A Specialization Project Report on

Commodity Price Movement and Trading in Indian Commodity Market in Pre-recession, Recession and Post recession Era

Report submitted in partial fulfillment of POST GRADUATE DIPLOMA IN MANAGEMENT

Submitted By
Swati Dixit PGDM-TPS-17th Batch Roll No. 17112

Under The Esteemed Guidance of

Prof. V.G.Chari Professor (Finance)

SIVA SIVANI INSTITUTE OF MANAGEMENT, KOMPALLY SECUNDERABAD-500014 (2008-10)

ACKNOWLEDGEMENT

I bow to Almighty for bestowing upon me with patience, perseverance and courage to complete this project timely and successfully. I express my heartiest gratitude to my extreme teacher, Prof. V. G. Chari, Professor (finance), SSIM, whose thorough knowledge, excellent guidance, valuable helps and co-operative nature became the way to complete this project report in the proper manner. I am also thankful to Mr. Pardha Saradhi and Dr. Murlidhar Prasad, Faculty Finance, SSIM for their help and guidance on this project. I also thank Mr. Shyam Sunder, in charge Library and other library staff for providing all the literatures required completing the project. Last but not the least; I want to express my gratitude towards my parents and my friends for their cooperation during the project.

DECLARATION

I, Swati Dixit, declare that this project report titled Commodity Price Movement and Trading in Indian Commodity Market in Pre-recession, Recession and Post recession Era is done by me on my own. I further declare that it is my original work as a part of my academic course. I have not published it anywhere else for any academic or business purpose.

PLACE: Hyderabad DATE:

(Swati Dixit) PGDM-TPS-17th batch

CONTENTS
1

Chapter-1
Abstract Objective of the study Scope of the Study Review of literature

Chapter 2 Commodity market- A brief introduction Indian commodity market Important products of commodity market Evolution, development and future prospects of Indian commodity market

Chapter-3
Research methodology

Chapter-4
Data Analysis and Interpretation

Chapter-5
Findings Conclusion Bibliography

CHAPTER 1
ABSTRACT OBJECTIVES SCOPE REVIEW OF LITERATURE

ABSTRACT World economy featured recently robust real economic growth, averaging about 4.5-5.5 percent per year during 200307. However, inflationary pressures re-emerged. Commodities market experienced highest inflation rates in post-war period with all commodities price index increasing at 23 percent per year during 200307. Prices hit US$119/barrel in April 2008 and might accelerate to dramatic levels. Parallel to commodities markets, real estate markets experienced phenomenal speculative price increases. In the same vein, the exchange rate of the U.S. dollar has depreciated considerably during 200208, plummeting to US$1.6 per Euro in April 2008, and might fall further. Financial markets face high uncertainty stemming from rising inflationary expectations, credit risks, and depreciating currencies. Moreover, many vulnerable countries were recently shaken by food riots and may face alarming food crisis arising from exorbitant food prices. The global economy is in the midst of a deep downturn as an adverse feedback loop between the real and financial sectors is taking its toll both in advanced and in emerging and developing countries. As a result, commodity prices are unlikely to recover in the short run. All major advanced economies are in recession, while activity in emerging and developing economies is slowing abruptly. Continued deleveraging by the financial sector and dramatic declines in consumer and business confidence have triggered a sharp deceleration in domestic demand across the globe. World trade and industrial activity are falling sharply, while labor markets are weakening at a rapid pace, particularly in the United States. The decline in commodity prices is providing some support to commodity importers, but is weighing heavily on growth in commodity exporters. With growth well below trend in emerging and developing economies, commodity prices have collapsed over the past few months. Expectations of resilience in these economics had underpinned commodity prices for much of 2008, but hopes for decoupling have since evaporated. Commodity prices tend to be significantly cyclical, as output contraction in commodity-intensive sectors exceeds that in other sectors. Financial turmoil and U.S. dollar appreciation have exacerbated the downward price momentum. Investors have sought to reduce their holdings of commodity assets, given increasing concerns about counterparty risks (many standard commodity investment instruments such as total return swaps involve such risks), decreasing availability of credit for leveraged commodity market exposure (e.g., by hedge funds), a rising preference for liquidity, and sizable recent appreciation of the U.S. dollar in nominal effective terms. Commodity prices are unlikely to recover while global activity is slowing. To measure the risk is vitally important task. This study focuses on studying the price movement of various commodities before recession, during recession, and after recession in India as well as world.

