JUN 3, 2020 By : ATHUL RAJEEV, VENTESKRAFT.
Commodity market is a physical or virtual marketplace for buying, selling, and trading raw or primary products. There are currently around 50 major commodity markets around the world facilitating trade in around 100 primary commodities. Commodity market are divided into two types: hard and soft commodities. Commoditymarket can be held in several different ways. An investor may buy stock in corporations that rely on commodity prices or buy mutual funds, index funds, or exchange-traded funds (ETFs)
By buying into a futures contract, the most direct way to invest in commodities will be to. A future contract requires the holder to buy or sell a product at a certain delivery date at a fixed price. The commodity market promotes trade of physical commodities between a country’s citizens. Individuals seeking to diversify their portfolio on the commodity market can undertake investments in both local and imported products, thus not only mitigating the risk factor but also providing a hedge against inflation rates in an economy.
Types of Commodities in the market
- Hard commodities
- Precious metals – Gold, platinum, copper, silver, etc.
- Energy – Crude oil, Natural gas, gasoline, etc.
- Soft commodities
- Agriculture – Soybeans, wheat, rice, coffee, corn, salt, etc.
- Livestock and meat – Live cattle, pork, feeder cattle, etc
Some examples of commodities most commonly traded on the market in India’s major commodity exchanges included crude oil and silver. While crude oil acts as one of the most important energy sources required for virtually any industry, with steady demand, silver is one of the most valuable metals other than gold.
As crude oil is not domestically available in abundance, almost 82% of it is imported from OPEC and Middle Eastern countries. Similarly, silver is traded in extensive quantities from countries such as Mexico, Peru, etc.
How to Invest in the Commodity Market?
Commodity trading is managed by four major commodity exchanges in India –
- Multi Commodity Exchange (MCX)
- Indian Commodity Exchange (ICEX)
- National Commodity and Derivatives Exchange (NCDEX)
- National Multi Commodity Exchange (NMCE)
Commodity markets facilitate an exchange of both physical goods and derivative contracts. While the physical exchange is undertaken by institutional investors and commodity brokers aiming to realize gains through the resale of the products in the retail sector of the country. Investors can practice investing in commodity markets through a futures or options contract. While a futures contract dictates individuals to sign a deed stipulating delivery of a product at a later date with respect to a fixed price. An options contract acts as an agreement but not a liability of the same.
One of the features of a commodity market is that its performance demonstrates an inverse relation with both stock and bond markets, as the bond and stock prices fall when the average price level of goods rise in the economy.
Traders in a Commodity Market
The commodity markets holds importance for two kinds of individuals based on the commodity market operations they partake in :-
These investors aim to reduce exposure to market fluctuations by entering into a futures contract with traders. Any change in the price level does not impact the rate at which respective goods are exchanged in the market. Most hedgers trade physical goods on the commodity market, as they require the stipulated goods or the purposes of production or resale.
Investors aiming to generate substantial profits from trade in the commodity market are termed as speculators. A prediction regarding the direction of movement of market prices are assumed by such individuals. Before signing a futures contract, and depending upon accuracy of market forecast, positive or negative returns can be realized, subject to spot prices.
Why Invest in the Commodities Market?
The importance of commodity markets investing is elucidated by the following factors :
- Inflation hedge
- Margin trading
- Substantial returns
Limitations of commodity market
- High risk –
The commodity market is volatile, as any fluctuations in the productive capacity, demand, or changing social circumstances readily affect the prices. Due to such high volatility, predicting the movement of commodity prices might be challenging, causing investors to lose out substantial returns due to unforeseen market events.
Hence, individuals need to be well-equipped with both the internal working of an economy. As well as external factors such as international trade before choosing to trade in commodities. Additionally, the demand and supply patterns should be kept in mind to mitigate the risk further.
- Limited returns –
While stock and bond markets have periodic pay-outs such as dividend yields, coupon payments, etc. commodity investment can only generate capital gains.While commodity market investments can reap significant returns, substantial expertise is required for the same. Individuals can trade in goods through any established commodity exchange by registering with a commodities broker.