Decoding commodity trading

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Not many people know that trading is not limited to equities alone. You can also trade in commodities. Common goods that you use daily, such as oil, gas, agri products, metals, etc., are some products that can be bought and sold in the commodities market. 

By Commodity trading, investors can trade in commodities in the physical (spot) market, Exchange-traded commodity derivatives and over-the-counter (OTC).

Commodities traded on global and Indian exchanges are in the form of derivatives, typically futures and options.

We can say that the commodities market is similar to the stock market and just as you would buy a company’s shares in a stock market, you can buy commodities in the commodities market.

In a commodity market, investors, producers, manufacturers, hedgers, farmers, etc., can trade in different commodities.

The commodities market is regulated by the Securities and Exchange Board of India (SEBI) and there are four commodity exchanges in India currently: 

  1. Multi Commodity Exchange (MCX)
  2. National Commodity and Derivatives Exchange (NCDEX)
  3. National Stock Exchange (NSE) 
  4. Bombay Stock Exchange (BSE)

The size of the global commodities market is increasing sharply. The global commodity services market size was an estimated $3503000 million in 2020. This is expected to rise by $51,63,750 million by 2027[i].

What are the different commodities that are traded?

Several types of commodities are traded on the market and these are typically classified into two groups:

Agricultural goods: This includes spices like: Coriander, Jeera and turmeric; Cereals like maize, barley and wheat; Pulses like Chana; and other agricultural products like crude palm oil, mustard seed, castor seed, guar seed and gum, cotton, rubber, and more. 

Non-agricultural goods such as: 

– Energy commodities like crude oil, natural gas 

– Bullion commodities like gold and silver

– Metal commodities like copper, steel, lead, nickel, aluminium, zinc, etc.  

Let us look at some of the reasons why should one invest in commodities and what are the benefits.

Diversification: Commodity trading can be a great way to diversify your portfolio. Commodities perform differently from stocks and bonds. Hence, they are often recommended for portfolio diversification. If you are already investing in the stock market, you can further expose yourself to commodity trading. This way, even if the stock market is highly volatile or goes down, you will be able to offset the losses with commodities. 

Helps beat inflation: Commodity trading is a viable strategy to counter inflation. The prices of commodities move up in the same direction as inflation. Hence, investing in them can help you in the long run. 

Gives high returns: Commodity trading can be risky. But this risk also has the potential to be rewarded with high returns. As long as you do your research well and invest in the right commodities, you can earn substantial returns over time. 

Provides better liquidity: You can enjoy a high level of liquidity, too, as opposed to investing in other tools like real estate. You can liquidate your commodities anytime you want. The process is quick and hassle-free. 

Hedge against decline in the base currency: Commodities market is always a good tool for hedge against decline in base currency. One who is having exposure in the Currency sector can minimize his risk by taking an opposite position in Commodity. 

Commodities trading can be ideal for the following types of investors:

  1. High-risk investors who are willing to expose themselves to some market volatility. Also, investors who want to limit their loss can invest through options. 
  2. Investors already investing in stocks and bonds looking to diversify their portfolio 
  3. Investors who want to earn high returns and offset inflation 
  4. Investors looking for long-term investments in commodities like Bullion, Metals, Agri products. Can also take advantage of multiple commodities by investing in Indices 
  5. Hedgers, Arbitragers also take interest in the market & fulfill their requirements through trading in commodity exchanges.
  6. Suitable platform for farmers, who want to hedge their crop or are interested to get a better price for their crop. 
  7. Oil mills, Masala companies, Tyre companies, metal industry use to trade in this market for hedging & procurement purposes.
  8. Bullion dealers frequently trade on this market for hedging their stock or limit their price risk. 

How to invest in commodities? 

Here are the steps you can follow to invest in commodities:

  1. Open a trading account with a broker. You need not open a Demat account in case of a commodity-only account. If you are interested only in Commodity delivery, you can open a Repository account with a broker.
  2. You need to maintain sufficient balance or pledge securities in account to cover the initial margin & MTM (If any). 
  3. Select the commodities you want to invest in, such as precious metals, agricultural goods, energy, metals, etc. 
  4. Once you have selected the commodities you wish to invest in, you can go ahead and buy them. Typically, investors buy commodities at low prices and sell them at a later date in the future when the price of the commodity moves.  
  5. Another way to trade is with a futures contract. A futures contract is an agreement where you agree to buy or sell a fixed amount of commodities at a certain price in the future. When the contract expires, the commodities are given to you at a price mentioned in the contract. This strategy helps to ward off the unwanted risk of price fluctuations in the future. 

Commodity trading may not be as popular as stock trading yet, but the market certainly has great potential. For experienced investors, this can be an excellent way to earn good returns and offset beat markets and inflation. Commodity trading is also ideal for diversification. And although it can be risky, it can also benefit you greatly as long you bet on the right goods. 

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