OBEJECTIVE OF STUDY It is needless to say that the financial markets finance economic growth. The commodity derivative exchanges witnessed several ups and downs the past few years. The project is undertaken with few specific objectives. The objectives were identified after undertaking library study. The research methodology ensures that all the objectives of study are fulfilled. The objectives of this study are:      To understand how commodities perform during economic growth. To understand the role of commodity derivative market in global meltdown. Strengthening and expanding the scope of commodity derivative in India as well as world. To understand the trends of price movement of various commodities before recession, after recession and after recession. To understand the commodity structure in India.

SCOPE OF STUDY 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 arbitrage opportunities in the market. The commodity futures industry has played a major role in helping such businesses manage that price risk. For over a century, the futures industry has played a major role in helping businesses manage those price risks. Futures Industry is a world leader in providing efficient markets and unparallel operational procedures for hedging and managing the volatility of the price movements associated with the markets. REVIEW OF LITERATURE Commodities are the most fundamental of human essentials. Things like wheat, corn, oil, zinc, copper and coal. While you might not physically buy some of these commodities, you cant go through a normal day without them. Every time you turn on a light switch or power up your stove, the electricity used is provided by coal or natural gas. Grains are the basic building blocks for all the foods we eat. Oil, besides being refined into gasoline, goes in things like plastic, carpets, soaps and detergents.Besides being essentials, commodities also have inflationary pricing power. If the government prints massive amounts of money to combat the recession, inflation will likely happen. It might not happen immediately afterwards, but it will rear its ugly head. Commodities, for those reasons are a good place to be. (www.investopedia.com) As per NBER (National Bureau of Economic Research), there have been ten recessions since 1945. From mid 1940s till 2007, the average recession lasted 10 months, while the average expansion lasted 57 months, giving us an average business cycle of 67 months or about 5 years and seven months. In this period, the shortest recession lasted only 6 months, from January to
7

July 1980. The two longest recessions during this period lasted 16 months each, one extending from November 1973 to March 1975, and the other from July 1981 to November 1982. There was a noticeable decline in real GDP in both of these periods. The shortest expansion period from the mid-1940s until 2007 lasted only 24 months, from April 1958 to April 1960. The longest expansion continued from March 1991 to March 2001, setting a record of 120 consecutive months of growth. As luck would have it, United States has experienced only two relatively mild recessions and extended periods of expansion over the past 25 years. (Recession, its cause and effects, article base, December 11, 2008) With the help of historical data, we can see that what happened in the 1929 crash and its aftermath tells a similar story. For example, in 1929, corn prices were dragged down by approximately 80% from its peak due to a crash in the market. However, in 1937, it made a new high, higher than the 1929 peak. We can see a similar trend during 2009 to 2010, as supply is shrinking in almost all commodities. With the Fed gambling with the US dollar, commodities still have legs, commodities perform better amidst a weak dollar. Due to the essential nature of commodities for human lives, investors shift their funds into commodities during war and financial crisis. The historical risk premium, during the 1959 to 2004 period, on commodity futures has been positive at about 5 percent, supporting the fact that commodities get continuous and somewhat definite returns in times of crisis as well. Commodity prices rise even during recession. Currently, many commodities are moving up on the hope of improvement in demand. Nowadays, all metals, energy and agricultural products are in the headlines due to their eye catching upside movements in prices. Most people are talking about a more than 60% fall in crude oil prices, which is now on the path of recovery. The fall in oil prices is not the ideal sign of recession, as in the last nine years, oil prices have declined three times by more than 50% and each time it was not the end of the bull market. During the tough time from 1959 to 2004, commodities offered better returns to investors and proved less risky as compared to stocks. (Commodities: opportunities during recession, www.seeking alpha.com ,may 4, 2009) A dollar appreciation (depreciation), due to dollar shortage, has depressed (ignited) commodities prices. Transmission of US dollar movements to commodities prices works through many channels. These include price and real cash balances (Pigou effect) effects for non dollar currencies, and credit channel whereby borrowing in US dollars becomes more (less) attractive in case of US dollar depreciation (appreciation), fueling thus higher (lower) demand and speculation in commodities markets. Moreover, as exchange rate is an asset price, its changes can be related to money supply. Lower (higher) US dollar could be attributed to rising (declining) US money supply or higher (lower) dollar velocity. A form of quantity theory (i.e., long-run proportionality) may therefore prevail between US money supply and commodities prices. If commodities prices were to be priced in gold, and given very slow increase in world gold stock, then commodities prices might turn out to be stable in terms of gold. (IMF International Financial Statistics)

