The title of the project is “Commodity: A Fundamental Research” it’s main objective is to
study the trading mechanism of the multi-commodity exchange and to describe the profile of
gold and silver as a commodity. It further delves into the fundamental research of a
The whole project is divided into five parts where in the first part deals with the objective,
scope and approach of the project. The second part deals with mechanism of commodity
trading carried by the multi –commodity exchange. Third part delves into the fundamentals
of bullions i.e. gold and silver. This part enables us to know the fundamental of gold and
silver that an analyst should know for research. Fourth part deals with the brief definition of
fundamental and technical analysis and a fundamental research is carried on the commodity
wheat. The conclusion is drawn as to what should be the trading strategy for trading in wheat
for the coming month futures. In the last section, the analysis is done related with the Indian
The information provided in the project would be useful to understand the fundamental
1
Chapter no. Name of the chapter Page no.
1 Part 1 3-4
1.1 Objective
1.2 Approach
1.3 Scope of the study
1.4 Limitations
2 Part-11 5-34
2.1 Theoretical framework
2.2 Derivatives
2.3 Derivative market
2.4 Commodity
2.5 History of commodity trading
2.6 Evolution of commodity market in India
2.7 Commodity derivatives
2.8 Futures contract
2.9 Hedging
2.10 Speculation
2.11 Arbitrage
2.12 Operational mechanism of MCX
References.
2
PART-I
A basic purpose or valid reason is always required in order to carry out ant business
activity, and this purpose is nothing but the researchers must know the main objectives of the
study.
IV. A brief insight into fundamental and technical (candle sticks) analysis of the
commodity.
3
APPROACH TO THE PROJECT:
Firstly to study the commodity market first in terms of its operational aspect with the help of
Secondly, studying the nature of the various commodities like steel, gold, silver, cotton,
• PRIMARY DATA:
The first hand data has been collected by meeting people from mcx
• SECONDARY DATA:
The secondary data has been collected from the website regarding the trend lines of the
The present study includes the scope of the “analysis of performance of the commodity
market.” The scope is limited to some commodities only and to fundamental research only.
4
I. Time constraints
III. The detail analysis of the commodities in limited to certain commodities only
PART -II
A derivative is a product whose value is derived from the value of one or more underlying
variables or assets in a contractual manner. The underlying asset can be equity, forex, and
commodity.
For e.g.: wheat farmers may wish to sell their harvest at a future date to eliminate the risk of
a change in prices by that date. Such a transaction is an example of a derivative. The price of
this derivative is driven by the spot price of wheat, which is the underlying in this case.
Derivative contracts are of different types. The most common ones are forwards, futures,
options and swaps. Participants who trade in the derivatives market can be classified under
5
1. Hedgers: The farmer's example that we discussed about was a case of hedging. Hedgers
face risk associated with the price of an asset. They use the futures or options markets to
2. Speculators: Speculators are participants who wish to bet on future movements in the
price of an asset. Futures and options contracts can give them leverage; that is, by putting in
small amounts of money upfront, they can take large positions on the market. As a result of
this leveraged Speculative position, they increase the potential for large gains as well as large
losses.
between prices of the same product across different markets. If, for example, they see the
futures price of an asset getting out of line with the cash price, they would take offsetting
positions in the two markets to lock in the profit. Whether the underlying asset is a
participants about the future and lead the prices of underlying to the perceived future
level. The prices of derivatives converge with the prices of the underlying at the
expiration of the derivative contract. Thus derivatives help in discovery of future as well
as current prices.
o The derivatives market helps to transfer risks from those who have them but may
o Derivatives, due to their inherent nature, are linked to the underlying cash
markets. With the introduction of derivatives, the underlying market witnesses higher
6
trading volumes because of participation by more players who would not otherwise
o Derivatives markets help increase savings and investment in the long run. The
• Derivative market:
Derivative markets can broadly be classified as commodity derivative market and financial
derivatives markets. As the name suggest, commodity derivatives markets trade contracts for
which the underlying asset is a commodity. It can be an agricultural commodity like wheat,
Soybeans, rapeseed, cotton, etc or precious metals like gold, silver, etc.
The most commonly used derivatives contracts are forwards, futures and options
COMMODITY:
The commodity means any intermediate goods, which is useful for production and which has
constant and standard qualities. Commodity is derived from the Latin word Commodus
7
Characteristics of a commodity and commodity market:
5. Markets are liquid and competitive i.e. liquidity means the total supply equals total
demands or more or less same and fluctuation due to seasonal imbalance and
Derivatives as a tool for managing risk first originated in the commodities markets. They
were then found useful as a hedging tool in financial markets as well. In India, trading in
commodity futures has been in existence from the nineteenth century with organized trading
in cotton through the establishment of Cotton Trade Association in 1875. Over a period of
8
only in the last decade that Commodity future exchanges have been actively encouraged.
However, the markets have been thin with poor liquidity and have not grown to any
significant level.
Bombay cotton trade association ltd.set up in 1875 was the first organized futures market.
Bombay cotton exchange ltd.was established in1893 following the widespread discontent
among leading cotton mill owners and merchants over functioning at Bombay cotton trade
association. The future trading in oils seed started in 1900 with the establishment of the
Gujarat vyapari mandli, which carried on futures trading in groundnut, castor seed, and
cotton. Futures trading in wheat were 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
established in 1919 for futures trading in raw jute and jute goods. But organized futures
trading in raw jute began only in 1945 to form the east India jute and Hessian ltd, to conduct
organized trading in both raw jute and jute goods. Forward contracts act was enacted in 1952
and the forward market commission was established in 1953 under the ministry of consumer
Present scenario:
9
Out of these 25 commodities the MCX, NCDEX and NMCE are large exchanges and MCX
is the biggest among them. Forward Markets Commission (FMC) headquartered at Mumbai
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
• Commodity derivative
The basic concept of a derivative contract remains the same whether the underlying happens
o Due to the bulky nature of the underlying assets, physical settlement in commodity
o In the case of commodities, the quality of the asset underlying a contract can vary largely.
• Trading tools:
1. FORWARD CONTRACTS:
A forward contract is an agreement to buy or sell an asset on a specified date for a specified
price. One of the parties to the contract assumes a long position and agrees to buy the
underlying asset on a certain specified future date for a certain specified price. The other
party assumes a short position and agrees to sell the asset on the same date for the same
price.
10
Other contract details like delivery date, the parties to the contract negotiate price and
quantity bilaterally. The forward contracts are normally traded outside the exchanges. The
• They are bilateral contracts and hence exposed to counter party risk.
• Each contract is custom designed, and hence is unique in terms of contract size,
• On the expiration date, the contract has to be settled by delivery of the asset.
• If the party wishes to reverse the contract, it has to compulsorily go to the same
Forward contracts are very useful in hedging and speculation. The classic hedging
application would be that of an exporter who expects to receive payment in dollars three
months later. He is exposed to the risk of exchange rate fluctuations. By using the currency
forward market to sell Dollars forward, he can lock on to a rate today and reduce his
uncertainty.
If a speculator has information or analysis, which forecasts an upturn in a price, then he can
go long on the forward market instead of the cash market. The speculator would go long on
the forward, wait for the price to rise, and then take a reversing transaction to book profit
Speculators may well be required to deposit a margin upfront. However, this is generally a
relatively small proportion of the value of the assets underlying the forward contract. The use
11
The disadvantages of forward market are:
1. Lack of liquidity
3. No standardization.
2. FUTURES CONTRACT:
A futures contract is an agreement between two parties to buy or sell an asset at a certain
time in the future at a certain price. But unlike forward contracts, the futures contracts are
standardized and exchange traded. To facilitate liquidity in the futures contracts, the
exchange specifies certain standard features of the contract. It is a standardized contract with
standard underlying instrument, a standard quantity and quality of the underlying instrument
that can be delivered, (or which can be used for reference purposes in settlement) and a
standard timing of such settlement. A futures contract may be offset prior to maturity by
entering into an equal and opposite transaction. More than 99% of futures transactions are
o Location of settlement
12
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the futures
market.
