Introduction to Commodity Markets

India, a commodity based economy where two-third of the one billion population depends on agricultural commodities, surprisingly has an under developed commodity market. Unlike the physical market, futures markets trades in commodity are largely used as risk management (hedging) mechanism on either physical commodity itself or open positions in commodity stock. A commodity contract is basically a derivative contract. Hence, a brief introduction to the concept of derivatives would help one understand commodity markets in depth. Introduction to Derivatives

The origin of derivatives can be traced back to the need of farmers to protect themselves against fluctuations in the price of their crop. From the time it was sown to the time it was ready for harvest, farmers would face price uncertainty. Through the use of simple derivative products, it was possible for the farmer to partially or fully transfer price risks by locking. in asset prices. These were simple contracts developed to meet the needs of farmers and were basically a means of reducing risk. A farmer who sowed his crop in June faced uncertainty over the price he would receive for his harvest in September. In years of scarcity, he would probably obtain attractive prices. However, during times of oversupply, he would have to dispose off his harvest at a very low price. Clearly this meant that the farmer and his family were exposed to a high risk of price uncertainty.

On the other hand, a merchant with an ongoing requirement of grains too would face a price risk - that of having to pay exorbitant prices during dearth, although favorable prices could be obtained during periods of oversupply. Under such circumstances, it clearly made sense for the farmer and the merchant to come

together and enter into a contract whereby the price of the grain to be delivered in September could be decided earlier. What they would then negotiate happened to be a futures. type contract, which would enable both parties to eliminate the price risk.

In 1848, the Chicago Board of Trade, or CBOT, was established to bring farmers and merchants together. A group of traders got together and created the `to.arrive' contract that permitted farmers to lock in to price upfront and deliver the grain later. These to-arrive contracts proved useful as a device for hedging and speculation on price changes. These were eventually standardized, and in 1925 the first futures clearing house came into existence. Today, derivative contracts exist on a variety of commodities such as corn, pepper, cotton, wheat, silver, etc. Besides commodities, derivatives contracts also exist on a lot of financial underlying like stocks, interest rate, exchange rate, etc.

Derivatives defined 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, commodity or any other asset. In our earlier discussion, we saw that 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.

The Forwards Contracts (Regulation) Act, 1952, regulates the forward/ futures contracts in commodities all over India. As per this the Forward Markets Commission (FMC) continues to have jurisdiction over commodity forward/ futures contracts. Derivatives trading in securities were introduced in 2001. The term security in the Securities Contracts (Regulation) Act, 1956 (SCRA), was amended to include derivative contracts in securities. Consequently, regulation

of derivatives came under the purview of Securities Exchange Board of India (SEBI). We thus have separate regulatory authorities for securities and commodity derivative markets.

Derivatives are securities under the SCRA and hence the trading of derivatives is governed by the regulatory framework under the SCRA. The Securities Contracts (Regulation) Act, 1956 defines derivative as

A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security. A contract which derives its value from the prices, or index of prices, of underlying securities. Products, participants and functions

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 the following three broad categories.

Hedgers, Speculators, Arbitragers. 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 reduce or eliminate this risk.

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.

Arbitragers: Arbitragers work at making Profit by taking advantage of discrepancy 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

Derivatives markets

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. Financial derivatives markets trade contracts that have a financial asset or variable as the underlying. The more popular financial derivatives are those which have equity, interest rates and exchange rates as the underlying. The most commonly used derivatives contracts are forwards, futures and options.

Spot versus forward transaction

Using the example of a forward contract, let us try to understand the difference between a spot and derivatives contract. Every transaction has three components trading, clearing and settlement. A buyer and seller come together, negotiate and arrive at a price. This is trading. Clearing involves finding out the net outstanding

that is exactly how much of goods and money the two should exchange. For instance A buys goods worth Rs.100 from B and sells goods worth Rs.50 to B. On a net basis A has to pay Rs.50 to B. Settlement is the actual process of exchanging money and goods.

In a spot transaction, the trading, clearing and settlement happens instantaneously i.e. .on the spot. Consider this example. On 1st January 2004, Aditya wants to buy some gold. The goldsmith quotes Rs.6, 000 per 10 grams. They agree upon this price and Aditya buys 20 grams of gold. He pays Rs.12, 000, takes the gold and leaves. This is a spot transaction.

