COMMODITY

MARKETS
Sharyn
MBA
Bangera, Roll no
(PHARMA-
06. Kanaka
T E C H )Gaonkar,
5TH Roll
YEAR
no 17. Kadambari Narang,
1 2 / 9 / 2 0 1 0
Roll no 43.
TABLE OF CONTENTS

TOPIC PAGE NO
1) Introduction 2
1.1) Commodity 2
1.2)Commodity Markets 2
1.3)Evolution of commodity market in India 2
1.4)Types of commodities traded 3
1.5)Regulatory body 3
1) Segments of Commodity market 4
2.1) OTC commodity market 4
2) Commodity Exchanges 5
3.1) Largest commodity exchanges 5
3.2) Structure of Indian Exchange-based commodity market 5
3.3) Leading Indian commodity exchanges 6
3.4) Trading volumes 6
3.5)MCX 6
3.6) NCDEX 8
3.7) NMCE 10
3.8) ICEX 11
3) Commodity Derivatives 12
4.1) Difference between commercial and financial derivatives 12
4.2) Benefits of commodity futures 12
4.3) Why commodity futures 13
4.4)Commodity trading 14
4) Future Trends in commodity markets: India 15
INTRODUCTION
COMMODITY

A commodity may be defined as an article, a product or material that is bought and sold. It can
be classified as every kind of movable property, except Actionable Claims, Money & Securities.
Any good that is unbranded and is commonly traded in the market is a commodity.
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.

COMMODITY MARKETS

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. Commodity market is an important constituent of the financial markets
of any country. It is the market where a wide range of products, viz., precious metals, base
metals, crude oil, energy and soft commodities like palm oil, coffee etc. are traded. It is
important to develop a vibrant, active and liquid commodity market. This would help investors
hedge their commodity risk, take speculative positions in commodities and exploit arbitrage
opportunities in the market.

EVOLUTION OF COMMODITY MARKET IN INDIA

Bombay Cotton Trade Association Ltd., set up in 1875, was the first organized futures market.
Bombay Cotton Exchange Ltd. was established in 1893 following the widespread discontent
amongst leading cotton mill owners and merchants over functioning of Bombay Cotton Trade
Association. The Futures trading in oilseeds started in 1900 with the establishment of the
Gujarati Vyapari Mandali, which carried on futures trading in groundnut, castor seed and cotton.
Futures' trading in wheat was existent at several places in Punjab and Uttar Pradesh. But the most
notable futures exchange for wheat was chamber of commerce at Hapur set up in 1913. Futures
trading in bullion began in Mumbai in 1920. Calcutta Hessian Exchange Ltd. was established in
1919 for futures trading in raw jute and jute goods. But organized futures trading in raw jute
began only in 1927 with the establishment of East Indian Jute Association Ltd. These two
associations amalgamated in 1945 to form the East India Jute & Hessian Ltd. to conduct
organized trading in both Raw Jute and Jute goods. Forward Contracts (Regulation) Act was
enacted in 1952 and the Forwards Markets Commission (FMC) was established in 1953 under
the Ministry of Consumer Affairs and Public Distribution. In due course, several other exchanges
were created in the country to trade in diverse commodities.

TYPES OF COMMODITIES TRADED

World-over one will find that a market exits for almost all the commodities known to us. These
commodities can be broadly classified into the following:
Precious Metals: Gold, Silver, Platinum etc
Other Metals: Nickel, Aluminum, Copper etc
Agro-Based Commodities: Wheat, Corn, Cotton, Oils, Oilseeds.
Soft Commodities: Coffee, Cocoa, Sugar etc
Live-Stock: Live Cattle, Pork Bellies etc
Energy: Crude Oil, Natural Gas, Gasoline etc

REGULATORY BODY

Commodity trading in India is regulated by the Forward Markets Commission (FMC)

headquartered at Mumbai, it is a regulatory authority which is overseen by the Ministry of
Consumer Affairs and Public Distribution, Govt. of India. It is a statutory body set up in 1953
under the Forward Contracts (Regulation) Act, 1952.