Contract cycle: The period over which a contract trades. The commodity
futures contracts on the NCDEX have one-month, two-month and three-month expiry
cycles, which expire on the 20th day of the delivery month. Thus a January expiration
contract expires on the 20th of January and a February expiration contract ceases trading
on the 20th of February. On the next trading day following the 20th, a new contract
Expiry date: It is the date specified in the futures contract. This is the last day
on which the contract will be traded, at the end of which it will cease to exist.
Delivery unit: The amount of asset that has to be delivered less than one
contract. For instance, the delivery unit for futures on Long Staple Cotton on the NCDEX
is 55 bales. The delivery unit for the Gold futures contract is 1 kg.
Basis: Basis can be defined as the futures price minus the spot price. There
will be a different basis for each delivery month for each contract. In a normal market,
basis will be positive. This rejects that futures prices normally exceed spot prices.
Cost of carry: The relationship between futures prices and spot prices can be
summarized in terms of what is known as the cost of carry. This measures the storage
cost plus the interest that is paid to finance the asset less the income earned on the asset.
Initial margin: The amount that must be deposited in the margin account at
the time a futures contract is first entered into is known as initial margin.
13
Marking-to-market (MTM): In the futures market, at the end of each trading
day, the margin account is adjusted to reflect the investor's gain or loss depending upon
Maintenance margin: This is somewhat lower than the initial margin. This is
set to ensure that the balance in the margin account never becomes negative. If the
balance in the margin account falls below the maintenance margin, the investor receives a
• Basic payoffs
A payoff is the likely profit/ loss that would accrue to a market participant with change in the
price of the underlying asset. This is generally depicted in the form of payoff diagrams,
which show the price of the underlying asset on the X-axis and the profits/ losses on the Y-
axis.
Futures contracts have linear payoff, just like the payoff of the underlying asset that we
looked at earlier. If the price of the underlying rises, the buyer makes profits. If the price of
the underlying falls, the buyer makes losses. The magnitude of profits or losses for a given
upward or downward movement is the same. The profits as well as losses for the buyer and
the seller of a futures contract are unlimited. These linear payoffs are fascinating as they can
be combined with options and the underlying to generate various complex payoffs.
14
Payoff for buyer of futures: Long futures
The payoff for a person who buys a futures contract is similar to the payoff for a person who
downside.
The figure shows the profits/ losses from a long position on gold. The investor bought gold at
Rs.6000 per 10 Gms. If the price of gold rises, he profits. If price of gold falls he looses.
Profit
+500
-500
Loss
15
Figure 2 Payoff for a seller of gold
The figure shows the profits/ losses from a short position on cotton. The investor sold long
staple cotton at Rs.6500 per Quintal. If the price of cotton falls, he profits. If the price of
16
Figure 3 Payoff for a buyer of gold futures
The figure shows the profits/ losses for a long futures position. The investor bought futures
when gold futures were trading at Rs.6000 per 10 Gms. If the price of the underlying gold
goes up, the gold futures price too would go up and his futures position starts making profit.
If the price of gold falls, the futures price falls too and his futures position starts showing
losses.
Take the case of a speculator who buys a two-month gold futures contract on the NCDEX
when it sells for Rs.6000 per 10 Gms. The underlying asset in this case is gold. When the
prices of gold in the spot market goes up, the futures price too moves up and the long futures
position start making profits. Similarly when the prices of gold in the spot market goes down,
the futures prices too move down and the long futures position starts making losses.
Profit
6000
17
Loss
The payoff for a person who sells a futures contract is similar to the payoff for a person who
downside. Take the case of a speculator who sells a two-month cotton futures contract when
the contract sells Rs.6500 per Quintal. The underlying asset in this case is long staple cotton.
When the prices of long staple cotton move down, the cotton futures prices also move down
and the short futures position starts making profits. When the prices of long staple cotton
move up, the cotton futures price also moves up and the short futures position starts making
losses.
The figure shows the profits/ losses for a short futures position. The investor sold cotton
futures at Rs.6500 per Quintal. If the price of the underlying long staple cotton goes down,
the futures price also falls, and the short futures position starts making profit. If the price of
the underlying long staple cotton rises, the futures too rise, and the short futures position
Profit
6500
18
Loss
Many participants in the commodity futures market are hedgers. They use the futures market
to reduce a particular risk that they face. This risk might relate to the price of wheat or oil or
any other commodity that the person deals in. The classic hedging example is that of wheat
farmer who wants to hedge the risk of fluctuations in the price of wheat around the time that
his crop is ready for harvesting. By selling his crop forward, he obtains a hedge by locking in
to a predetermined price.
What hedging does however is, that it makes the outcome more certain. Hedgers could be
and even other participants in the value chain, for instance farmers, extractors, ginners,
Basic principles of hedging: When an individual or a company decides to use the futures
markets to hedge a risk, the objective is to take a position that neutralizes the risk as much as
possible. Take the case of a company that knows that it will gain Rs.1, 00,000 for each 1
rupee increase in the price of a commodity over the next three months and will lose Rs.1,
00,000 for each 1 rupee decrease in the price of a commodity over the same period. To
hedge, the company should take a short futures position that is designed to offset this risk.
The futures position should lead to a loss of Rs.1, 00,000 for each 1-rupee increase in the
price of the commodity over the next three months and a gain of Rs.1, 00,000 for each 1-
19
rupee decrease in the price during this period. If the price of the commodity goes down, the
The figure shows the payoff for a soy oil producer who takes a short hedge. Irrespective of
what the spot price of soy oil is three months later, by going in for a short hedge he locks on
20
The price of the commodity goes up, the loss on the futures position is offset by the gain on
the commodity.
There are basically two kinds of hedges that can be taken. A company that wants to sell an
asset at a particular time in the future can hedge by taking short futures position. This is
called a short hedge. Similarly, a company that knows that it is due to buy an asset in the
future can hedge by taking long futures position. This is known as long hedge.
Short hedge
A short hedge is appropriate when the hedger already owns the asset, or is likely to own the
asset and expects to sell it at some time in the future. For example, a cotton farmer who
expects the cotton crop to be ready for sale in the next two months could use a short hedge.
Example:
15th of January and that a refined soy oil producer has just negotiated a contract to sell
10,000 Kgs of soy oil. It has been agreed that the price that will apply in the contract is the
market price on the 15th April. The oil producer is therefore in a position where he will gain
Rs.10000 each 1 rupee increase in the price of oil over the next three months and lose
Rs.10000 for each one rupee decrease in the price of oil during this period. Suppose the spot
price for soy oil on January 15 is Rs.450 per 10 Kgs and the April soy oil futures price on the
NCDEX is Rs.465 per 10 Kgs. The producer can hedge his exposure by selling 10,000 Kgs
worth of April futures contracts (10 units). If the oil producers closes his position on April
15, the effect of the strategy would be to lock in a price close to Rs.465 per 10 Kgs. On April
15, the spot price can either be above Rs.465 or below Rs.465.
21
Case 1: The spot price is Rs.455 per 10 Kgs. The company realizes Rs.4, 55,000 under its
sales contract. Because April is the delivery month for the futures contract, the futures price
on April 15 should be very close to the spot price of Rs.455 on that date. The company closes
its short futures position at Rs.455, making a gain of Rs.465 - Rs.455 = Rs.10 per 10 Kgs, or
Rs.10, 000 on its short futures position. The total amount realized from both the futures
position and the sales contract is therefore about Rs.465 per 10 Kgs, Rs.4, 65,000 in total.
