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Commodity
A commodity may be defined as an article, a product or material that is
bought and sold. It can be classified as every kind of movable property,
except Actionable Claims, Money & Securities. 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.
Commodity market
Commodity markets are markets where raw or primary products are
exchanged. These raw commodities are traded on regulated commodities
exchanges, in which they are bought and sold in standardized contracts
Commodity market is an important constituent of the financial markets of
any country. It is the market where a wide range of products, viz.,
precious metals, base metals, crude oil, energy and soft commodities like
palm oil, coffee etc. are traded. It is important to develop a vibrant, active
and liquid commodity market. This would help investors hedge their
commodity risk, take speculative positions in commodities and exploit
Page | 1
Overview
Despite intermittent curbs, Indias six-year-old commodity futures market
has seen a steady stream of new entrants, drawn by the promise of richer
rewards. The intense growth, even in the absence of basic reforms, has
attracted financial institutions, trading companies and banks to set up
large commodity bourse. Since, Indian Commodity Exchange (ICEX),
promoted by India Bulls Financial Services Ltd. in partnership with
MMTC is going to start its operation from November 2009; it is expected
to create an extensive competition among national level commodity
exchanges. Commodity derivatives market of India is drawing attention
from all over the world, albeit FMC had banned nine commodities since
early 2007, out of which 4 are still out of trade and even financial
institutions and foreign entities are barred from trading in the market.
Even, industry players are of the view that commodity market regulator
(FMC) should permit banks and financial institutions to trade in
commodity futures, allow options, exchange-traded indices and some
more powers to the market regulator from Ministry of Consumer Affairs
to develop the market.
Page | 2
History
Before the North American futures market originated some 150 years
ago, farmers would grow their crops and then bring them to market in the
hope of selling their commodity of inventory. But without any indication
of demand, supply often exceeded what was needed, and un-purchased
crops were left to rot in the streets. Conversely, when a given commodity
such as Soybeans was out of season, the goods made from it became very
expensive because the crop was no longer available, lack of supply.
In the mid-19th century, grain markets were established and a central
marketplace was created for farmers to bring their commodities and sell
them either for immediate delivery (spot trading) or for forward delivery.
The latter contracts, forwards contracts, were the forerunners to today's
futures contracts. In fact, this concept saved many farmers from the loss
of crops and helped stabilize supply and prices in the off-season.
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The vast geographical extent of India and her huge population is aptly
complemented by the size of her market. The broadest classification of
the Indian Market can be made in terms of the commodity market and the
bond market. The commodity market in India comprises of all palpable
markets that we come across in our daily lives. Such markets are social
institutions that facilitate exchange of goods for money. The cost of
goods is estimated in terms of domestic currency. India Commodity
Market can be subdivided into the following two categories:
Wholesale Market
Retail Market
The traditional wholesale market in India dealt with whole sellers who
bought goods from the farmers and manufacturers and then sold them to
the retailers after making a profit in the process. It was the retailers who
finally sold the goods to the consumers. With the passage of time the
importance of whole sellers began to fade out for the following reasons:
The whole sellers in most situations, acted as mere parasites that
did not add any value to the product but raised its price which was
eventually faced by the consumers.
The improvement in transport facilities made the retailers directly
interact with the producers and hence the need for whole sellers
was not felt.
In recent years, the extent of the retail market (both organized and
unorganized) has evolved in leaps and bounds. In fact, the success stories
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Page | 5
Ministry of Consumer
Affairs
Commodity Exchange
100
80
60
East
40
West
20
North
0
2nd 3rd
National1st
Exchange
Qtr
NCDEX
Qtr
Qtr
MCX
4th
Qtr
Regional Exchange
NMCE
NBOT
20 Other
Regional
Exchanges
Page | 6
METAL
BULLION
FIBER
ENERGY
SPICES
PLANTATION
S
Areca nut, Cashew Kernel, Coffee (Robusta), Rubber
PULSES
PETROCHEMI
CALS
HDPE, Polypropylene(PP), PVC
OIL & OIL
SEEDS
CEREALS
Maize
OTHERS
Page | 7
(Agra), Potato
(Tarkeshwar), Sugar M-30, Sugar S-30
Functioning
The futures market is a centralized market place for buyers and sellers
from around the world who meet and enter into commodity futures
contracts. Pricing mostly is based on an open cry system, or bids and
offers that can be matched electronically. The commodity contract will
state the price that will be paid and the date of delivery. Almost all
futures contracts end without the actual physical delivery of the
commodity.