Now suppose Aditya does not want to buy the gold on the 1st January, but wants to buy it a month later. The goldsmith quotes Rs.6, 015 per 10 grams. They agree upon the forward price for 20 grams of gold that Aditya wants to buy and Aditya leaves. A month later, he pays the goldsmith Rs.12, 030 and collects his gold. This is a forward contract, a contract by which two parties irrevocably agree to settle a trade at a future date, for a stated price and quantity. No money changes hands when the contract is signed. The exchange of money and the underlying goods only happens at the future date as specified in the contract. In a forward contract the process of trading, clearing and settlement does not happen instantaneously. The trading happens today, but the clearing and settlement happens at the end of the specified period. A forward is the most basic derivative contract. We call it a derivative because it derives value from the price of the asset underlying the contract, in this case gold. If on the 1st of February, gold trades for Rs.6,050 in the spot market, the contract becomes more valuable to Aditya because it now enables him to buy gold at Rs.6,015. If however, the price of gold drops down to Rs.5, 990, he is worse off because as per the terms of the contract, he is bound to pay Rs.6, 015 for the same gold. The contract has now lost value from Aditya's point of view. Note that the value of the forward contract to the goldsmith varies exactly in an opposite manner to its value for Aditya.

Exchange traded versus OTC derivatives

Derivatives have probably been around for as long as people have been trading with one another. Forward contracting dates back at least to the 12th century, and may well have been around before then. These contracts were typically OTC kind of contracts. Over the counter (OTC) derivatives are privately negotiated contracts. Merchants entered into contracts with one another for future delivery of specified amount of commodities at specified price. A primary motivation for pre - arranging a buyer or seller for a stock of commodities in early forward contracts was to lessen the possibility that large swings would inhibit marketing the commodity after a harvest. Later many of these contracts were standardized in terms of quantity and delivery dates and began to trade on an exchange.

The OTC derivatives markets have the following features compared to exchangetraded derivatives:

The management of counter-party (credit) risk is decentralized and located within individual institutions. There are no formal centralized limits on individual positions, leverage, or margining. There are no formal rules for risk and burden-Sharing. There are no formal rules or mechanisms for ensuring market stability and integrity, and for safeguarding the collective interests of market participants. The OTC contracts are generally not regulated by a regulatory authority and the exchange's self-regulatory organization, although they are affected indirectly by national legal systems, banking supervision and market surveillance. The OTC derivatives markets have witnessed rather sharp growth over the last few years, which have accompanied the modernization of commercial and investment banking and globalization of financial activities. The recent developments in

information technology have contributed to a great extent to these developments. While both exchange-traded and OTC derivative contracts offer many benefits, the former have rigid structures compared to the latter. The largest OTC derivative market is the interbank foreign exchange market. Commodity derivatives the world over are typically exchange-traded and not OTC in nature.

Some commonly used derivatives

Here we define some of the more popularly used derivative contracts. Some of these, namely futures and options will be discussed in more details at a later stage.

Forwards: As we discussed, a forward contract is an agreement between two entities to buy or sell the underlying asset at a future date, at today's pre-agreed price.

Futures: A futures contract is an agreement between two parties to buy or sell the underlying asset at a future date at today's future price. Futures contracts differ from forward contracts in the sense that they are standardized and exchange traded.

Options: There are two types of options - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

Warrants: Options generally have lives of upto one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longerdated options are called warrants and are generally traded over-the-counter.

Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a weighted average of a basket of assets. Equity index options are a form of basket options.

Swaps: Swaps are private agreements between two parties to exchange cash _ows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are :

Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction. Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap.

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. In fact, the size of the commodities markets in India is also quite significant. Of the country's GDP of Rs 13, 20,730 crore (Rs 13,207.3 billion), commodities related (and dependent) industries constitute about 58 per cent. Currently, the various commodities across the country clock an annual turnover of Rs 1, 40,000 crore (Rs 1,400 billion). With the introduction of futures trading, the size of the commodities market grows many folds here on.

Indian Commodity Market India commodity market consists of both the retail and the wholesale market in the country. The commodity market in India facilitates multi commodity exchange within and outside the country based on requirements. Commodity trading is one facility that investors can explore for investing their money. The India Commodity market has undergone lots of changes due to the changing global economic scenario; thus throwing up many opportunities in the process. Demand for commodities both in the domestic and global market is estimated to grow by four times than the demand currently is by the next five years.

Evolution of commodity markets 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 ground nut, 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. What Exactly Is a Commodity Contract? Let's say, for example, that you decide to subscribe to satellite TV. As the buyer, you enter into an agreement with the company to receive a specific number of channels at a certain price every month for the next year. This contract made with the satellite company is similar to a futures contract, in that you have agreed to receive a product or commodity at a later date, with the price and terms for delivery already set. You have secured your cost for now and the next year, even if the price of satellite rises during that time. By entering into this agreement, you have reduced your risk of higher prices.