Case 2: The spot price is Rs.475 per 10 Kgs. The company realizes Rs.4, 75,000 under its
sales contract. Because April is the delivery month for the futures contract, the futures price
on April 15 should be very close to the spot price of Rs.475 on that date. The company closes
its short futures position at Rs.475, making a loss of Rs.475 - Rs.465 = Rs.10 per 10 Kgs, or
Rs.10, 000 on its short futures position. The total amount realized from both the futures
position and the sales contract is therefore about Rs.465 per 10 Kgs, Rs.4, 65,000 in total.
Long hedge:
A long hedge is appropriate when a company knows it will have to purchase a certain asset in
the future and wants to lock in a price now. Suppose that it is now January 15. A firm
involved in industrial fabrication knows that it will require 300 Kgs of silver on April 15 to
The payoff for an industrial fabricator who takes a long hedge. Irrespective of what the spot
price of silver is three months later, by going in for a long hedge he locks on to a price of
The payoff for the buyer of a long hedge. Let us look at how this works. On April 15, the
22
Case 1: The spot price is Rs.1780 per kg. The fabricator pays rs.5, 34,000 to buy the silver
from the spot market. Because April is the delivery month for the futures contract, the futures
price on April 15 should be very close to the spot price of Rs.1780 on that date. The company
closes its long futures position at Rs.1780, making a gain of Rs.1780 - Rs.1730 = Rs.50 per
kg, or Rs.15, 000 on its long futures position. The effective cost of silver purchased works
Case 2: The spot price is Rs.1690 per MT. The fabricator pays Rs.5, 07,000 to buy the silver
from the spot market. Because April is the delivery month for the futures contract, the futures
price on April 15 should be very close to the spot price of Rs.1690 on that date. The company
closes its long futures position at Rs.1690, making a loss of Rs.1730 - Rs.1690 = Rs.40 per
kg, or Rs.12, 000 on its long futures position. The effective cost of silver purchased works
out to be about Rs.1730 per MT, or Rs.5, 19,000 in total. Note that the purpose of hedging is
not to make profits, but to lock on to a price to be paid in the future upfront. In the industrial
fabricator example, since prices of silver rose in three months, on hind sight it would seem
that the company would have been better off buying the silver in January and holding it. But
this would involve incurring interest cost and warehousing costs. Besides, if the prices of
silver fell in April, the company would have not only incurred interest and storage costs, but
would also have ended up buying silver at a much higher price. In the examples above we
assume that the futures position is closed out in the delivery month. The hedge has the same
basic effect if delivery is allowed to happen. However, making or taking delivery can be a
costly process. In most cases, delivery is not made even when the hedger keeps the futures
contract until the delivery month. Hedgers with long positions usually avoid any possibility
of having to take delivery by closing out their positions before the delivery period.
23
Advantages of hedging:
Besides the basic advantage of risk management, hedging also has other advantages:
1. Hedging stretches the marketing period. For example, a livestock feeder does not have to
wait until his cattle are ready to market before he can sell them. The futures market permits
him to sell futures contracts to establish the approximate sale price at any time between the
time he buys his calves for feeding and the time the fed cattle are ready to market, some four
to six months later. He can take advantage of good prices even though the cattle are not ready
for market.
2. Hedging protects inventory values. For example, a merchandiser with a large, unsold
inventory can sell futures contracts that will protect the value of the inventory, even if the
3. Hedging permits forward pricing of products. For example, a jewelry manufacturer can
determine the cost for gold, silver or platinum by buying a futures contract, translate that to a
price for the finished products, and make forward sales to stores at firm prices. Having made
the forward sales, the manufacturer can use his capital to acquire only as much gold, silver,
or platinum as may be needed to make the products that will fill its orders.
Hedging can only minimize the risk but cannot fully eliminate it. The loss made during
selling of an asset may not always be equal to the profits made by taking a short futures
position. This is because the value of the asset sold in the spot market and the value of the
asset underlying the future contract may not be the same. This is called the basis risk. In our
24
examples, the hedger was able to identify the precise date in the future when an asset would
be bought or sold. The hedger was then able to use the perfect futures contract to remove
almost all the risk arising out of price of the asset on that date. In reality, this may not always
The asset whose price is to be hedged may not be exactly the same as the asset
underlying the futures contract. For example, in India we have a large number of varieties
of cotton being cultivated. It is impractical for an exchange to have futures contracts with
The hedger may be uncertain as to the exact date when the asset will be bought or
sold. Often the hedge may require the futures contract to be closed out well before its
The expiration date of the hedge may be later than the delivery date of the futures
contract. When this happens, the hedger would be required to close out the futures
contracts entered into and take the same position in futures contracts with a later delivery
date.
An entity having an opinion on the price movements of a given commodity can speculate
using the commodity market. Commodities are bulky products and come with all the costs
and procedures of handling these products. The commodities futures markets provide
To trade commodity futures on the mcx, a customer must open a futures trading account with
a commodity derivatives broker. Buying futures simply involves putting in the margin
25
money. This enables futures traders to take a position in the underlying commodity without
having to actually hold that commodity. With the purchase of futures contract on a
commodity, the holder essentially makes a legally binding promise or obligation to buy the
underlying security at some point in the future (the expiration date of the contract)
Take the case of a speculator who has a view on the direction of the price movements of
gold. Perhaps he knows that towards the end of the year due to festivals and the upcoming
wedding season, the prices of gold are likely to rise. He would like to trade based on this
view. Gold trades for Rs.6000 per 10 Gms in the spot market and he expects its price to go
up in the next two three months. How can he trade based on this belief? In the absence of a
deferral product, he would have to buy gold and hold on to it. Suppose he buys a 1 kg of
gold, which costs him Rs.6, 00,000. Suppose further that his hunch proves correct and three
months later gold trades at Rs.6400 per 10 Gms. He makes a profit of Rs.40, 000 on an
investment of Rs.6, 00,000 for a period of three months. This works out to an annual return
of about 26 percent. Today a speculator can take exactly the same position on gold by using
gold futures contracts. Let us see how this works. Gold trades at Rs.6000 per 10 Gms and
three-month gold futures trades at Rs.6150. The unit of trading is 100 Gms and the delivery
unit for the gold futures contract on the NCDEX is 1 kg. He buys One kg of gold futures,
which have a value of Rs.6, 15,000. Buying an asset in the futures market only requires
making margin payments. To take this position, he pays a margin of Rs.1, 20,000. Three
months later gold trades at Rs.6400 per 10 Gms. As we know, on the day of expiration, the
futures price converges to the spot price (else there would be a risk free arbitrage
26
opportunity). He closes his long futures position at Rs.6400 in the process making a profit of
Rs.25, 000 on an initial margin investment of Rs.1, 20,000. This works out to an annual
return of 83 percent. Because of the leverage they provide, commodity futures form an
A speculator who believes that there is likely to be excess supply of a particular commodity
in the near future and hence the prices are likely to see a fall can also use commodity futures.
How can he trade based on this opinion? In the absence of a deferral product, there wasn't
much he could do to profit from his opinion. Today all he needs to do is sell commodity
futures. Let us understand how this works. Simple arbitrage ensures that the price of a futures
commodity. If the commodity price rises, so will the futures price. If the commodity price
falls, so will the futures price. Now take the case of the trader who expects to see a fall in the
price of cotton. He sells ten two month cotton futures contract, which is for delivery of 550
bales of cotton. The value of the contract is Rs.4, 00,000. He pays a small margin on the
same. Three months later, if his hunch were correct the price of cotton falls. So does the price
of cotton futures. He close out his short futures position at Rs.3, 50,000, making a profit of
Rs.50, 000.
27
The technique of ARBITRAGE:
A central idea in modern economics is the law of one price. This states that in a competitive
market, if two assets are equivalent from the point of view of risk and return, they should sell
at the same price. If the price of the same asset is different in two markets, there will be
operators who will buy in the market where the asset sells cheap and sell in the market where
it is costly. This activity termed as arbitrage, involves the simultaneous purchase and sale of
the same or essentially similar security in two different markets for advantageously different
prices. The buying cheap and selling expensive continues till prices in the two markets reach
equilibrium. Hence, arbitrage helps to equalize prices and restore market efficiency.