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.)
In every commodity contract, everything is specified: the quantity and
quality of the commodity, the specific price per unit, and the date and
method of delivery. The price of a futures contract is represented by the
agreed - upon price of the underlying commodity or financial instrument
that will be delivered in the future. For example, in the above scenario,
the price of the contract is 5,000 bushels of grain at a price of $4 per
bushel.
$4 per bushel. The farmer, as the holder of the short position, has lost $1
per bushel because the selling price just increased from the future price at
which he is obliged to sell his wheat. The bread maker, as the long
position, has profited by $1 per bushel because the price he is obliged to
pay is less than what the rest of the market is obliged to pay in the future
for wheat. On the day the change occurs, the farmer's account is debited
$5,000 ($1 per bushel X 5,000 bushels) and the bread maker's account is
credited by $5,000 ($1 per bushel X 5,000 bushels).
As the market moves every day, these kinds of adjustments are made
accordingly. Unlike the stock market, futures positions are settled on a
daily basis, which means that gains and losses from a day's trading are
deducted or credited to a person's account each day. In the stock market,
the capital gains or losses from movements in price aren't realized until
the investor decides to sell the stock or cover his or her short position. As
the accounts of the parties in futures contracts are adjusted every day,
most transactions in the futures market are settled in cash, and the actual
physical commodity is bought or sold in the cash market. Prices in the
cash and futures market tend to move parallel to one another, and when a
futures contract expires, the prices merge into one price. So on the date
either party decides to close out their futures position, the contract will be
settled. If the contract was settled at $5 per bushel, the farmer would lose
$5,000 on the contract and the bread maker would have made $5,000 on
the contract. But after the settlement of the wheat futures contract, the
bread maker still needs wheat to make bread, so he will in actuality buy
his wheat in the cash market (or from a wheat pool) for $5 per bushel (a
total of $25,000) because that's the price of wheat in the cash market
when he closes out his contract. However, technically, the bread maker's
futures profits of $5,000 go towards his purchase, which means he still
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Now that you see that a futures contract is really more like a financial
position, you can also see that the two parties in the wheat futures
contract discussed above could be two speculators rather than a farmer
and a bread maker. In such a case, the short speculator would simply have
lost $5,000 while the long speculator would have gained that amount.
(Neither would have to go to the cash market to buy or sell the
commodity after the contract expires.
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Hedgers:
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.
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 future 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.
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Speculator:
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.
Hedger
Speculator
Long
Short
more solid the information entering the market will be regarding the
commodity in question. Thus, all can expect a more accurate reflection
of supply and demand and the corresponding price. Regulatory Bodies
the United States' futures market is regulated by the Commodity
Futures Trading Commission, CFTC, and an independent agency of the
U.S. government. The market is also subject to regulation by the
National Futures Association, NFA, a self-regulatory body authorized
by the U.S. Congress and subject to CFTC supervision.
Arbitrage:
Arbitrage refers to the opportunity of taking advantage between the price
difference 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 x 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
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Page | 16
Precious Metals
Gold prices recovered strongly from its lows during last week and almost
touched a high of $970/oz., as the Federal Reserve's plans to purchase as
much as $1.15 trillion in U.S. bonds and mortgage-backed securities
sparked worries of inflation ahead, raising gold's appeal as a hedge
against rising prices. This is the most aggressive plan taken by Fed since
the early 1960. Demand from gold ETF also increased during this week.