That's how the futures market works. Except instead of a satellite TV provider, a producer of wheat may be trying to secure a selling price for next season's crop, while a bread maker may be trying to secure a buying price to determine how much bread can be made and at what profit. So the farmer and the bread maker may enter into a futures contract requiring the delivery of 5,000 bushels of grain to the buyer in June at a price of $4 per bushel. By entering into this futures contract, the farmer and the bread maker secure a price that both parties believe will be a fair price in June. It is this contract that can then be bought and sold in the commodity market. A futures contract is an agreement between two parties: a short position, the party who agrees to deliver a commodity, and a long position, the party who agrees to receive a commodity. In the above scenario, the farmer would be the holder of the short position (agreeing to sell) while the bread maker would be the holder of the long (agreeing to buy). (We will talk more about the outlooks of the long and short positions in the section on strategies, but for now it's important to know that every contract involves both positions.)

Leading commodity markets of India The government has now allowed national commodity exchanges, similar to the BSE & NSE, to come up and let them deal in commodity derivatives in an electronic trading environment. These exchanges are expected to offer a nationwide anonymous, order driven, screen based trading system for trading. The Forward Markets Commission (FMC) will regulate these exchanges. Consequently four commodity exchanges have been approved to commence business in this regard. They are: Multi Commodity Exchange (MCX) located at Mumbai.

National Commodity and Derivatives Exchange Ltd (NCDEX) located at Mumbai.

National

Board

of

Trade

(NBOT)

located

at

Indore.

National Multi Commodity Exchange (NMCE) located at Ahmadabad.

Commodities represent virtually every raw material, ranging from the precious metals of gold and silver to sugar and soybeans. The commodities market is a very volatile market due to the overwhelming number of fundamental and technical factors that play into it. Trading oil isn't as much trading oil as it is the fundamentals that are involved. For example, a terrorist attack overseas, an OPEC oil cut, or a natural disaster can all play into the price of oil around the world. Commodities traders are some of the most resilient investors; it takes a lot of nerve to stay in the market when it makes it wild moves.

The Ministry of Consumer Affairs and Public Distribution, Govt. of India supervises the regulatory authority Forward Markets Commission (FMC) which is a statutory authority established in 1953 under Forward Contracts (Regulation) Act. FMC regulates Commodity trading in India. In India equity trading had always been one of the greatest boosters. But, now a days because of peoples affection towards gold and silver even commodity trading has been increasing. This brings itself to around 3 times the volume of equity traded. Commodity future is the prediction of a commodity i.e. future supply of a commodity on particular date and price. Contract Expiry date is the predicted future date and the contract size is fixed quantity. Due to the introduction of commodities future the total of retail traders taking part in market has been

gradually increasing. In the next 5 years the commodity market is expected to grow by 40%. The List of exchanges in India are: Batinda Om & Oil Exchange Ltd., Batinda., The Bombay Commodity Exchange Ltd. Mumbai, The Rajkot Seeds oil & Bullion Merchants` Association Ltd, The Meerut Agro Commodities Exchange Co. Ltd., Meerut, Ahmadabad Commodity Exchange Ltd., and many more. Commodity Market Characteristics Given the nature of the Commodity futures market, the calculation of profit and loss will be slightly different than on a normal stock exchange. Let's take a look at the main concepts: Margins. In the futures market, margin refers to the initial deposit of good faith made into an account in order to enter into a futures contract. This margin is referred to as good faith because it is this money that is used to debit any losses. When you open a futures account, the futures exchange will state a minimum amount of money that you must deposit into your account. This original deposit of money is called the initial margin. When your contract is liquidated, you will be refunded the initial margin plus or minus any gains or losses that occur over the span of the futures contract. In other words, the amount in your margin account changes daily as the market fluctuates in relation to your futures contract. The minimum-level margin is determined by the futures exchange and is usually 5% to 10% of the futures contract. These predetermined initial margin amounts are continuously under review: at times of high market volatility, initial margin requirements can be raised. The initial margin is the minimum amount required to enter into a new futures contract, but the maintenance margin is the lowest amount an account can reach before needing to be replenished. For example, if your margin account drops to a certain level because of a series of daily losses, brokers are required to make a margin call and request that you make an additional deposit into your account to bring the margin back up to the initial amount. Let's say that you had to deposit an initial margin of $1,000 on a contract and the maintenance margin level is $500. A series of losses dropped the value of your