The commodity futures market is regulated under the provisions of the Forward Contracts
(Regulation) Act, 1952 (FCR Act).
SEGMENTS OF COMMODITY
MARKET
The commodities market exits in two distinct forms namely the Over the Counter (OTC)
market and the Exchange based market. Also, as in equities, there exists the spot and the
derivatives segment. The spot markets are essentially over the counter markets and the
participation is restricted to people who are involved with that commodity say the farmer,
processor, wholesaler etc. Derivative trading takes place through exchange-based markets with
standardized contracts, settlements etc.

OTC COMMODITY MARKET

The OTC markets are essentially spot markets and are localized for specific commodities.
Almost all the trading that takes place in these markets is delivery based.

The buyers as well as the sellers have their set of brokers who negotiate the prices for them. This
can be illustrated with the help of the following example: A farmer, who produces castor,
wishing to sell his produce, would go to the local ‘mandi’. There he would contact his broker
who would in turn contact the brokers representing the buyers. The buyers in this case would be
wholesalers or refiners. In event of a deal taking place the goods and the money would be
exchanged directly between the buyer and the seller.

This market is restricted to only those people who are directly involved with the commodity. In
addition to the spot transactions, forward deals also take place in these markets. However, they
too happen on a delivery basis and hence are restricted to the participants in the spot markets.
COMMODITY EXCHANGES
LARGEST COMMODITY EXCHANGES:
• CME- USA

• Tokyo Commodity Exchange- Japan

• NYXE Euronext- EU

• Dalian Commodity Exchange- China

• Multi Commodity Exchange- India

• Inter Continental Exchange- US, Canada, China, UK

STRUCTURE OF INDIAN EXCHANGE BASED COMMODITY

MARKET

LEADING INDIAN COMMODITY EXCHANGES

1. Multi Commodity Exchange (MCX)

2. National Commodity and Derivatives Exchange (NCDEX)

3. National Multi-Commodity Exchange (NMCE)

4. Indian Commodity Exchange (ICEX)

TRADING VOLUMES
 • The trading volumes in India's commodity exchanges have risen by 65.81% on a yearly
basis as on May 15, 2010 compared to previous year.

• Total value of trading at the Commodity Exchanges during the fortnight from 1st May
2010 to 15th May 2010 was Rs. 4,35,312.59 crore.

• Agri-commodities volume at Rs 42,639.17 cr in the fortnight ended May 15, 2010 was
17.38% higher than Rs 36,326 cr recorded in corresponding period last year.

• Gold futures trading volume at Rs 20,7178 cr for fortnight ended May 15, was higher by
91% compared to previous year's level of Rs 108455.24 cr. Base metals trading volumes
rose 116.87% at Rs 112, 312.66 cr as against 51788.69 cr last year.

MCX

Headquartered in Mumbai, Multi Commodity Exchange of India Ltd (MCX) is a state-of-the-art

electronic commodity futures exchange. The demutualised Exchange set up by Financial
Technologies (India) Ltd (FTIL) has permanent recognition from the Government of India to
facilitate online trading, and clearing and settlement operations for commodity futures across the
country.

Having started operations in November 2003, today, MCX holds a market share of over 80% of
the Indian commodity futures market, and has more than 2000 registered members operating
through over 100,000 trader work stations, across India. The Exchange has also emerged as the
sixth largest and amongst the fastest growing commodity futures exchange in the world, in terms
of the number of contracts traded in 2009 and the turnover of the exchange for the fiscal year
2009 was US$ 1.24 trillion

MCX has also set up in joint venture the MCX Stock Exchange. Earlier spin-offs from the
company include the National Spot Exchange, an electronic spot exchange for bullion and
agricultural commodities, and National Bulk Handling Corporation (NBHC) India's largest
collateral management company which provides bulk storage and handling of agricultural
products.