Holdings in SPDR Gold Trust, worlds largest gold ETF, touched an all
time high of 1103.29 tons.
Page | 17
The volatility in prices in the Bullion pack has increased greatly over the
past few months with 19 March being a highly volatile trading day. Spot
Gold is finding excellent support in the zone of $880-$890 levels which is
viewed as value buying zone by investors. Whereas major resistance zone
is seen between $960-$970. The demand for the safe-haven asset is still
prevalent with the USD weakening consistently over the past few trading
sessions. Also, the increased volatility in the Rupee is playing its role in
determining domestic bullion prices. In coming weeks & months, the
state of the overall global economic scenario will play a key role in
determining bullion prices as investors evaluate various asset classes to
channel their funds. Still gold remains the best bet under current market
scenario. MCX April Gold can face resistance around Rs.15600 levels,
whereas support is seen at Rs. 14850 per 10 gram.
Crude Oil
Crude Oil prices traded higher amidst high amount of volatility in the last
week. Oil prices surged to a three month high on account of weak dollar
and rally in global equity markets. Despite bearish inventory data, prices
rebounded from its lows, after US Federal Reserve decided to buy
Treasury bonds worth $300bn to ease credit market. Steps taken by Fed
rekindled hopes for economic recovery and rise in energy demand. Crude
Oil prices have increased by more than 20% this year, on account of strict
implementation of production cuts by OPEC to reduce excess supply and
weak dollar against major currencies. Volatility in oil prices has increased
sharply in past few trading sessions. We expect that oil prices can witness
fierce tussle between bulls and bears in coming weeks. Factors like
falling demand and weak economic data are favoring bears, but weak
dollar, rise in risk appetite amidst strong equity markets are giving bulls a
Page | 18
reason to come back in to market. After last weeks rally, oil prices can
witness profit booking. During this week, NYMEX May Crude Oil prices
are expected to trade in the range of $42.50 and $53.50.
Rubber
Rubber prices in domestic and global markets were on a recovery mode
this week. In the weekend covering groups lifted the prices to further
highs driven by possibly a speculative interest. However, 2009 as
predicted by many analysts is not going to be a good year for rubber with
consumption to fall 5.5 percent across the globe mainly due to falling
automobile sales. Rubber prices have slumped 50 percent in a year as the
global recession slashed tire demand.
Europes car market shrank 7.8 percent in 2008, while U.S. sales
contracted 18 percent to a 16 percent year low.
In TOCOM and Shanghai, benchmark natural rubber futures climbed to
the highest in more than two weeks as producers restated proposed
output cuts and on speculation China, the worlds largest consumer, is
adding the commodity to state stockpiles.
Spot rubber flared up on Friday. Sheet rubber RSS 4 moved up to Rs
76.50 from Rs.75.50 a kg, while the market made all-round
improvement even in the absence of enquires from the major
manufacturers. The volumes were comparatively better.
The April futures for RSS 4 firmed up to Rs 77.99 (Rs 77.50), May to
Rs 79 (Rs 78.56), June to Rs 79.99 (Rs 79.67) and July to Rs 79.95 (Rs
79.80) a kg on National Multi Commodity Exchange (NMCE).
Towards weekend in global markets, RSS 3 slipped further to Rs 73.37
(Rs 73.81) a kg on
Singapore Commodity Exchange. The grades spot weakened to Rs 73.68
(Rs 74.43) a kg at
Page | 19
Bangkok. The physical rubber rates were: RSS-4: 76.50 (75.50), RSS-5:
75 (74), Ungraded: 73.50 (73), ISNR 20: 74 (73.50), and Latex 60%:
57.50 (57).
Meanwhile, Indias Rubber Board has raised alarm against the rapid
growth in tyre imports mainly from China. A steady trend with an slight
upward bias could be expected for rubber next week.