account to $400. This would then prompt the broker to make a margin call to you, requesting a deposit of at least an additional $600 to bring the account back up to the initial margin level of $1,000. Word to the wise: when a margin call is made, the funds usually have to be delivered immediately. If they are not, the commodity brokerage can have the right to liquidate your Commodity position completely in order to make up for any losses it may have incurred on your behalf. Leverage: Leverage refers to having control over large cash amounts of a commodity with comparatively small levels of capital. In other words, with a relatively small amount of cash, you can enter into a futures contract that is worth much more than you initially have to pay (deposit into your margin account). It is said that in the futures market, more than any other form of investment, price changes are highly leveraged, meaning a small change in a futures price can translate into a huge gain or loss. Futures positions are highly leveraged because the initial margins that are set by the exchanges are relatively small compared to the cash value of the contracts in question (which is part of the reason why the futures market is useful but also very risky). The smaller the margin in relation to the cash value of the futures contract, the higher the leverage. So for an initial margin of $5,000, you may be able to enter into a long position in a futures contract for 30,000 pounds of coffee valued at $50,000, which would be considered highly leveraged investments. You already know that the futures market can be extremely risky, and therefore not for the faint of heart. This should become more obvious once you understand the arithmetic of leverage. Highly leveraged investments can produce two results: great profits or even greater losses. Due to leverage, if the price of the futures contract moves up even slightly, the profit gain will be large in comparison to the initial margin. However, if the price just inches downwards, that same high leverage will yield huge losses in comparison to the initial margin deposit. For example, say that in anticipation of a rise in stock prices across the board, you buy a futures contract with a margin deposit of $10,000, for an index currently standing at 1300. The value of the contract is worth $250 times the index (e.g. $250 x 1300 = $325,000), meaning that for every point gain or loss, $250 will be gained or lost.

If after a couple of months, the index realized a gain of 5%, this would mean the index gained 65 points to stand at 1365. In terms of money, this would mean that you as an investor earned a profit of $16,250 (65 points x $250); a profit of 162%! On the other hand, if the index declined 5%, it would result in a monetary loss of $16,250--a huge amount compared to the initial margin deposit made to obtain the contract. This means you still have to pay $6,250 out of your pocket to cover your losses. The fact that a small change of 5% to the index could result in such a large profit or loss to the investor (sometimes even more than the initial investment made) is the risky arithmetic of leverage. Consequently, while the value of a commodity or a financial instrument may not exhibit very much price volatility, the same percentage gains and losses are much more dramatic in futures contracts due to low margins and high leverage. Pricing and Limits As we mentioned before, contracts in the Commodity futures market are a result of competitive price discovery. Prices are quoted as they would be in the cash market: in dollars and cents or per unit (gold ounces, bushels, barrels, index points, percentages and so on). Prices on futures contracts, however, have a minimum amount that they can move. These minimums are established by the futures exchanges and are known as ticks . For example, the minimum sum that a bushel of grain can move upwards or downwards in a day is a quarter of one U.S. cent. For futures investors, it's important to understand how the minimum price movement for each commodity will affect the size of the contract in question. If you had a grain contract for 3,000 bushels, a minimum of $7.50 (0.25 cents x 3,000) could be gained or lost on that particular contract in one day. Futures prices also have a price change limit that determines the prices between which the contracts can trade on a daily basis. The price change limit is added to and subtracted from the previous day's close, and the results remain the upper and lower price boundary for the day. Say that the price change limit on silver per ounce is $0.25. Yesterday, the price per ounce closed at $5. Today's upper price boundary for silver would be $5.25 and the lower boundary would be $4.75. If at any moment during the day the price of futures contracts for silver reaches either boundary, the exchange shuts down all trading of silver futures for the day. The next day, the new boundaries are again calculated by adding and subtracting $0.25 to the previous day's close. Each day

the silver ounce could increase or decrease by $0.25 until an equilibrium price is found. Because trading shuts down if prices reach their daily limits, there may be occasions when it is NOT possible to liquidate an existing futures position at will. The exchange can revise this price limit if it feels it's necessary. It's not uncommon for the exchange to abolish daily price limits in the month that the contract expires (delivery or spot month). This is because trading is often volatile during this month, as sellers and buyers try to obtain the best price possible before the expiration of the contract. In order to avoid any unfair advantages, the CTFC and the Commodity futures exchanges impose limits on the total amount of contracts or units of a commodity in which any single person can invest. These are known as position limits and they ensure that no one person can control the market price for a particular commodity.