Whenever the futures price deviates substantially from its fair value, arbitrage opportunities
arise. To capture mispricing that result in overpriced futures, the arbitrager must sell futures
and buy spot, whereas to capture mispricing that result in under priced futures, the arbitrager
must sell spot and buy futures. In the case of investment commodities, mispricing would
result in both, buying the spot and holding it or selling the spot and investing the proceeds.
However, in the case of consumption assets, which are held primarily for reasons of usage,
even if there exists a mispricing, a person who holds the underlying may
An arbitrager notices that gold futures seem overpriced. How can he cash in on this
opportunity to earn risk less profits? Say for instance, gold trades for Rs.600 per gram in the
28
spot market. Three month gold futures on the NCDEX trade at Rs.625 and seem overpriced.
He could make risk less profit by entering into the following set of transactions.
1. On day one, borrow Rs.60, 07,460 at 6% per annum to cover the cost of buying and
holding gold.
Buy 10 Kgs of gold on the cash/ spot market at Rs.60, 00,000. Pay (310 + 7150) as
warehouse costs.
(We assume that fixed charge is Rs.310 per deposit up to 500 Kgs. and the variable storage
3. Take delivery of the gold purchased and hold it for three months.
4. On the futures expiration date, the spot and the futures price converge. Now unwind the
position.
5. Say gold closes at Rs.615 in the spot market. Sell the gold for Rs.61, 50,000.
7. From the Rs.62, 50,000 held in hand, return the borrowed amount plus interest of
Rs.60, 98,251.
When does it make sense to enter into this arbitrage? If the cost of borrowing funds to buy
the commodity is less than the arbitrage profit possible, it makes sense to arbitrage. This is
termed as cash and carry arbitrage. Remember however, that exploiting an arbitrage
opportunity involves trading on the spot and futures market. In the real world, one has to
29
Under priced commodity futures: buy futures, sell spot
An arbitrager notices that gold futures seem under priced. How can he cash in on this
opportunity to earn risk less profits say for instance, gold trades for Rs.600 per gram in the
spot market Three month gold futures on the NCDEX trade at Rs.605 and seem under priced.
If he happens to hold gold, he could make risk less profit by entering into the following set of
transactions.
1. On day one, sell 10 Kgs of gold in the spot market at Rs.60, 00,000.
2. Invest the Rs.60, 00,000 plus the Rs.7150 saved by way of warehouse costs for three
months 6%.
4. Suppose the price of gold is Rs.615 per gram. On the futures expiration date, the spot and
If the returns you get by investing in risk less instruments is more than the return from the
Arbitrage trades; it makes sense for you to arbitrage. This is termed as reverse cash and carry
arbitrage. It is this arbitrage activity that ensures that the spot and futures prices stay in line
with the cost ñ carry. As we can see, exploiting arbitrage involves trading on the spot market.
As more and more players in the market develop the knowledge and skills to do cash-and-
30
carry and reverse cash-and-carry, we will see increased volumes and lower spreads in both
MCX is designed in a manner to ensure that it broad bases the market participation by
making its operations inclusive and expansive, but at the same time building in sufficient
measures that would ensure the safety and integrity of the market is maintained at all times.
Moreover, in order to provide a strong correlation between the Physicals and Futures
markets, and based on India’s long history of trade practice continuing since over 100 years,
MCX provides for settlement of all open positions at the end of the contract through delivery.
The salient features of the MCX market framework include the following:
Matching System - Order Driven system of matching based on the logic of price-time
priority
Margins – Initial margins are computed and adjusted online whereas the Mark to Market
margins are collected by the next day. The business is based on the deposit contribution
made by the Members to MCX that is earmarked online with every trade. Thus, Members
are able to take only such positions as their deposit entitles them, based on the commodity
31
Guarantee – MCX, through its Settlement Guarantee Fund, guarantees the net settlement
liability of futures contract executed in the Exchange as per its Rules, Byelaws, Business
Settlement - All net outstanding futures contracts during the delivery period may be settled
by delivery of the underlying commodity. The objective is to ensure that MCX is able to
maintain close association between the Futures Market and the Physical Market.
Delivery - To start with the trade practice, which has been in existence in the country for
over 100 years that delivery will be sellers’ option and the Buyer’s obligation, has been
adopted. However, going forward, should the market desire so, suitable amendments can be
32
PART-III
COMMODITY PROFILE
SILVER:
Silver’s unique properties make it’s a very useful ‘Industrial Commodity’, despite it being
Demand: Demand for silver is built on three main pillars; industrial uses, photography and
jewelry & silverware accounting for 342, 205 and 259 million ounces respectively in 2002.
make it a key component in numerous products used on a daily basis. The main uses for
and bearings.
Briefing of demand:
• Together, industrial and decorative uses, photography and jewelry and silverware
33
• Industrial use of silver is the largest component of silver fabrication demand, with
silver being used in a wide range of products. Electrical and electronics applications
account for the largest area of industrial silver off take, (roughly 85% of the silver
demand)
Supply:
The supply of silver is based on two facts: mine production and recycled silver scraps. Mine
production is surprisingly the largest components of silver supply. It normally accounts for a
34
• Silver is often mined as by product of other base metal production, which accounts
• Other sources of supply are scrap: it is the silver that returns to the market when
recovered from the existing manufactured goods and wastes. it makes fifth of the supply.
• Disinvestments
• Government sales.
• Producers hedging
• Recycling
PRODUCTION:
In many instances, silver occurs in ores along with gold, copper, lead, zinc and other metals.
In many mines, the primary product is one of these metals, with silver being a by-product. At
Just over half of mined silver comes from Mexico, Peru and United States, respectively, the
first, second and fourth largest producing countries. The third largest is Australia.
• Silver occurs in the metallic state, commonly associated with gold, copper, lead, and
• The amount of silver extracted from primary silver mines fell, while silver mined as a
35
• Growth in silver bearing products worldwide has also led to increases in the amount
of silver recovered from scrap recycling. Most scrap comes from photographic materials,
36
2002 World Mine Production of Silver by Source
Supply
2002 2003
Mine Production 596.4 595.6
Net government Sales 61.2 82.6
Oil Silver Scrap 186.8 199.6
Producer hedging - -
Implied net disinvestments 26.2 10.4
Total Supply 870.7 880.2
Indian Scenario
Silver imports into India for domestic consumption in 2002 was 3,400 tons down 25 % from
37
Open General License (OGL) imports are the only significant source of supply to the Indian
market.
Non-duty paid silver for the export sector rose sharply in 2002, up by close to 200% year-
Around 50% of India’s silver requirements last year were met through imports of Chinese
silver and other important sources of supply being UK, CIS, Australia and Dubai.
Indian industrial demand in 2002 is estimated at 1375 tons down by 13 % from 1,579 tons in
2001. In spite of this fall, India is still one of the largest users of silver in the world, ranking
By contrast with United States and Japan, Indian industrial off take for fabrication in
hardcore industrial applications like electronics and brazing alloys accounts for only 15 %
and the rest being for foils for use in the decorative covering of food, plating of jewelry and
In India silver price volatility is also an important determinant of silver demand as it is for
gold.
Percentage
Pharmacy & Chemicals 22.4
Foil 9.0
Plating 13.7
38
Solders & Brazing 5.4
Electrical 13.5
Photography 0.85
Jari 17.1
World Markets
silver. Comex futures in New York is where most fund activity is focused.
Frequency Distribution of Silver London Fixing Volatility from 1995 till date
Percentage Change
Note: Post September 1999 daily silver prices have shown more than 5% movement not once
39
The price of silver is not only a function of its primary output but more a function of the
price of other metals also, as world mine production is more a function of the prices of other
metals
1. Inflation
3. Fluctuation in deficit
4 Interest rates.
5. Prices and demand of the main products: the greater profitability to the miner in other
metals will lead to the increment in production of the metal and hence of the silver in
tandem.