Base metals
Base metal prices are moving higher on the back of a weaker dollar and
stable equities as both these factors have improved market sentiments. A
weaker dollar makes base metals look attractive for holders of other
currencies. This is providing a strong support to base metal prices but the
upside could be capped as LME inventories have touched a 15-year high.
The base metals market is in an oversupply situation and fundamentals
look bearish. However, the current rise in base metal prices is mainly due
to technical buying and short-covering. In the coming week, base metal
prices are expected to remain volatile as the US is expected to announce
economic data like existing home sales, new home sales, 4Q GDP,
personal income and spending.
Soybean
Refined soy oil futures fell sharply during the last week as government
of India scrapped import duty on soy oil to reduce premium over palm
oil. Government of India extended ban on exports of edible oil. Last year,
Govt. of India had banned export soy oil in March to control rise in price.
According to the Solvent Extractors Association of India, Indias import
of edible oil increased to 7,30,094 metric tonnes in February, 2009, up
Page | 20
69.40% as compared to last year during the same period. Edible oil
imports in the first four months of oil marketing year (November to
February) was 28,24,941 metric tonnes, up 87% as compared to
15,12,695 metric tonnes during the same period last year. PEC Ltd. has
floated two separate tenders for the local sales of 3161 metric tonnes of
crude soy oil. PEC is authorized by the government of India to import
edible oils and sales the local market. Global vegetable oil prices may
still fall due to ample global supply. In the coming week, prices are
expected to move lower on account of higher import of edible oil and
scrapped import duty on soybean oil. NCDEX April Refined Soy Oil has
support at 430/422 and resistance is seen at 452/460 levels in this week.
Turmeric
Spot prices at Erode and Nizamabad over the past couple of days are
being quoted at higher rates due to better off takes at the domestic market.
Prices in the previous week were quoted in the range of Rs. 4,2004,350/qtl. Even though the arrivals are more off takes are equally better
due to domestic buying. Arrivals on an average in the previous week
Page | 21
were around 25,000 bags daily in both the major mandis of Nizamabad
and Erode. Fear of lower availability of Turmeric in 2009 is supporting
the prices to strengthen. Demand from the domestic market especially
from local stockiest is present but the overseas demand has reduced as the
prices are at higher levels. Farmers are hoarding the stocks and not
bringing in fresh turmeric to the market in good quantity in order to reap
maximum profits. Turmeric Futures April 09 contract touched a high of
Rs.5,090/qtl tracking spot prices. Prices are ruling at higher levels thus
cautious trading is advisable at futures. Prices have initial support at
Rs.4,840/qtl and thereafter at Rs.4,700/qtl. Resistance could be seen at
Rs.5,205/qtl and thereafter at Rs. 5,395/qtl.
Sugar
Sugar market declined sharply by 15% in the last 3-4 weeks as the Indian
government has adopted various measures to curb spiraling Sugar prices.
Besides imposition of stock limits and duty free impost of Raw Sugar,
Government is now considering a proposal to let state-run trading
companies import refined sugar at zero duty to bridge the widening gap
between demand and supply. Final decision by the cabinet regarding the
duty free imports of refined Sugar is expected in the coming week.
India will have to import 3 million tonnes of Sugar to meet its domestic
consumption of 22.5-23 million tonnes. But imported sugar is much more
expensive than local sweeteners at present, making the imports unviable.
Thus, despite governments effort to ease import norms, we dont expect
imports to take place in the coming months. Any significant decline in the
prices should be treated as a good buying opportunity as Overall,
fundamentals remain supportive for the prices with lower output forecast
in India and a global deficit of more than 4.3 million tonnes.
Page | 22
April Sugar futures are currently trading at around Rs. 2035 levels. Prices
are having initial support at Rs. 1995 and then 1953. Resistance could be
seen at Rs. 2080/qtl and thereafter Rs. 2120/qtl.