The few majors in commodity exchanges are: MCX(Multi Commodity Exchange of India Ltd.): MCX presents futures trading defined in terms of type of contracts offered in 58 commodities, from various market segments including energy, bullion, iron and non-iron metals, oil seeds, and other agricultural commodities. It is the worlds first and fore most also one and only company acquired ISO 27001:2005 certification

Active Contracts Traded in MCX S.N COMMODIT Price/Un Trading O IY NAME it Lot 1 2 3 GOLD GOLDM GOLD Rs / 1 KG 10Gms Rs / 100Gms 10Gms Rs/ 8Gms

Delivery Center MUMBAI MUMBAI MUMBAI

Multipli er 100 10 1

Initial Margi n% 7 5 14.5

GUINEA 4 5 6 7 8 9 10 11 12 SILVER SIVERM MENTHA OIL KAPASIA KHALLI ALUMINIUM COPPER NICKEL ZINC LIGHT SWEET CRUDE OIL NATURAL GAS

8Gms RS/ KG 30 KG

Rs / 1 5 KGS KG Rs/KG 360 KG Rs/50 KG Rs/KG Rs/KG RS/KG RS/KG Rs/Barre l Rs/mmB tu 10 MT 5 MT 1 MT 250 KG 5000 KG 100/Barrel

/AHMEDAB AD AHMEDABA D AHMEDABA D CHANDAUS I AKOLA MUMBAI MUMBAI MUMBAI MUMBAI JNPTMUMBAI

30 5 360 200 5000 1000 250 5000 100

8 8 11 6.5 7 12 15.5 11 12

13

1250/mmB tu

1250

10.5

National Multi-Commodity Exchange of India Limited (NMCE): It was declared a National status in November 2002 on permanent basis by Govt. of India. And is considered to be first De-Mutualised Electronic Exchange National Commodity & Derivatives Exchange Limited (NCDEX): It is a private limited company which has obtained Certificate for Commencement of Business in Mat 2003 and is online commodity exchange based in India. Market Share of National Exchange in India

35.7%

NCDEX NMCE Other

58.1%

MCX

3.2% 3.0%

Different segments in Commodities 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. Commodity Trading

Commodity trading is an interesting option for those who wish to diversify from the traditional options like shares, bonds and portfolios. The Government has made almost all commodities entitled for futures trading. Three multi commodity exchanges have been set up in the country to facilitate this for the retail investors. The three national exchanges in India are:

Multi Commodity Exchange (MCX) National Commodity and Derivatives Exchange (NCDEX) National Multi-Commodity Exchange (NMCE) Commodity trading in India is still at its early days and thus requires an aggressive growth plan with innovative ideas. Liberal policies in commodity trading will definitely boost the commodity trading. The commodities and future market in the country is regulated by Forward Markets commission (FMC). DIFFERENT TYPES OF COMMODITIES TRADED World-over one will find that a Aluminium, Copper, Lead, Nickel, market exits for almost all the Sponge Iron, Steel Long commodities known to us. These (Bhavnagar), Steel Long commodities can be broadly (Govindgarh), Steel Flat, Tin, Zinc classified into the following: METAL Gold, Gold HNI, Gold M, i-gold, BULLION Silver, Silver HNI, Silver M Cotton L Staple, Cotton M Staple, FIBER Cotton S Staple, Cotton Yarn, Kapas Brent Crude Oil, Crude Oil, Furnace ENERGY Oil, Natural Gas, M. E. Sour Crude Oil Cardamom, Jeera, Pepper, Red SPICES Chilli Arecanut, Cashew Kernel, Coffee PLANTATIONS (Robusta), Rubber Chana, Masur, Yellow Peas PULSES HDPE, Polypropylene(PP), PVC PETROCHEMICALS Castor Oil, Castor Seeds, Coconut OIL & OIL SEEDS 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 Guargum, Guar Seed, Gurchaku, Mentha Oil, Potato (Agra), Potato (Tarkeshwar), Sugar M-30, Sugar S-

Energies This type of commodity has been highly active over the last few years. It features several different products which provide energy to power and heat up homes and businesses. This category includes petroleum and its byproducts, propane, heating oil, coal and natural gas. The minimum price in this kind is set by exchange and there are also standard contract sizes, which are the amount covered by futures contracts. Grains This category includes oat, corn, soybean, rice and wheat and lots of other agricultural products. Usually, these commodities are sold out as future trades and have a minimum and a standard contract size also. The CBOT or Chicago Board of Trade has been involved in these types of commodities. Softs These commodities include coffee, sugar, cocoa, orange juice and cotton. Oranges are not traded in this type because almost 80% of them are converted into frozen concentrates, and that is why orange juice itself is traded. New York Cotton Exchange even has FCOJ or Frozen Concentrated Orange Juice as one thing that they trade. Meat This type of commodities includes pork bellies, lean hogs and live cattle. This commodity is perhaps less volatile than the other types and for a number of times, it depends upon grains also. This is because most of the livestock is fed by grain only. This commodity is primarily exchanged by the KCBT or Kansas City Board of Trade.