The reality of these trends is that as investment demand for bullion increases, jewelry
demand decreases and vice versa. Thus, we have a “pendulum demand/ supply” behavior.
When we adjust for currency changes, hedging and de-hedging, we end up with a stable,
long-term “staircase style” upward secular trend projection for gold bullion over the next
decade.
GOLD:
More than two thirds of gold’s total accumulated holdings relate to ‘value for
investment’ with central bank reserves, private players and high-carat jewelry.
40
Less than one third of gold’s total accumulated holdings are as a ‘commodity’ for
Gold market is highly liquid and gold held by central banks, other major institutions
Economic forces that determine the price of gold are different from, and in many
South Africa is the world's largest gold producer with 394 tons in 2001, followed by
US and Australia.
India is the world's largest gold consumer with an annual demand of 800 tons.
Demand:
Industrial uses:
• Gold possesses a unique combination of properties that have resulted in its use in a wide
• Gold and its alloys have been used for decorative purposes.
41
Gold is not a liability of any government or corporation it does not, unlike currencies, bonds
and equities, run any risk of becoming worthless through the default of the issuer. In more
recent times its role as an excellent portfolio diversifier. Since, unlike jeweler and industrial
demand, investment is measured on a net basis this makes it appear more volatile. However
interest in gold also rises and falls as a result of the political and economic situation; its role
Investment holdings (institutional and retail) account for 16% of the total stocks of gold.
Over the last five years net retail investment has accounted for 13% of total demand. Its
share of gold stocks is greater than its share of demand, due to the greater importance
42
Due to large stocks of gold as against its demand, it is argued that the core driver of the real
SUPPLY:
43
The main suppliers of gold are Grasberg, Australia, Russia, Switzerland, Netherlands,
Germany and Greece. Gold is produced in every continent except for Antarctica.
1. Mining
2. Scrap
3. Hedging activity
44
Mine Production by major region, 2003(total, 2,593 tonnes)
PRODUCTION: The grade of ore refers to the proportion of gold contained in the ore of a
particular mine and is quoted in grams per tonnes (g/t). The type of mine depends on the
depth and grade of the ore. At a rough estimate, the larger, better quality South African
45
underground operations are around 8-10g/t (Anglogold), while the marginal South African
underground mines run at around 4-6g/t. Many of the operations elsewhere in the world are
open pit mines, which run at lower grades, from as little as 1g/t up to around 3-4g/t. A more
significant piece of information than average gold mining grade is cost per ounce, which is a
COST OF PRODUCTION:
Production costs vary widely, according to the nature of the mine, be it open pit or
underground and at what depth, the nature and distribution of the ore-body (and by
implication the metallurgy which affects processing techniques) and the grade. Average
quoted cash costs for 2003 were estimated by GFMS at US$222/ounce with total cash costs
RECYCLED GOLD:
In the statistics, scrap is defined as being gold that has been sourced from old fabricated
products that have been recovered and refined back into bars. It does not include jewellery
that has simply been traded in and resold without being re-refined, or resold investment bars
and coins.
Most recycled gold generated originates from jewellery. Smaller amounts come from
recuperated electronics components and, at times, from investment bars and coins.
46
The supply of scrap depends largely on economic circumstances and on the behavior sof the
gold price. It is common practice in the Middle East and Asia for customers to trade in one
piece of jewellery in exchange for another, and the piece traded in may be melted down
rather than simply being resold. But gold can also be sold for cash either if the owner has
need of money or if the owner wants to cash in a profit following a rise in the gold price. It
follows that scrap supply typically rises in times of economic distress or following a price
rise.
47
JEWELLERY:
JEWELLERY is not a homogenous market globally. Its use, the type of jewellery acquired
and the conditions under which it is bought and sold are determined by custom and usage
which vary both from country to country and also within countries according to social
factors. A broad - although somewhat oversimplified - distinction can be made between two
types of jewellery: that which is primarily for adornment; and that which is also bought as a
means of saving.
World scenario:
In recent years retail investment in gold has been largely concentrated in a few countries.
These are
• The USA, Turkey where the official gold coin is widely used for savings and is also
used as currency
• Japan where saving plans encourage regular purchases and where banking crises and
• Indonesia, Thailand, South Korea, Saudi Arabia and the Gulf States are also
• In China latent demand has been heavily restrained due to regulations largely
prohibiting investment.
48
• London as the great clearing house
regions
49
India in world gold industry
India World
(Rounded Figures) % Share
(In Tons) (In Tons)
Total Stocks 13000 145000 9
Central Bank holding 400 28000 1.4
Annual Production 2 2600 0.08
Annual Recycling 100-300 1100-1200 13
Annual Demand 800 3700 22
Annual Imports 600 --- ---
Annual Exports 60 --- ---
• Gold is valued in India as a savings and investment vehicle and is the second
• In July 1997 the RBI authorized the commercial banks to import gold for sale or loan
to jewelers and exporters. At present, 13 banks are active in the import of gold.
• This reduced the disparity between international and domestic prices of gold from 57
jewellery off take is sensitive to price increases and even more so to volatility.
• In the cities gold is facing competition from the stock market and a wide range of
consumer goods.
50
• Facilities for refining, assaying, making them into standard bars in India, as compared
to the rest of the world, are insignificant, both qualitatively and quantitatively.
Frequency Dist. of Gold London Fixing Volatility from 1995 till date
Percentage
> 5% 2-5% < 2%
Change
Daily
Number of times 4 54 2147
Percentage times 0.2 2.4 97.4
Weekly
Number of times 3 62 376
Percentage times 0.7 14.1 85.3
Between September 24 and October 5, 1999, daily prices witnessed a rally of more than 21
51
• In the Middle and Far East, where financial and banking are not fully developed or
available, universally takes the form of high carat, heavy jewelry. Sold at a low markup it
• In the more affluent Western countries, it is more often-low carat, high design and
high margin fashion jewelry. For this type of jewelry the demand is more income related
• Most of the increase in for gold comes from extremely price sensitive markets, such
as the Middle East and the Indian Sub Continent. The typical investor there, unlike his
counterpart in the West, is far more rational and invests for the long haul. They tend to
buy when prices are low and sell when prices are high, which is the reverse of many
• As developing countries prosper and urbanize, they tend to switch towards Western
style fashion jewelry. In rural India, it is regarded as the property of women; a haven
• Eleven years ago, when India deregulated the gold trade, consumption began to climb
from 200 tons per annum to 900 tons in 2003. Today, China consumes an average 0.02
grams per capita, the same as India before gold was deregulated. Over 90% of Chinese
gold purchases go towards jewelry, for which is growing at over 15% per annum.
• Goldfields Minerals Services estimates that private investors own 15% of the above-
ground stock of gold (exclusive of jewelry), with the fastest growth occurring in the
Eastern Asian developing countries. GMS also estimates that from 1993 to 2000 retail
OTHER FACTS:
52
1. The gold price is usually quoted in US dollars per troy ounce. To calculate the cost of
one gram of gold, divide the US dollar price for one troy ounce by 31.1035 (one fine troy
2. The price movements of the gold and of sensex has been in opposite or near opposite
direction.
3. Price movement of gold in relation with the dollar is also negatively related.
4. While it is true that bullion responds to adversity in the short run, its trend in the long
run is a function of widened world prosperity, which in turn leads to an enlarged market
for jewery.over half of the ever mined currently resides in the form of jewelry. As each
53
FACTORS AFFECTING GOLD PRICES:
1. Dollars
2. Interest rates
3. Political situation
8. Above ground supply from sales by central banks, reclaimed scrap and official gold
loans
The peak year for scrap sales occurred during the 1997 / 1998 Asian financial crisis, whereas
the 2001 / 2002 increase was mostly due to profit taking as the price increased.