Black Pepper
The undertone in the Black Pepper spot and futures counter this week was
steady due to increased buying interest and aided by a tight supply
position. Indian parity in the international market was at $2,225-2,325 a
tonnes (c&f) as the rupee has strengthened against the dollar on
Wednesday. Overseas reports on Wednesday said that Brazil was firmer
and exporters appeared to reluctant to offer. Basta was said to have been
offered at $2,000 a tonnes while B1 at $1,900 a tonnes.
Vietnam was reportedly steady at $1,800 a tonnes for faq 500 GL. More
buying interest was seen for black and white pepper from industry albeit
for nearby deliveries. Lasta was being offered on replacement basis at
$2,200-2,250 a tonnes (fob). New Indonesian crop is said to be lower at
15,000 tonnes against an estimated 30,000 tonnes last season. However,
some substantial quantity of carry over stock is reportedly available
therein the hands of middlemen and exporters.
Page | 24
Trends
900
$780 bn
800
$663 bn
700
600
$479 bn
500
400
300
200
100
$127.1 bn
$28.7 bn
0
2003-04
2004-05
2005-06
2006-07
2007-08
Page | 25
Septemb
2009
-er
Tradin Percent Trading
g on all age
on all
Exchan To total Exchang
ges
Turnov es
(Rs
er
(Rs
crore)
crore)
Octob
2009
-er
Percenta Tradin
ge
g on
To total all
Turnove Excha
r
nges
(Rs
crore)
2009
Percen
tage
To
total
Turno
ver
22.3
21.8
Gold
91419
15.1
Metal
141174
Silver
75206
12.4
110285
17.4
Copper
Zinc
Nickel
Lead
Crude
Oil
Natural
Gas
Total
94141
17572
35145
15941
117257
15.6
2.9
5.8
2.6
19.4
77801
18225
24270
30777
96711
12.3
2.9
3.8
4.9
15.3
30607
5.1
40640
6.4
539882
85.3
Agro
1726
1760
597
Product
0.3
2019
0.3
2070
0.1
590
477288 79.0
Pepper 4071
Jeera
2272
Castor 666
Seed
0.7
0.4
0.1
14002
3
10479
4
69443
23042
23776
22877
10851
1
37640
16.3
10.8
3.6
3.7
3.6
16.9
5.9
53010 82.7
6
0.3
0.3
0.1
Page | 26
Gaur
Seed
R/M
Seed
Soy
Bean
Turmer
-ic
Soy
Oil
Chana
Total
33753
5.6
19597
3.1
25012 3.9
6968
1.2
8047
1.3
8570
1.3
6339
1.0
5846
0.9
9014
1.4
11445
1.9
5355
0.8
9709
1.5
17067
2.8
16498
2.6
17319 2.7
14553
97133
2.4
16.1
7687
67113
1.2
10.6
10352 1.6
84654 13.2
Page | 27
Gold
(Indian commodity market)
Introduction
Gold is a unique asset based on few basic characteristics. First, it is
primarily a monetary asset, and partly a commodity. As much as two
thirds of golds total accumulated holdings relate to store of value
considerations. Holdings in this category include the central bank
reserves, private investments, and high-cartages jewelers bought
primarily in developing countries as a vehicle for savings. Thus, gold is
primarily a monetary asset. Less than one third of golds total
accumulated holdings can be considered a commodity, the jewelers
bought in Western markets for adornment, and gold used in industry.
Page | 28
Market Characteristics
The gold market is highly liquid. Gold held by central banks,
other major institutions, and retail jewelry is reinvested in
market.