Wholesale Market

The wholesale market in India, an important component of the India commodity market, traditionally dealt with framers and manufacturers of goods. However, in the present scenario, their roles have changed to a large extent due to the enormous growth that the economy has witnessed. The lengthy process of wholesalers buying from manufacturers; then selling it to retailers who in turn sold it to consumers does not seem feasible today. An improvement in the transport facility has made the interaction between the retailer and manufacturer easier; the need for a wholesale market is gradually diminishing. Retail Market The retail market in India is currently witnessing a boom. The growth in the India commodity market is largely attributed to this boom in the retail market. Policy reforms and liberal government policies have ensured that this sector is growing at a good pace. Some of the reasons attributed to the growth of retail sector in India include the large population of the country who has an increased purchasing power in their hand. Another factor is the heavy inflow of foreign direct investment in this sector. More than 80% of the retail industry in the country is concentrated in large cities. Delivery Mechanism One of the methods of settling the contracts is by taking or making delivery. Delivery period at NMCE is during last three days of the contract expiry date. During this period Members of the exchange are not permitted to create any fresh position in the expiring contracts. They can either square up their position or take/give delivery to settle their outstanding contracts. Various steps required to be followed by the participants having outstanding position on 12th ofdelivery month

are as follows Steps to follow 1. Sellers and buyers have to convey intention on or before three days of the contract expiry date 2. The intentions are then matched and assigned by the Exchange with the corresponding buyers. As is the case universally, seller has freedom to tender delivery during the delivery period at any approved delivery centers. In other words, buyer cannot demand delivery at delivery center of his choice. When the seller gives intimation, a call is made to the corresponding buyer to whom the delivery is assigned by the Exchange. Delivery margin is collected from both the buyer and seller 3. After matching the open positions of relevant buyer and seller, the same is transferred from the system and settled at the closing price of the preceding day, so that mark to market (MTM) is not levied or paid to the member 4. Within three days from the position transfer, the buyer has to maintain the required funds in their clearing & settlement account while the seller has to tender the warehouse receipts to the exchange along with the computation of warehouse charges. On the 3rd day, the exchange makes pay-in & payout simultaneously after retaining the warehouse charges margin and sales tax margin from the buyer and seller respectively 5. After the completion of pay-in and payout, duly endorsed warehouse receipts are sent to the buyer immediately 6. Settlement of warehouse charges, margins and sales tax margins take place soon after receipt of relevant documents (copies of sales bill, sales tax form) from the member DELIVERY MECHANISM OF NMCE

World Scenario of Commodities Market

The commodities market is virtually a 24/7 market. Though there are many different markets that trade throughout the day and open and close at different

times, commodities in the US are the same as commodities in Europe and Asia. The price of gold in Asian commodity trading will be reflected in the price when the US markets open. Many traders who enjoy the foreign exchange market, but would prefer to trade more fundamentally driven investments, will find the commodities market a nice change from the currency markets. There are some drawbacks to a 24/7 market, as the price of your positions will change as you sleep; thus, short term investors in the commodities market are likely to buy and sell within the day rather than hold an investment through another trading cycle in a foreign country.

Major Commodity Exchange

A commodities exchange is an exchange where various commodities and derivatives products are traded. Most commodity markets across the world trade in agricultural products and other raw materials (like wheat, barley, sugar, maize, cotton, cocoa, coffee, milk products, oil, metals, etc.) and contracts based on them. These contracts can include spot prices, forwards, futures and options on futures. Other sophisticated products may include interest rates, environmental instruments, swaps, or ocean freight contracts. In today's world of specialization, we see that domestic and international commodity exchanges have also grabbed on to the concept of focusing in on an area of expertise. The most robust commodity exchanges in the world today and their specialty commodities include: New York Board of Trade (NYBOT) - which includes coffee, cocoa, cotton, orange juice and sugar. New York Mercantile Exchange (NYMEX) - which specializes in energy products such as crude and heating oil, gasoline, natural gas, coal, propane as well as metal such as gold, silver, platinum, copper, aluminum and palladium. Chicago Board of Trade (CBOT) - which specializes in bonds and more traditional commodities such as corn / maize, oats, rough rice, soybeans, soybean meal, soybean oil, and wheat. Chicago Mercantile Exchange (CME) - which specializes in bond futures and more traditional commodities such as live and feeder cattle, lumber,