54
PART-IV
FUNDAMANTAL ANALYSIS:
markets, which affect the supply and demand of a particular market. It is in stark contrast to
technical ANALYSIS since it focuses, not on price but on factors like weather, government
policies, domestic and foreign political and economic events and changing trade prospects
fundamental analysis theorizes that by monitoring relevant supply and demand factors for a
identified before the state has been reflected in the price level of that market. Fundamental
analysis assumes that markets are imperfect that information is not instantaneously
equilibrium prices, which may indicate that current prices are inconsistent with underlying
Another definition:
It is an approach to analyzing market behavior that stresses the study of underlying factors of
supply and demand. It is done in the belief that such analysis will enable one to profit by
55
participant who relies principally on Supply/demand considerations in price forecasting.
Supply:
• Weather
• Government Programs
• USDA Reports
Demand:
• USDA Reports
• Exports
• Transportation
TECHNICAL ANALAYSIS:
Technical analysis operates on the theory that market prices at any given point in time reflect
all known factors affecting supply and demand for a particular market. Consequently,
technical analysis focuses, not on evaluating those factors directly, but on an analysis of
market prices themselves. This approach theorize that a detailed analysis of, among other
things, actual daily, weekly and monthly price fluctuations is the most effective means of
56
generally utilize a series of mathematical measurements and calculations designed to monitor
market activity. Trading decisions are based on signals generated by charts, manual
India has a very long tradition of commodity futures. It was having sporadic of futures
markets almost all over the country in not only such diverse cash crops as Cotton, Oilseeds,
and Raw jute and their products but also food grains. Futures trading started with the setting
up of Bombay Cotton Trade Association in 1875. The organized futures trading started in
1922 by the East India Cotton Organization. More and more commodities were added
between 20’s and 40’s, for futures trading like Groundnut, Groundnut oil, Raw jute, Jute
goods, Castor seed, Wheat, Rice, Sugar, Gold and Silver. This was indicative of a very long
tradition of commodity futures in our country. This is on the basis of recorded regulation in
various provinces in pre-independence time. But sporadic futures trading are heard even prior
to that. Teji, mandi, gali, phataks are the derivatives of futures heard happening centuries
ago.
Wheat markets were in existence in several centers of Punjab and UP. The prominent and
active was the Chamber Of Commerce of Hapur, which was established in 1913. Other
markets were located at Amritsar, Moga, Ludhiana, Jalandhar, Bhatinda, in Punjab and at
Futures trading in wheat have been taking place since long back at various renowned
commodity exchanges of world like Chicago Board of Trade (CBOT) in Chicago; USA,
57
Winnipeg Commodity Exchange in Canada, Kansas City Board of Trade in Kansas, USA,
Minneapolis Grains in Missouri, USA and many other exchanges located in Japan, Australia,
This bears testimony to the fact that the food grains are suitable for futures trading. With
evolution of scientific grades and standards, scientific warehousing systems and practices,
Wheat is one of the most important staple food grains of human race. India produces about
70 million tones of wheat per year or about 12 per cent of world production. It is now the
second largest producer of wheat in the world. Being the second largest in population, it is
also the second largest in wheat consumption after China, with a huge and growing wheat
demand.
It is cultivated from a sea level up to even 10,000 feet. More than 95 percent of the wheat
area in India is situated north of a line drawn from Bombay to Calcutta and also in Mysore
The Major Wheat producing states in India is placed in the Northern hemisphere of the
country with UP, Punjab and Haryana contributing to nearly 80% of the total wheat
58
production (Chart 1).
Rajas than
10% Uttar Pradesh
Madhy a Prades h
12% 41%
Hary ana
13%
Punjab
24%
59
Types Regions Uses Seasons Indian varieties*
of US 147-Avg. Lok-1
Hard Red Spring Wheat Northern Plains Bread Spring None
macaroni, pasta
147-Avg, Lok-1
NOTE: Dara variety produced all over in India (Maximum production), Desi (Durum)
produced all over in India, Lok-1 in Gujarat and part of MP& Rajsthan,
60
Production of Wheat in India as can be seen from Chart 2 has shown a rising trend in the past
5 decades. However, there was a steep jump in production of wheat during 1960-70 to 1970-
1980 by nearly 109%. The Green Revolution in the 1960’s contributed to this phenomenal
rise in wheat production in the country over the decade. However, following 1980’s, there
has been a consistent declining trend in production of Wheat in India. For instance, the
production of Wheat rose by just 61% from 1970-1980 to 1980-1990. In recent years, there
has been a worsening trend with wheat production actually growing by just 7% from 2000-01
61
to 2001-02. (Please refer to Table 1)
70
63.91
60
50
Production of Wheat (in MMT)
44.76
40
30
27.78
20
13.3
10
8.36
0
1950-51 to 1960 1960-61 to 1970 1970-71 to 1980 1980-81 to 1990 1990-99 to 2000
Years
62
Production of Wheat (MMT) over the past 5 decades
70
63.91
60
50
Production of Wheat (in MMT)
44.76
40
30
27.78
20
13.3
10
8.36
0
1950-51 to 1960 1960-61 to 1970 1970-71 to 1980 1980-81 to 1990 1990-99 to 2000
Years
For nearly a decade, i.e. upto mid 70’s agricultural production had stagnated. The spectacular
yield growth recorded in the post-Green Revolution years in Punjab and Haryana has receded
into history. Food grain production in the frontline agricultural states of Punjab, Haryana and
western Uttar Pradesh, comprising the country's food bowl, has decelerated. The miracle that
began with wheat was replicated in rice.The area under production of Wheat has increased
from a mere 12.93 million hectares in 1960-61 to 27.49 million hectares in 1999-2000, an
increase of more than 100% over the past 5 decades. The production of Wheat at the same
time, increased from 11 million tones in 1960-61 to 76.37 million tones in 1999-2000. The
yield (kg/hectare) on the other hand, increased from 851 in 1960-61 to 2778 in 1999-2000, an
increase of around 3.56 times. This indicates that although wheat production over the past 5
63
decades increased by 6.87 times but the yield of wheat has actually increased by only half of
this figure.
As can be seen from Chart 3, the demand of wheat has increased by 2% (approximately) over
the past 7 years while the supply of wheat has increased by 3% over the same time period.
This indicates that the supply of wheat is more than needed for domestic use leading to stock
64
surpluses.
D em a n d & S u p p ly o f W h e at (in M M T )
80 66
78
64
76
74 62
Demand
72
Supply
60
70
68 58
66
56 Total S upply
64
62 54
Dem and
94/95 95/96 96/97 97/98 98/99 99/00 00/01
Ye a rs
Since 1998 India’s share in world wheat production is around 12% to 13%, at the same time.
India’s share in world wheat consumption is around 10% to 11%. It proves that some sort of
extra stock (around 1% to 2%) arises every year. The demand-supply gap which is open at a
rate of about 1 to 2 per cent per year is equivalent to 0.7 to 1.4 million tones of wheat,
growing larger over the years. Resultantly the ending stocks of wheat have been increasing
and the same thing can be visualized from the following chart
65
Indian Wheat Consumption and Stock variables
OF WHEAT:
Since the Green Revolution, Indian production of cereals including Wheat has been on the
rise with the production of wheat rising from a mere 8.6 million tones in 1960-61 to 73.53
million tones in 1999-2000[1]. A study of the supply and demand trends over the past decade
66
also indicates that there is always a 1%-2% surplus in Wheat. The MSP for Wheat has also
increased from Rs. 275 in 1992-93 to Rs. 620 in 2002-03 (Please refer Table 2).