MCX offers more than 40 commodities across various segments such as:

METAL BULLION
Aluminium, Copper, Lead, Nickel, Steel Long Gold, Gold HNI, Gold M, i-gold, Silver, Silver
(Bhavnagar), Steel Long (Govindgarh), Steel HNI, Silver M
Flat, Tin, Zinc

FIBER ENERGY

Cotton L Staple, Cotton M Staple, Cotton S Brent Crude Oil, Crude Oil, Furnace Oil,
Staple, Cotton Yarn, Kapas Natural Gas, M. E. Sour Crude Oil, ATF,
Electricity(Now delisted), Carbon Credit

SPICES PLANTATION

Cardamom, Jeera, Pepper, Red Chilli Arecanut, Cashew Kernel, Coffee (Robusta),
Rubber

PULSES PETROCHEMICALS

Chana, Masur, Yellow Peas DPE, Polypropylene(PP), PVC

OIL AND SEEDS

Castor Oil, Castor Seeds, Coconut Cake, Coconut Oil, Cotton Seed, Crude Palm Oil, Groundnut
Oil, Kapasia Khalli, Mustard Oil, Mustard Seed (Jaipur), Mustard Seed (Sirsa), RBD Palmolein,
Refined Soy Oil, Refined Sunflower Oil, Rice Bran DOC, Rice Bran Refined Oil, Sesame Seed,
Soymeal, Soy Bean, Soy Seeds

CEREALS OTHERS

Maize, Barley Guargum, Guar Seed, Gurchaku, Mentha Oil,

Potato (Agra), Potato (Tarkeshwar)

MCX has been certified to three ISO standards including ISO 9001:2000 Quality Management
System standard, ISO 14001:2004 Environmental Management System standard and ISO
27001:2005 Information Security Management System standard. The Exchange’s platform
enables anonymous trades, leading to efficient price discovery. Moreover, for globally-traded
commodities, MCX’s platform enables domestic participants to trade in Indian currency.

The Exchange strives to be at the forefront of developments in the commodities futures industry
and has forged strategic alliances with various leading International Exchanges, including
Euronext-LIFFE, London Metal Exchange (LME), New York Mercantile Exchange, Shanghai
Futures Exchange (SHFE), Sydney Futures Exchange, The Agricultural Futures Exchange of
Thailand (AFET), among others. For MCX, staying connected to the grassroots is imperative. Its
domestic alliances aid in improving ethical standards and providing services and facilities for
overall improvement of the commodity futures market. Key shareholders Promoted by FTIL,
MCX enjoys the confidence of blue chips in the Indian and international financial sectors.

It is regulated by the Forward Markets Commission.

 MCX is India's No. 1 commodity exchange with 83% market share in 2009
 The exchange's main competitor is National Commodity & Derivatives Exchange Ltd
 Globally, MCX ranks no. 1 in silver, no. 2 in natural gas, no. 3 in crude oil and gold in
futures trading
 The highest traded item is gold.
 MCX COMDEX is India's first and only composite commodity futures price index

NCDEX

National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed

on-line multi commodity exchange. The shareholders of NCDEX comprises of large national
level institutions, large public sector bank and companies.

NCDEX is a nation-level, technology driven de-mutualised on-line commodity exchange with an

independent Board of Directors and professional management.

NCDEX is regulated by Forward Markets Commission. NCDEX is subjected to various laws of

the land like the Forward Contracts (Regulation) Act, Companies Act, Stamp Act, Contract Act
and various other legislations.

NCDEX headquarters are located in Mumbai and offers facilities to its members from the centres
located throughout India.