beef, boneless beef trimmings, lean hogs, frozen pork bellies, fresh pork bellies, milk and butter. London Metal Exchange (LME) - which specializes in the trading of metals such as copper, lead, zinc, aluminum, tin and nickel. London Commodity Exchange / Euro next - which specializes in the trading of commodities such as grains and meat. ICE Futures - the International Petroleum Exchange specializes in commodities such as crude and heating oil, natural gas and unleaded gasoline Shanghai Metal Exchange (SHME) - one of the national level futures exchanges of China, was established on 28 May 1992. SHME is a nonprofit, self-regulating corporation. The exchange was created for trading in non-ferrous metals and currently contracts for several non-ferrous metals including copper, aluminum, lead, zinc, tin, and nickel. Kansas Board of Trade - Kansas Board of Trade in US specializes in hard red winter wheat. Hard winter wheat constitutes the maximum of US production. This exchange is benchmark for bread wheat prices. Tokyo Commodity Exchange (TOCOM) - Tokyo Commodity Exchange (TOCOM) is the largest exchange in Japan and second largest commodity exchange in the world for futures and options. Crude oil, gasoline, kerosene,

gas oil, gold, silver, aluminium, platinum and rubber are the commodities that are actively traded. London International Financial Futures and Options Exchange (LIFFE) - London International Financial Futures and Options Exchange (LIFFE) also know as Euro next. Among actively commodities trades are cocoa, robusta coffee, corn, potato, rapeseed, sugar and wheat. Robusta coffee prices are determined through this exchange. Dalian Commodity Exchange - Dalian Commodity Exchange in China trades in corn and soybean. The exchange is planning to introduce futures and options in crude oil, power, steel and plastic.

Daily Time of Different Exchange

Exchange

Timing IST

Tokyo Commodity Exchange

5.30 am 12 pm

Shanghai Metal Exchange

6.30 am - 12.30 pm

5:20 PM - 10:30 PM (Winter) London Metal Exchange 4:20 PM - 9:30 PM (Summer)

6:40 PM - 11:30 PM (Winter) COMEX/NYMEX/CBOT 5:40 PM - 10:30 PM (Summer)

10:00 AM - 23:55 PM (Winter) MCX & NCDEX 10:00 AM - 23:30 PM (Summer)

STRUCTURE OF COMMODITY MARKETS IN INDIA

Ministry of Consumer Affairs

FMC

Commodity Exchange

National Exchange

Regional Exchange

NCDEX

MCX NBOT 20 other Regional

Different types of commodities traded

Major Commodities on Indian Exchanges

Commoditie s

Agro Spices Chana Seeds Others Pepper Soybean

Softs

Precious
Metals

Rape seed O Castor O

Rape see Oil

Mustard

Energy gy

Pulses Metals Edible Oils

Base

Commodities can be broadly classified into the following: METAL Aluminum, Copper, Lead, Nickel, Sponge Iron, Steel Long (Bhavnagar), Steel Long (Govindgarh), Steel Flat, Tin, Zinc BULLION Gold, Gold HNI, Gold M, i-gold, Silver, Silver HNI, Silver M FIBER Cotton L Staple, Cotton M Staple, Cotton S Staple, Cotton Yarn, Kapas ENERGY Brent Crude Oil, Crude Oil, Furnace Oil, Natural Gas, M. E. Sour Crude Oil Cardamom, Jeera, Pepper, Red Chili SPICES Areca nut, Cashew Kernel, Coffee (Robusta), Rubber PLANTATIONS Chana, Masur, Yellow Peas PULSES HDPE, Polypropylene (PP), PVC

PETROCHEMICALS Castor Oil, Castor Seeds, Coconut Cake, Coconut Oil, Cotton Seed, OIL & OIL SEEDS 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, Soy meal, Soy Bean, Soy Seeds CEREALS Maize OTHERS Guargum, Guar Seed, Gurchaku, Mentha Oil, Potato (Agra), Potato (Tarkeshwar), Sugar M-30, Sugar S-30

Regulation of commodity markets

Country

Exchange

Regulator

U.S.A

Chicago Board of Trade Chicago Mercantile Exchange New York Board of Trade New York Mercantile Exchange Kansas City Board of Trade