However, although the MSP has risen over the past decade substantially above Cost of
Production leading to price distortion. For instance, in 2000-01, the MSP was set at Rs 610
(Rs/qtnl.). As against this, the C2 (Cost of Production i.e., all costs including the imputed
costs of family labour, owned capital and rental on owned land) in case of Punjab was Rs 422
leading to a margin of Rs 171 (Rs/qtnl.) In addition, the fragmentation of the Wheat market
has resulted in further widening of price differentials between the North and South regions of
the country.
Cost to MSP
(Rs./qntl.)
1992-93 275 507 1.84
1993-94 330 532 1.61
1994-95 350 551 1.57
1995-96 360 584 1.62
1996-97 380 663 1.74
1997-98 475 798 1.68
1998-99 510 800 1.57
1999-00 550 888 1.61
2000-01 580 858 1.48
2001-02 610 871 1.43
2002-03 620 - -
From the above table it is clear that during the 90’s MSP has shown a steadily rising trend
and at the same time economic cost has increased physically, but the ratio of FCI’s
67
MSP, PROCUREMENT AND STOCKS – WHEAT
rate as WPI
1996-97 380 127.2 380.0
1997-98 475 132.8 396.7
1998-99 510 140.7 420.3
1999-00 550 145.3 434.1
2000-01 580 155.7 465.1
2001-02 610 161.3 481.9
The distortions in prices are evident from the above table also. If consider Wholesale Price
Index 127.2 as base during 96-97 when MSP was Rs. 380/- per quintal for both wheat and
rice then MSP in 2001 should have been Rs. 481.90 as against Rs.610/- per quintal.
The demand of Wheat in the country is pretty stable over the past few years with the average
demand of Wheat staying at around 63 MMT over the past 4 years. (Please see table 4) On
the other hand, the supply of Wheat has also remained steady at 77 MMT (approximately)
over the same time period. This condition is highly conducive to commencement of futures
trading in wheat with better chances of price discovery. The reason being that stable demand
and supply would help in correct future forecasting and future spot price fixation. This in turn
would lead to convergence between futures price and future spot price and hence correct risk
management mechanism.
68
97/98 75.32 61.69
98/99 76.29 62.56
99/00 77.41 63.53
00/01 78.66 64.60
700
600
MSP Prices (Rs 620/qntl.)
500
Prices (Rs./qntl.)
400
300
HARVESTING-- SOWING OF
SLACK SEASON--MAY-AUG
SUP P LY of WINTER WINTER
200 WHEAT Wheat
100
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Months (2002)
69
As can be seen from Chart 4A, the MSP is always higher than the Mandi Prices in
entire year of 2002 indicating that the MSP prices are not reflecting actual demand-
% Share of Country
Others
China
Pakistan 13%
22%
3%
Turkey
4%
Italy
4%
Australia
4% India
Canada 13%
5%
Russian Federation
6% Romania USA
6% France 13%
7%
Wheat production in India has increased by over ten times in the past five decades
and India has become the second largest wheat producer in the world. Today wheat
Since 1998-99 India’s share in world Wheat production hovers around 11%
to13%.
70
INDIA’S POSITION IN THE WORLD WHEAT MARKET
Starting from 1998-99 till date India’s share in world wheat export shows a rising trend. Not
only share, India’s physical export also sharply rising. India’s percentage share in both world
71
Since wheat prices at procurement level and at disposal level are placed under controlled
mechanism with defined objectivity, scope of general price trend analysis also becomes govt.
policies centric. The related price in the open market has got a substantial relationship with
the prices of wheat traded in the open market. Therefore our presentation on this aspect has a
notion that the price elasticity of demand has got direct relationship on prices of wheat of
other varieties (whatsoever be the size of share in total production). However, availability of
targeted variety (Mexican/Dara) wheat shall increase, if Govt. withdraws gradually from
PURCHASES:
The policy of Minimum Support Price (MSP) supports economic growth. MSP is a critical
policy component of the Indian Economy. It generates broadly different purchasing power,
health and wealth. Governments works out the MSP giving due consideration to all the
economic factors like cost of input, power, capital; and labor with reasonable going margins.
With the certainty about the support price, farmers expend better effort and resources provide
confidence and motivation to the growers. MSP and commodity options are consistent with
72
PROCUREMENT OF WHEAT (CENTRAL POOL ACCOUNT)
Marketing 1994- 1995- 1996- 1997- 1998- 1999- 2000- 2001- 2002-03
Year 95 96 97 98 99 2000 01 02
Wheat 119 123 82 93 126 141 163 206 #190.2
SALES/LIQUIDATION OF INVENTORIES:
The prime objective of MSP of providing assured market to the growers achieved and
production kept on upward swing which culminated into comfort level of food security and
paused much more serious issues. One of them was the slower pace of replenishing the
inventories. Pricing policies of disposal of stocks thrusted at the social commitment of the
Government. Government kept on pumping wheat stocks at the issue price, which need to be
73
lower than MSP through States machinery of Public Distribution channels throughout the
country that has helped to sustain the high growth rate and maintain regular, supply of Wheat
and Rice.
Government of India introduced a new scheme called Targeted Public Distribution Scheme
(TPDS) in 1997 where in ultimate consumers were segmented in two categories i.e., Below
Poverty Line and Above Poverty Line as per the recommendation of Planning Commission.
The issue price of Wheat during 2001 and 2002 were as under:-
(Rs./Quintal)
Besides above stocks were earmarked for various other welfare schemes by the Government
When the impact of Government policies on pricing started showing little effect on the wheat
market; it was more or less stabilized, but at the same time off take by states in PDS either
steady or slightly showing downswing, resulting into burgeoning and inventories with the
Govt. agency (FCI). Therefore Govt. for minimizing subsidies decided release first old grain
or below quality grain and then superior quality grain in Open market at the best available
74
EXPORTS:
When saturation of domestic demand was observed and further compulsion of sustaining the
present market condition, the only avenue of liquidation of inventories was Exports. But
disparity of domestic and international prices were dealt with subsidized issue price which
served prime objective of quick and faster replacement, reducing carrying cost which
ultimately form the major share of subsidy and ultimately earn the foreign exchange which
75
ISSUE PRICE
APL BPL
TRADING:
Futures as well as MSP and OMSS (Open Market Sales Scheme) are price risk management
mechanisms with the same objective to help remove uncertainties arising due to price
volatility in Wheat. However, in light of administered price regime, futures trading in Wheat
cannot kick off. Futures trading in Wheat would help in proper price discovery only if the
76
market is allowed to determine the prices based on demand-supply factors affecting Wheat.
The reason is that in case of an administered price scenario, the futures market would not
trade freely. That is, if the MSP is say Rs 620/qntl. then the trading in market would not go
below Rs 620 in any case distorting the functioning of futures market. Even if the
International markets were trading lower, the Indian markets would still stay above the Rs
620 mark.
As can be seen from Chart 8, the Issue price of Wheat, which is administered by FCI, was at
around Rs. 525 per quintal for 2002. A comparison with FOB prices of US Wheat prices in
the same time period indicates that the US Wheat Export Prices are more subsidized and
In the light of the above discussion, MSP and Issue Price should not be enhanced in the
future but kept constant and removed in a phased manner over a time frame. In its place,
77
CORRELATION BETWEEN INDIAN AND US WHEAT PRICES:
Price (Rs/qntl)
140
400
120 US Wheat
Prices
100 300
80
200
60
40
100
20
0 0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Months 2002
The Government fixes an issue price for Export of wheat for one year (Please see Table -9).