Page | 30
Total demand
2006
2486
3574
3409
2007
2473
3488
3526
2008
2407
3468
3659
Source: GFMS
Page | 31
Share
China
12%
United States
South Africa
29%
10%
Australia
Peru
Russia
10%
3%
Canada
Indonesia
4%
10%
4%
4%
7%
7%
Uzbekistan
Ghana
Others
Page | 32
Domestic Scenario
India is arguably the largest bullion market in the world. It has been
until now, the undisputed single-largest Gold bullion consumer, with its
own final demand outweighing the next largest market China by
almost 57 percent. But it seems now, that the Chinese Gold buyers have
caught up during 2008 as Chinese demand is surging rapidly (up by 15
percent year-on-year). Indian demand fell as Indian Gold sales
collapsed by about 65 percent in the year 2008. In spite of being the
largest consumer of gold, India plays no major role globally in
influencing this precious metal's pricing, output or quality issues.
Indias total gold holdings are between 10,000 tonnes and 15,000 tonnes
of which the Reserve
Bank of India has only around 400 tonnes. India has the largest number
of gold Jewelry shops in the world.
Page | 33
2005-06
2006-07
2007-08
Karnataka
2.846
2.334
2.831
Jharkhand
0.201
0.154
0.027
Gujrat
6.710
10.335
9.135
Total
9.757
12.823
11.993
Page | 34
India (IN
TONNES)
World (IN
TONNES)
% share of
World
Demand
2004
617.7
2961.5
20.86
2005
721.6
3091.9
23.34
2006
721.9
2681.9
26.92
2007
769.2
2810.9
27.36
2008
660.2
2906.8
22.71
Source: GFMS
Indian demand for Gold accounts for on an avg. 25% share of world
gold demand. In 2008, demand for gold has decreased in India because
of high price amid global financial crisis.
Page | 35
Gold Prices
There are many factors, which affect the gold prices in domestic as well
as international market. However, it is highly correlated with the US
dollar, the world's main trading currency. Gold has long been regarded by
investors as a good protection against depreciation in a currency's value,
both internally (i.e. against inflation) and externally (against other
currencies). Gold is widely considered to be a particularly effective hedge
against fluctuations in the US dollar, the world's main trading currency.
The gold price has been found to be negatively correlated with the US
dollar and this relationship appeared to be consistent over time. It is a
consistently good protection against the economic instability and the
exchange rate fluctuations.
Page | 37
Page | 39
1) 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.
Page | 40
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.
E.g. - 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.
2) Leverage
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.
On the other hand, if the index declined 5%, it would result in a monetary
loss of $16,250a 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.
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
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as position limits and they ensure that no one person can control the
market price for a particular commodity.
1) Going Long
When an investor goes long, that is, enters a contract by agreeing to buy
and receive delivery of the underlying at a set price, it means that he or
she is trying to profit from an anticipated future price increase.
For example, let's say that, with an initial margin of $2,000 in June, Joe
the speculator buys one September contract of gold at $350 per ounce, for
a total of 1,000 ounces or $350,000. By buying in June, Joe is going long,
with the expectation that the price of gold will rise by the time the
contract expires in September.
By August, the price of gold increases by $2 to $352 per ounce and Joe
decides to sell the contract in order to realize a profit. The 1,000 ounce
contract would now be worth $352,000 and the profit would be $2,000.
Given the very high leverage (remember the initial margin was $2,000),
by going long, Joe made a 100% profit!
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Of course, the opposite would be true if the price of gold per ounce had
fallen by $2. The speculator would have realized a 100% loss. It's also
important to remember that throughout the time the contract was held by
Joe, the margin may have dropped below the maintenance margin level.
He would have thus had to respond to several margin calls, resulting in an
even bigger loss or smaller profit.
2) Going Short
A speculator who goes short, that is, enters into a futures contract by
agreeing to sell and deliver the underlying at a set price, is looking to
make a profit from declining price levels. By selling high now, the
contract can be repurchased in the future at a lower price, thus generating
a profit for the speculator.
Let's say that Sara did some research and came to the conclusion that the
price of Crude Oil was going to decline over the next six months. She
could sell a contract today, in November, at the current higher price, and
buy it back within the next six months after the price has declined. This
strategy is called going short and is used when speculators take advantage
of a declining market.