Commodity

Future

Trading Commission

India

National Exchange

Commodity

&

Derivatives Forward Commission

Markets

National Multi-Commodity Exchange U.K London Metal Exchange Euro next London International Financial Futures Exchange Financial Authority (1986) Services

China

Dalian Commodity Exchange Shanghai Futures Exchange

China

Securities

Regulatory Commission

Major Players In Commodity market: The players in the futures market fall into three categories:

1) Hedger 2) Speculator 3) Arbitrage A Hedger can be Farmers, manufacturers, importers and exporter. A hedger buys or sells in the futures market to secure the future price of a commodity intended to be sold at a later date in the cash market. This helps protect against price risks. The holders of the long position in futures contracts (buyers of the commodity), are trying to secure as low a price as possible. The short holders of the contract (sellers of the commodity) will want to secure as high a price as possible. The commodity contract, however, provides a definite price certainty for both parties, which reduces the risks associated with price volatility. By means of futures contracts, Hedging can also be used as a means to lock in an acceptable price margin between the cost of the raw material and the retail cost of the final product sold. Example: A silversmith must secure a certain amount of silver in six months time for earrings and bracelets that have already been advertised in an upcoming catalog with specific prices. But what if the price of silver goes up over the next six months? Because the prices of the earrings and bracelets are already set, the extra cost of the silver can't be passed onto the retail buyer, meaning it would be passed onto the silversmith. The silversmith needs to hedge, or minimize her risk against a possible price increase in silver. How? The silversmith would enter the futures market and purchase a silver contract for settlement in six months time (let's say June) at a price of $5 per ounce. At the end of the six months, the price of silver in the cash market is actually $6 per ounce, so the silversmith benefits from the

futures contract and escapes the higher price. Had the price of silver declined in the cash market, the silversmith would, in the end, have been better off without the futures contract. At the same time, however, because the silver market is very volatile, the silver maker was still sheltering himself from risk by entering into the futures contract. So that's basically what a hedger is: the attempt to minimize risk as much as possible by locking in prices for a later date purchase and sale. Someone going long in a securities future contract now can hedge against rising equity prices in three months. If at the time of the contract's expiration the equity price has risen, the investor's contract can be closed out at the higher price. The opposite could happen as well: a hedger could go short in a contract today to hedge against declining stock prices in the future. A potato farmer would hedge against lower French fry prices, while a fast food chain would hedge against higher potato prices. A company in need of a loan in six months could hedge against rising in the interest rates future, while a coffee beanery could hedge against rising coffee bean prices next year. Speculators other commodity market participants, however, do not aim to minimize risk but rather to benefit from the inherently risky nature of the commodity market. These are the speculators, and they aim to profit from the very price change that hedgers are protecting themselves against. A hedger would want to minimize their risk no matter what they're investing in, while speculators want to increase their risk and therefore maximize their profits. In the commodity market, a speculator buying a contract low in order to sell high in the future would most likely be buying that contract from a hedger selling a contract low in anticipation of declining prices in the future.

Unlike the hedger, the speculator does not actually seek to own the commodity in question. Rather, he or she will enter the market seeking profits by off setting rising and declining prices through the buying and selling of contracts. Long Secure a price now to Hedger protect against future rising prices Short

Secure a price now to protect against future declining prices

Speculator

Secure a price now in Secure

price

now

in

anticipation of rising prices anticipation of declining prices

Arbitrage: Arbitrage refers to the opportunity of taking advantage between the price differences between two different markets for that same stock or commodity. In simple terms one can understand by an example of a commodity selling in one market at price and the same commodity selling in another market at price x + y. Now this y, is the difference between the two markets is the arbitrage available to the trader. The trade is carried simultaneously at both the markets so

theoretically there is no risk. (This arbitrage should not be confused with the word arbitration, as arbitration is referred to solving of dispute between two or more parties.) The person who conducts and takes advantage of arbitrage in stocks, commodities, interest rate bonds, derivative products, forex is know as an arbitrageur.

An arbitrage opportunity exists between different markets because there are different kind of players in the market, some might be speculators, others jobbers, some market-markets, and some might be arbitrageurs. In India there are a good amount of Arbitrage opportunities between NCDEX, MCX in commodities.

REFERENCE BOOKS: 1. COMMODITY MARKETS DEALERS MODULE BY NCFM WEBSITES:

1. www.nseindia.com 2. www.investopedia.com 3. www.rediffmoney.com 4. www.google.com 5. http://www.fmc.gov.in/index.htm 6. http://www.mcxindia.com/home.aspx 7. http://ncdex.com/aboutus/index.aspx