed on your

income.

Stock is fictitious, there is no real basis for stock value other

than earnings. Stock can be “delisted” overnight and can

become worthless. Commodities have intrinsic value and will

always have value. People will always want grain and gold.

As the WTO looks at opening up the agricultural sector and

other commodity markets for global competition, India being

a major consumption market, will be an extremely attractive

market. Indian producers and traders will have growing

opportunity to be a part of the global market.

The author is Centre Director, T.I.M.E. Madurai.

MCX is the world's largest exchange insilver and gold futures, second largest incopper and natural gas futures, and the

third largest in crude oil futures.

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