The commodities contracts offered by NCDEX are as follows:

AGRI-BASED COMMODITIES BULLION

Castor Seed, Chana, Chilli, Coffee - Arabica, Gold 1 KG
Coffee – Robusta, Cotton Seed Oilcake, Crude Gold 100gm
Palm Oil, Expeller Mustard Oil, Groundnut (in Silver 30 KG
shell), Groundnut Expeller Oil, Guar gum, Silver 5 KG
Guar Seeds, Gur, Jeera, Jute sacking bags,
Kidney Beans, Indian 28 mm Cotton, Indian
31 mm Cotton, Masoor Grain Bold, Medium
Staple Cotton, Mentha Oil, Mulberry Green
Cocoons, Mulberry Raw Silk, Rapeseed -
Mustard Seed, Pepper, Raw Jute, RBD
Palmolein, Refined Soy Oil, Rubber, Sesame
Seeds, Soy Bean, Sugar – Small, Sugar –
Medium, Turmeric, Urad (Black Matpe), V-
797 Kapas, Yellow Peas, Yellow Red Maize,
Yellow Soybean Meal.

FERROUS METALS ENERGY

Mild Steel Ingot Brent Crude Oil

Furnace Oil
Light Sweet Crude Oil.

NON-FERROUS METALS PLASTICS

Aluminum Ingot, Polypropylene

Copper Cathode Linear Low Density Polyethylene
Nickel Ingot Polyvinyl Chloride.
Zinc Cathode

The top 5 commodities, in terms of volume traded at the Exchange, were Rape/Mustard Seed,
Gaur Seed, Soyabean Seeds, Turmeric and Jeera.

NCDEX also offers as an information product, an agricultural commodity index. This is a

composite index, called NCDEXAGRI that converts 20 commodities currently being offered for
trading by NCDEX. This is a spot-price based index. NCDEX also offers as an information
product, the index futures, called FUTEXAGRI. This is essentially a what-if index. It indicates
that if futures on the index could be traded, then the current FUTEXAGRI value should be the
no-arbitrage value for the index futures. However, indexes and index futures are not allowed to
be traded under the current regulatory structure.
NMCE

The first state-of-the-art demutualised multi-commodity Exchange, National Multi Commodity

Exchange of India Ltd. (NMCE) was 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).

NMCE is a zero-debt company; following widely accepted prudent accounting and auditing
practices. It has robust delivery mechanism making it the most suitable for the participants in the
physical commodity markets. The exchange does not compromise on its delivery provisions to
attract speculative volume. Public interest rather than commercial interest guide the functioning
of the Exchange. It has also established fair and transparent rule-based procedures and
demonstrated total commitment towards eliminating any conflicts of interest. It is the only
Commodity Exchange in the world to have received ISO 9001:2000 certification from British
Standard Institutions (BSI).

NMCE commenced futures trading in 24 commodities on 26th November, 2002 on a national

scale and the basket of commodities has grown substantially since then to include cash crops,
food grains, plantations, spices, oil seeds, metals & bullion among others.

The commodities traded are as follows:

OIL & OIL SEEDS SPICES & PULSES

Castor seeds 10MT, Copra, Rape/ Mutard Pepper, Cardamom, Turmeric, Chana
seeds, Soya bean oil

PRECIOUS METALS BASE METALS

Gold Guinea, Gold (100gms), Gold (1kg), Aluminium, Copper, Lead, Nickel, Zinc
Silver

AGRO-BASED PRODUCTS & FIBERS

Rubber, Raw jute, Methol, Isabgul seeds, Kalyan Kapas V-797, Sacking, Coffee REP bulk, Guar
seeds, Guar gum, Wheat

NMCE was the first commodity exchange to provide trading facility through internet, through
Virtual Private Network (VPN).
NMCE follows best international risk management practices. The contracts are marked to market
on daily basis. The system of upfront margining based on Value at Risk is followed to ensure
financial security of the market.
The unique strength of NMCE is its settlements via a Delivery Backed System, an imperative in
the commodity trading business. These deliveries are executed through a sound and reliable
Warehouse Receipt System, leading to guaranteed clearing and settlement.

ICEX

Indian Commodity Exchange Limited is a screen based on-line derivatives exchange for
commodities and has established a reliable, time tested, and a transparent trading platform. It is
also in the process of putting in place robust assaying and warehousing facilities in order to
facilitate deliveries. It is jointly promoted by Indiabulls Financial Services Ltd and MMTC
Limited, and has Indian Potash Ltd., KRIBHCO and IDFC among others, as its partners.