Commodities have been going through a bottoming process and with the supply cutbacks, when demand returns in a big way probably fourth quarter of 2009 or in beginning of 2010 we may see a return to strong gains in commodity prices. There is a light at the end of the tunnel. We hope that this tunnel should not much longer than people are anticipating.(Commodities: opportunities during recession, www.seeking alpha.com, may 4, 2009) The recent efforts to promote globalization have caused the worlds bigger financial & investment markets and economies to work in solidarity. Hence, the regional markets and economies have to create their developmental strategies according to these markets. The declaration of the US mortgage crisis has led bankruptcy and mergers between the big financial and investment players. (Global :Impact of Financial Crisis on GCC Oil & Gas Projects, November 28, 2008) The recession will continue at least until December. It will probably rank with the 1957-58 and 1973-75 declines, the worst of the ten U.S. recessions since World War II. It will be global as exports sold to U.S. consumers shrink, thus slashing the primary growth source for the rest of the world. With global recession, demand for industrial commodities and oil will fade. Copper can be a proxy for global industrial production. (Copper meltdown, Vol. 4 Issue 4, p19-19, Shilling, A. Gary) Mike Burninck, the editor of global market investor says that- Probably over the next few months well see some downside volatility in oil and in gold because of the concerns about global growth. Energy more so than gold because the dynamic behind gold has more to do with the declining U.S. dollar and worries about inflation. (Commodity Crash: How US recession will affect the commodities super cycle, Today financial news, January 26, 2008) Recession has become a buzzword, everybody is losing confidence but it is well said that crisis generates opportunity and one should know how to turn crisis into opportunity. Commodity is the field which generated opportunity in every phase of business cycles. Two dimensions could be attributed to these higher prices after during recession. First, production cut due to lack of demand and liquidity and secondly, various monetary steps to revive the economy, viz; interest rate cut, relief packages, tax cut etc. With the gambling of Fed with US dollar, commodity still have legs that commodity performs better amid weak dollar. Due to its essential nature of commodities for human lives, investors shift their funds into commodities during war and financial crisis. The historical risk premium, during the 1959-2004 period, on commodity futures has been positive at about 5 percent, is supporting the fact that commodities get continuous and somewhat definite returns in time of crisis as well. Commodity prices rise even during recession, currently many commodities moving up on the hope of improvement in demand. Now a day, all metals, energy and agro products are in headlines due to their eye catching upside movements in the prices. Most of the people talking about more than 60% fall in crude oil prices, which is now on the path of recovery. Fall in oil prices are not the ideal sign of recession, as in last nine years, three times oil prices have declined by more than 50% and
9

each time it was not the end of the bull market. From 1959 to 2004, during the tough time commodities offered better return to the investors and proved less risky as compare to stocks. (Encash the opputunity during recession in commodity, Vandana Bharti, Delhi, April 28, 2009)