In case of 2002, the Government declared an issue price for export at Rs. 5250 per tone (525
Rs/qntl). In comparison with the US FOB prices of Wheat for exports, it can be seen from
Chart 8 above that from January-July 2002, the US Wheat FOB prices were much below the
Indian Export Issue Prices. One reason could be that although wheat export is subsidized in
both India and USA, it is highly subsided in case of USA. In addition, in 2002, the MSP
(Procurement price) by FCI was set as high as Rs. 620 per quintal (Please see Table 2 of
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Year Issue Price of Wheat Export
(Rs./tonnes)
1999-00 4910
2000-01 5110
2001-02 5110
2002-03 5250
2003-04* 5550
Wheat grown in India is of winter variety i.e. it is sown in Winter (November) and harvested
in summer (April). In 2002, there was a bumper crop of wheat and owing to issue price being
much higher than mandi prices there was excessive stock of Wheat by FCI, which was then
released during September -November resulting in declining prices. On the contrary, during
August – September, US winter wheat prices showed an upward trend, this is due to part
declining of wheat ending stocks, which was the result of lower production caused by
drought. That was the smallest US wheat crop in 30 years as ending stocks were lowest since
1966-67.
Again during November and December of 2002 as seen in Chart 8 US and Indian prices
because of Food Corporation of India’s (FCI) decision to stop sale of sound wheat under the
To summarize, during 2002 the movement of wholesale prices of Indian wheat reflect the
procurement and prices declared by FCI. During the harvest season from January to July
2002, FCI procured huge stocks of wheat, which it then released in August-mid November
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leading to declining in prices during that time. However, from mid – November to
December, FCI stopped the sale of sound wheat through OMSS scheme leading to hike in
In case of US wheat prices (FOB) in 2002, the prices reflect demand-supply condition. In
January-July, which is the harvest season for winter wheat in USA, the prices are low. The
hike in price between August-September was owing to lower stocks of wheat. The lower
Mandis
Exporters Industry A
FCI (Flour Mills &
Chakis) Retailers t
Consumers
Consumers End- Users
BPL (Below
Poverty APL (Above
Poverty Line) (Consumer
Line)
s)
present, there are various channels of Wheat active in the market at different levels. The
Government procures Wheat from Growers through agencies such as (FCI) Food
Corporation of India. This wheat thus procured is distributed through State PDS (Public
Distribution System). The PDS system at grass root level is well defined and organized
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sector set up at state level. FCI being the major player in wheat procurement and distribution;
procures nearly 18% of wheat from growers and maintains buffer stocks in the Central Pool
The balance 82% of the Wheat produced is marketed through various channels such as
flourmills, and large-scale manufacturers such as bread makers and flour mills (maida-suji).
Though the Government procures 18% of the wheat but in comparison to the remaining
sector, it is the largest organized buyer in the Wheat market. Therefore, the Government can
The phasing out of Government’s involvement in the wheat market would result in increased
participation of the Private Sector in this market. This would lead to two-fold benefit----
For a commodity to be suitable for smooth futures trading generally a favorable supply-
demand balance is considered necessary, though this condition is no longer very relevant in
grains under the EXIM policy of India. Nevertheless, India is no longer dependent on imports
of food grains with nearly 2% of surplus of Wheat over the last decade. With the withdrawal
of Government in the Wheat market, volatility and vibration in wheat market would be
conducive for Futures trading in the country. Traders and manufactures could do away with
storing excessive stock of Wheat resulting in increased carrying cost. For instance, the
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economic cost of carrying buffer stocks of Wheat for FCI is projected to rise to Rs 921/per
quintal in 2003-04 from the present cost of 879.16/per quintal due to increase in MSP, open
ended procurement and hike in the rates of state taxes and levies. In light of this, futures
trading in Wheat would provide a mechanism to lock in prices today of future production or
future sale. This would enable reduction of buffer stocks with traders and stockiest who
would use futures to maintain optimal levels of Wheat stocks. The locking in of Futures price
and buying/selling forward on estimated production would help in removing intra seasonal
Such a futures market would not only provide management of price risks through hedging
but also assist in efficient discovery of prices, which could serve as reference for trade in
India:
Seasons: Winter
Usa:
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Type pf Wheat: a) Soft Red Winter Wheat (SRW) & b) White Wheat
Area Grown: SRW is grown in Great Lakes Area of USA and White Wheat in
Northern Plains
Seasons: SRW is grown in Winter & White Wheat Spring as well as in Winter
India:
Area Grown: Punjab, M.P. (Max), Tamil Nadu, Gujarat, Karnataka, West Bengal
and H.P.
Seasons: Winter
Usa:
Seasons: Spring
Bread:
India:
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Type of Wheat: Common Bread
Area Grown: Punjab, U.P. Bihar & parts of Rajas than (Bulk of Crop)
Seasons: Winter
USA:
Type of Wheat: a) Hard Red Winter (HRW) & b) Hard Red Spring (HRS)
1. In rural areas the wheat consumption rises significantly with income levels. Thus,
income increase in rural areas will lead to a larger increase in wheat consumption. In
urban areas, too, the rise is present but not as much. However, the average
2. The consumption of wheat and rice rises with income whereas the consumption of
coarse cereals falls. The consumption of rice rises to a certain level and then tapers
off. The consumption of wheat starts at a lower level but continues to increase as
income rises – this indicates a more buoyant demand for wheat with income growth.
Thus, the three different cereal types show quite different consumption behaviour in
relation to income, and wheat shows a sustained rise with income increase.
3. For wheat the bound rate of duty is 100 per cent, but roller flourmills are allowed to
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4. The cost of production of wheat varies considerably across states and ranges from an
average of Rs.292 per quintal to Rs.377 per quintal (1995/96). Haryana shows the
lowest cost in all the years followed by Punjab and Uttar Pradesh. Madhya Pradesh
has the highest cost of production. The differences are due to agroecology as well as
crop management.
5. The system includes the Commission on Agricultural Costs and Prices (CACP), the
government every year at the beginning of every wheat season. These prices are
7.The issue prices or the price at which the grain is released to the government Public
Distribution System (PDS) is fixed and revised only from time to time. The distribution is
mainly by state governments through thousands of fair price shops spread throughout the
country in the urban and rural areas. There is an element of subsidy in this but the
government has been trying to target and reduce this in recent years.
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OUTLOOK FOR 2005:The expected production of the wheat for 2005 is 75 million tonnes
by India and over all 622 million tonnes. The production is in abundance so the outlook is
bearish. As per the seasonality says that the price is expected to go up from the month of
November to February.
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PART –1V
ANALYSIS:
Lesser risk
Lower margins
Lesser variations.
No fluctuation.
The lack of liquidity and fluctuation in the market keeps the main players viz:
Producers
Traders
Manufacturers
The reasons being the government policies like floor price i.e. minimum supply price,
subsidies, export subsidies etc (macro factors). All these affect the free movements of the
prices.
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3. Reasons for not investing in commodity market:
High brokerage.
Low volume
Lack of information.
Lack of awareness
No fluctuation.
No sense of taking delivery i.e. you don t get dividend or bonus after taking
economy.
4. Factors that are holding back the healthy growth of commodity market are:
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• Government policy like floor rates, quota, subsidy (all these tampers with the
• No turnover
• No volatility.
Macro analysis:
India has tremendous potential as far as commodity market is concerned. So the dealers can
look forward to tap this potential .at present very minimal proportion of the total trade-
taking place is done through the exchange and so we can look forward to tap this market of
commodities.
OILSEEDS (EXAMPLE):
The total value of the oil seed trade that can take place is 40x60=2400000000 per day.
FOOD GRAINS:
The total food grain production in India is 22 million tones the total volume traded on
exchange is very negligible. The per capita consumption of the food grains is in India is 417
The factors that are hampering the growth of the commodity market (natural commodities)
are:
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1-Government policies like floor prices
4. Lack of information.
All these factors affect the free movements of the prices of the commodities and thus it
affects the natural environment for the price fixation on the basis of the demand and supply
of the commodities.
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References:
• www.Usda.gov
• www.Uswheatassociate.com
• www.Mcxindia.com
• www.Nmce.com
• www.Agronet.com
• www.indiancommodity.com
• www.commoditiescontrol.com
• www.kitco.com
• www.forexnews.com
• www.seasonalcharts.com
• www.tradingcharts.com
• www.eagritraders.com
Books:
• Advanced commodity -Windsor
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