This exchange is ideally positioned to tap the huge scope for increasing the depth and size of
commodities’ market and fill in the structural gaps existing in the Indian market. Our head office
is located in North India (Gurgaon), one of the key regions in India's Agri belt, with a vision to
encourage participation of farmers, traders and actual users to hedge their positions against the
wild price fluctuations.

The commodities traded are as follows:

PRECIOUS METALS ENERGY

Gold, Silver Crude oil, Natural gas

METALS OIL & OIL COMPLEX

Aluminium, Copper, Lead, Nickel, Zinc Mustard seed, Soybean, Soya oil, Palm oil

SPICES, PULSES & FIBERS OTHER AGRO PRODUCTS

Black pepper, Jeera, Turmeric, Chana, Raw Guar Seed, Mentha oil
Jute
COMMODITY DERIVATIVES
Derivatives as a tool for managing risk first originated in the commodities markets. Commodity
future is a derivative instrument for the future delivery of a commodity on a fixed date at a
particular price. The underlying in this case is a particular commodity. If an investor purchases
an oil future, he is entering into a contract to buy a fixed quantity of oil at a future date. The
future date is called the contract expiry date. The fixed quantity is called the contract size. These
futures can be bought and sold on the commodity exchanges.

DIFFERENCE BETWEEN COMMODITY AND FINANCIAL

DERIVATIVE
The basic concept of a derivative contract remains the same whether the underlying happens to
be a commodity or a financial asset. However there are some features, which are very peculiar to
commodity derivative markets. In the case of financial derivatives, most of these contracts are
cash settled. Even in the 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. Similarly, the concept of
varying quality of asset does not really exist as far as financial underlyings are concerned.
However in the case of commodities, the quality of the asset underlying a contract can vary
largely. This becomes an important issue to be managed.

BENEFITS OF COMMODITY FUTURES

• To producer: A producer of a commodity can sell the futures of the commodity, thereby
ensuring that he can sell a particular quantity of his commodity at a particular price at a
particular date.

To investors: An investor has alternative investment instruments where he can take a

position as to future price and the spot price at a particular date in future and buys and
sells options. He is not interested in taking deliveries of the commodities.
 • To commodity trader: A commodity trader can use these to ensure that he is protected
against any adverse changes in the prices. He can enter into a futures contract for
purchase of a certain quantity of the underlying at a particular price on a particular date,
or he can enter into a futures contract for sale of a particular quantity on a particular date
at a particular price and be assured of the margins because both his purchase price as well
as the sale price are fixed. Traders do a good arbitrage in Gold and Silver. Whenever they
find Gold moving up, they short silver and similarly whenever they find silver moving up
and gold likely to move down, they hedge.

• To exporters: Future trading is very useful to the exporters as it provides an advance

indication of the price likely to prevail and thereby help the exporter in quoting a realistic
price and thereby secure export contract in a competitive market. Having entered into an
export contract, it enables him to hedge his risk by operating in futures market.