Suppose that, with an initial margin deposit of $3,000, Sara sold one May
crude oil contract (one contract is equivalent to 1,000 barrels) at $25 per
barrel, for a total value of $25,000.
By March, the price of oil had reached $20 per barrel and Sara felt it was
time to cash in on her profits. As such, she bought back the contract
which was valued at $20,000. By going short, Sara made a profit of
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$5,000! But again, if Sara's research had not been thorough, and she had
made a different decision, her strategy could have ended in a big loss.
3) Spreads
As going long and going short, are positions that basically involve the
buying or selling of a contract now in order to take advantage of rising or
declining prices in the future. Another common strategy used by
commodity traders is called spreads. Spreads involve taking advantage of
the price difference between two different contracts of the same
commodity. Spreading is considered to be one of the most conservative
forms of trading in the futures market because it is much safer than the
trading of long / short (naked) futures contracts.
There are many different types of spreads, including:
Calendar spread - This involves the simultaneous purchase and sale
of
two futures of the same type, having the same price, but different
delivery dates.
Inter-Market spread - Here the investor, with contracts of the same
month, goes long in one market and short in another market. For
example, the investor may take Short June Wheat and Long June
Pork Bellies.
Inter-Exchange spread - This is any type of spread in which each
position is created in different futures exchanges. For example, the
investor may create a position in the Chicago Board of Trade,
CBOT and the London International Financial Futures and Options
Exchange, LIFFE.
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3) Commodity Pool: - A third way to enter the market, and one that offers
the smallest risk, is to join a commodity pool. Like a mutual fund, the
commodity pool is a group of commodities which can be invested in. No
one person has an individual account; funds are combined with others and
traded as one. The profits and losses are directly proportionate to the
amount of money invested. By entering a commodity pool, you also gain
the opportunity to invest in diverse types of commodities. You are also
not subject to margin calls. However, it is essential that the pool be
managed by a skilled broker, for the risks of the futures market are still
present in the commodity pool.
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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.
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10
11
12
13
14
15
16
17
18
19
20
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Regulators
Each exchange is normally regulated by a national governmental
(or semi-governmental)
regulatory agency:
Country
Regulatory agency
Australia
Chinese
mainland
Hong Kong
India
Singapore
UK
USA
Malaysia
Securities Commission
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S.NO
1.
2.
3.
4.
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2%
22%
NMCE
NBOT
MCX
NCDEX
Others
74%
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Conclusion
The commodity Market is poised to play an important role of price
discovery and risk management for the development of agricultural
and other sectors in the supply chain. New issue and problems
Govt. regulators and other share holders will need to proactive and
quick in their response to new developments. WTO regime makes
it all the more urgent to develop these markets to enable our
economy, especially agriculture to meet the challenge of new
regime and benefits from the opportunities unfolding before U.S.
with risks not belong absorbed any more the idea is to transfer it as
the focus is shifting to Manage price change rather than change
prices the commodity markets will play a key role for the same.
While almost all agricultural product prices increased at least in
nominal terms, the rate of increase varied significantly from one
commodity to another. In particular, international prices of basic
foods, such as cereals, oilseeds and dairy products, increased far
more dramatically than the prices of tropical products, such as
coffee and cocoa, and raw materials, such as cotton or rubber.
Therefore, developing countries dependent on exports of these
latter products found that while their export earnings might have
been increasing this was at a slower rate than the cost of their food
imports. As many developing countries are net food importers, this
imposed a serious balance of payments problem. The leap in food
prices was in sharp contrast to the secular downward trend and the
prolonged slump in commodity prices from 1995 to 2002, which
even prompted calls for the revival of international commodity
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agreements.
For some analysts, the increases or signaled the end of the longterm decline in real agricultural commodity prices, with The
Economist (2007) announcing the end of cheap food. It is an
interesting
question
whether
these
sharp
increases
are
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