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March 2006 20
What is Commodity Trading?
A
ny goods that are unbranded and are
commonly traded in the market, are called
commodities. Globally, the commodity
trade market is about three times the size of equities
trade market. In India, the commodities market is
still in a nascent stage and is going to be the next
big thing for investors. The expected growth rate
of commodity market is 40 per cent annually over
the next five years. The volume of business of the
24 commodity exchanges, including three national
exchanges, in the country during the year 2004-05
had touched a whopping Rs 5.71 lakh crore
(US$130 billion) while transactions during the first
six months of the current year has already touched
Rs 7.8 lakh crore.
The main difference between a commodity
exchange and stock exchange is as follows:
A commodity exchange deals in non-financial
commodities, be it agricultural commodities like
cotton, wheat, rice, groundnut, and non-agro
commodities like aluminum, zinc, and oil, whereas
a stock exchange deals in financial products like
stocks and government securities.
Commodity markets are quite like equity markets.
The commodity market also has two constituents
i.e. spot market and derivative market. In case of a
spot market, the commodities are bought and sold
for immediate delivery. In case of a commodities
derivative market, various financial instruments
involving commodities are traded on the
exchanges.
Commodity future
Commodity future is a derivative instrument for
the future delivery of a commodity on a fixed date
at a particular price. For e.g., if an investor
purchases a palm oil future, he is entering into a
contract to buy a fixed quantity of palm oil at a
future date. The future date is called the contract
expiry date. The fixed quantity is called the
contract size. Such a contract is called a Forward
Contract. These futures can be bought and sold
on the commodity exchanges.
Futures Contract is a type of forward contract.
Futures are exchange-traded contracts to sell or
buy physical commodities for delivery on a
specified future date at an agreed price. Futures
trading, which provide for greater transparency
in prices, are used generally for protection against
adverse price fluctuations (hedging) in basic
commodities.
The commodities exchanges facilitate an online
platform for trading on futures contract in a wide
range of commodities, by following the
best-global practices of professionalism and
transparency. The items traded on the
commodities exchanges include agricultural
commodities like wheat, rice, tea, jute, spices,
soya, groundnut, coffee, rubber, cotton; precious
metals - gold and silver; base metals - iron ore,
lead, aluminium, nickel, zinc, etc., and energy
commodities - crude oil and coal. Over 100
commodities are traded in the national exchanges.
Commodity trading is witnessing an unprecedented boom the world over, including in India.
This incisive article by Mr Krishna Kumar delves on all the facets of commodity trading.
An MBA from IIFT, the author also holds a Masters degree in Strategic Management
from Manchester Business School, UK.
March 2006 21
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The Forward Markets Commission (FMC) is the
regulatory body for commodity trading in
futures / forward trade in India. FMC set up in
1953, has its headquarters in Mumbai and is
overseen by the Ministry of Consumer Affairs
and Public Distribution.
History of Commodity trading in India
India has a long history of futures trading in
commodities. At one time, there were as many as
110 regional exchanges conducting forward trade
in various commodities. That was the time, when
the equity market was a poor cousin of this market
as there were not many companies whose shares
were traded. However, Indian economy in the late
1950s and early 1960s saw a period of endemic
shortages in many essential commodities. This
resulted in inflationary pressures on prices of such
commodities and government regulations in this
area, resulted in the decline of this market since
the mid-1960s. Futures trading came to be
prohibited in most of the important commodities
and many traders migrated to the securities
market.
The interest in commodities futures trading has
revived since early 1990s. Though the futures
trading is not new to India as mentioned above,
we have missed more than three decades within
which tremendous strides have been made in
futures trading worldwide.
Commodity exchanges in India
There are 24 commodity exchanges in India
including three national exchanges. The rest are
regional exchanges. The objective of establishing
national exchanges is to ensure that the
commodity exchanges operate at a national level,
trade in all commodities with economies of scale
and adopt best practices in exchange
management like demutualisation (i.e. they are
not owned or managed by member brokers),
automation, and settlement guarantee.
An individual, partnership firm, private limited
company, public limited company, co-operative
societies are eligible to become members of the
following national exchanges subject to the
conditions for the membership.
(a) National Commodity & Derivatives
Exchange Limited (NCDEX)
NCDEX is an online multicommodity exchange
promoted by ICICI Bank, LIC, NABARD and
National Stock Exchange of India Limited (NSE).
NCDEX is the only commodity exchange in the
country promoted by national level institutions.
NCDEX is located in Mumbai and offers facilities
to its members in about 91 cities throughout India.
This is Indias biggest commodity exchange and
did trading business worth Rs 8,71,486 crore in
2005. It has a 55% share of the national
commodities market.
(b) Multi Commodity Exchange (MCX)
MCX, which started operations in 2003, is the
fastest growing commodity exchange in India.
Its turnover jumped nine times in 2005 as
compared to the previous year with its share of
the Indian commodities market shooting up from
24.9% to 43.4%. The volume of business was
worth Rs 6,85,360 crore in 2005.
The shareholders of MCX are Financial
Technologies (India) Ltd., State Bank of India,
NABARD, NSE, HDFC Bank, State Bank of
Indore, State Bank of Hyderabad, State Bank of
Saurashtra, SBI Life Insurance Co. Ltd., Union
Bank of India, Bank of India, Bank of Baroda,
Canara Bank, and Corporation Bank. It is
headquartered in Mumbai.
(C) National Multi Commodity Exchange of
India (NMCE)
The National Multi Commodity Exchange of India
Ltd. (NMCE) is unique as it is promoted by
commodity-relevant public institutions, viz.,
ECO F UNDA S F O R Y OU
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March 2006 22
Central Warehousing Corporation (CWC),
National Agricultural Cooperative Marketing
Federation of India (NAFED), Gujarat
Agro-Industries Corporation Limited (GAICL),
Gujarat State Agricultural Marketing Board
(GSAMB), National Institute of Agricultural
Marketing (NIAM), and Neptune Overseas
Limited (NOL).
Commodity vs stocks
With stocks, you need to put up the full
amount of the stock value to buy the stock.
With commodities, you control commodity
futures contracts with a margin deposit which
is usually between 5%-10% of the value of
the commodity.
While there are thousands of stocks traded
at an exchange, the number of commodities
are just over a 100.
Stock prices often move slowly. Frequently,
stock price may linger in a narrow trading
range (sometimes for years) causing your
financial resources to be unproductively
used. Commodities frequently have fast price
movement, providing increased profit
potential.
If you own stock, you get taxed twice. Once
when the company pays corporate tax on its
earned income; and again, when you pay
personal taxes on dividends or capital gains
from your shares. The real tax can be very
high. With commodity profits, you are only
taxed on your income.
Stock is fictitious, there is no real basis for
stock value other than earnings. Stock can be
delisted overnight and become worthless.
Commodities have intrinsic value and will
always have value. People will always want
grain and gold.
As the WTO looks at opening up the agricultural
sector and other commodity markets for global
competition, India being a major consumption
market, will be an extremely attractive market. Indian
producers and traders will have growing
opportunity to be a part of the global market.
ECO F UNDA S F O R Y OU
(The author, Krishna Kumar, is
Director, T TT TT. .. ..I II II. .. ..M MM MM. .. ..E EE EE. .. .. Trivandrum.
)
Yes! ready money is Aladdins lamp.
- Samuel Butler
Im living so far beyond my income that we may almost be
said to be living apart.
- William Cowper
Money the root of all evil. . . Man needs roots.
- Anonymous
Its all
about
money,
honey!
(Ad-line of
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