WHY COMMODITY FUTURES

In India agriculture has traditionally been an area with heavy government intervention.
Government intervenes by trying to maintain buffer stocks, they try to fix prices, and they have
import-export restrictions and a host of other interventions. Many economists think that we could
have major benefits from liberalization of the agricultural sector.
In this case, the question arises about who will maintain the buffer stock, how will we smoothen
the price fluctuations, how will farmers not be vulnerable that tomorrow the price will crash
when the crop comes out, how will farmers get signals that in the future there will be a great
need for wheat or rice. In all these aspects the futures market has a very big role to play.
If you think there will be a shortage of wheat tomorrow, the futures prices will go up today, and
it will carry signals back to the farmer making sowing decisions today. In this fashion, a system
of futures markets will improve cropping patterns.
Next, if I am growing wheat and am worried that by the time the harvest comes out prices will
go down, then I can sell my wheat on the futures market. I can sell my wheat at a price, which is
fixed today, which eliminates my risk from price fluctuations. These days, agriculture requires
investments -- farmers spend money on fertilizers, high yielding varieties, etc. They are worried
when making these investments that by the time the crop comes out prices might have dropped,
resulting in losses. Thus a farmer would like to lock in his future price and not be exposed to
fluctuations in prices.
The third is the role about storage. Today we have the Food Corporation of India, which is
doing a huge job of storage, and it is a system, which -- in my opinion -- does not work. Futures
market will produce their own kind of smoothing between the present and the future. If the future
price is high and the present price is low, an arbitrager will buy today and sell in the future. The
converse is also true, thus if the future price is low the arbitrageur will buy in the futures market.
These activities produce their own "optimal" buffer stocks, smooth prices. They also work very
effectively when there is trade in agricultural commodities; arbitrageurs on the futures market
will use imports and exports to smooth Indian prices using foreign spot markets.
In totality, commodity futures markets are a part and parcel of a program for agricultural
liberalization. Many agriculture economists understand the need of liberalization in the sector.
Futures markets are an instrument for achieving that liberalization.

COMMODITY TRADING

• Commodity trading is done through the exchanges, especially the national exchanges, which
have electronic trading and settlement systems.

• Minimum investment-Rs.5000/-For trading in bullion (gold and silver), minimum amount

required is Rs 650 and Rs 950 for on the current price of approximately Rs 65,00 for gold for
one trading unit (10 gm) and about Rs 9,500 for silver (one kg).

• Margins – 5-10% of commodity contract

• Both delivery and settlement in cash is permitted. If you want your contract to be cash
settled, you have to indicate at the time of placing the order that you don't intend to deliver
the item. If you plan to take or make delivery, you need to have the required warehouse
receipts. The option to settle in cash or through delivery can be changed as many times as
one wants till the last day of the expiry of the contract.

• Sales tax is applicable only in case of trade resulting into delivery. Normally it is the seller's
responsibility to collect and pay sales tax. The sales tax is applicable at the place of delivery.
FUTURE TRENDS IN COMMODITY
MARKETS: INDIA
India: Being in a time-zone that falls in the gap left by the major commodity exchanges in the
US, Europe and Japan has also worked in India’s favour because commodity business by its very
nature is a 24/7 business. Innovation coupled with modern and successful financial market
environment has ensured the beginning of a success story in commodities which will eventually
see India becoming a price-setter in major commodities on the strength of its large production
and consumption.

It is pertinent to note that India and China are being projected as the major drivers for the
initiation of yet another commodity super-cycle. Tracking price trends and analysing the
statistics have always been key areas of economic research; but in each cycle – whether defined
by Jim Rogers, Kondratieff or Dewey & Dakin – the trigger is always different, and in this case
it may well be increase in regional consumption, some of which we have already seen.

One outcome of the recent boom-bust cycle has been that mergers and acquisitions have gained
speed and the biggest beneficiaries will likely be large companies from historically conservative
countries, like India. This phase is likely to propel India into the international big league quicker
and on a firmer footing. In fact, India did well to weather the global financial crisis over the last
year and a half, with GDP growing at 6% at the worst of times, compared to almost every other
country which showed negative growth in one or more quarters during this period. Growth did
fall from 9% to 6% but was way above the World Bank’s forecast of 4%, demonstrating
economic resilience, a sure sign of things to come. It would seem that the alignment of growth
with commodities is the most likely outcome to underline the changing world economic order.

In addition to futures trading, the number of Indians looking at commodities as part of their
investment portfolio is fast reaching critical mass, as gold demonstrates. Add to that a state-of-
the-art infrastructure for trading and the availability of trained personnel, and you have a ready
market for businesses wishing to hedge their risks as the markets become more and more
globalised on account of the removal of trade barriers worldwide. With a conducive financial
environment, the commodity markets in India have come of age and benefits are accruing to
those who are most willing to identify consumer needs and service them.