10

CHAPTER 2
INDUSTRY PROFILE

11

INDUSTRY PROFILE

India has a long history of commodity derivative trading, spanning over 130 years. The commodity derivative exchanges witnessed several ups and downs for the past 13 decades, with a booming phase of unbridled free futures trading in as many as 300 markets during the pre-independence era, followed by a ban on such trading for almost a decade after the outbreak of the Second World War in 1939. Subsequent to independence in 1947, the then Government of Bombay enacted the Bombay Forward Contracts Act and permitted futures trading in cotton and oilseeds under the auspices of the recognized associations. Outside Bombay Presidency, commodity futures trading was also revived, but remained free and unregulated except by the exchanges organizing such trading. With the Constitution of India coming into force on January 26, 1949, the subject of futures trading came under the Union List. As a result, the Government of India brought on the Statute Book the Forward Contracts (Regulation) Act, 1952 (FCRA), and established the Forward Markets Commission (FMC) in 1953. Under the FCRA, futures trading came to be allowed in select agricultural commodities and their products under the auspices of associations recognized by the Government of India. By mid1960s, around 30 associations were recognized for trading in about a score of commodities. Trading was subject to severe regulatory measures. But no sooner the markets began to bloom with some activity, the government turned volte-face, and proscribed futures trading in almost all major food crops in the fond hope of restraining the raging inflation in the economy. Following the launch of economic reforms in the early 1990s, and especially after India signed the General Agreement on Trade and Tariffs (GATT) to enter the World Trade Organization (WTO), the World Bank and UNCTAD submitted a joint report to the Government of India recommending revival of futures trading in farm commodities and their products to render trade in such commodities competitive in the world markets after the envisaged removal of trade and non-trade barriers. As a result, futures trading were revived, after a lapse of nearly three and a half decades, towards the close of the 20th century. The onset of the new millennium thereafter witnessed the setting up of three new national commodity exchanges, which were permitted to trade in commodities of their choice, unlike the traditional regional and single commodity exchanges that traded in one or few closely related commodities only. At present, there are almost two dozen commodity exchanges, including three national exchanges, trading in as many as 100 commodities together. The new national commodity exchanges marked a distinct transfer scene on the commodity derivative trading landscape in the country. In contrast with the conventional 3 commodity exchanges, in which prevailed the long established floor-based open outcry trading system, the new national exchanges organized derivative trading on screen-based anonymous automated electronic system. The national exchanges also guaranteed the performance of the contracts, eliminating thereby the counterparty risks, whereas the old exchanges did not provide any such guarantee, but distributed the losses arising from any defaults among the members entitled to receive payments from the defaulting member. Incidentally, while trading volumes in several nonagricultural commodities, especially metals and energy products, has been quite high, the major agric-commodities have failed to take off. To be sure, as much as around 80% of the trading turnover in commodity exchanges is confined to half a dozen non-farm goods, whereas
12

the rest is widely dispersed among a wide spectrum of agricultural commodities and their products. Despite a long history of commodity futures trading in the country, futures markets are still viewed with suspicion by many in both the academic and official circles. The recent deflation in the values of various assets underlying the different derivatives, including commodity derivatives, following the global meltdown, have provoked even more doubts about the much acclaimed economic utility of futures trading for price discovery and risk management. As a result, its support for futures business in many commodities notwithstanding, the authorities have still not permitted such trading in several food grains like rice and millets, and some major pulses, too. The government also continues to suspend futures trading in commodities as soon as it suspects that such trading may affect adversely the prices of those commodities to the detriment of one or the other class of society. Even in USA, which has the most active commodity exchanges in the world, the new administration of President Obama is not merely rewriting the rules of regulation, but even investigating the role of commodity futures trading in the steep rise in prices of wheat and crude oil in 2007-08, regardless of the fact that commodities as an asset class have revealed the resoluteness and resilience in the face of global financial crisis. Role of Commodity Derivative Markets in the Global Meltdown In the context of the global financial meltdown that brought down precipitously the asset values of both movables and immovable, and tangibles and intangibles, affecting adversely the real economy with receding, and even negative, growths in almost all sectors of the economy, and raising in the process unemployment rates to record levels, commodity markets have shown an amazing resilience and steadfastness, despite the initial setbacks in base metals and energy. Commodity exchanges the world over, including those in India, have been surprisingly registering record turnovers in the face of a crisis that shook the entire financial ambit of the world economy. It appears that commodities have emerged as a new asset class for safe and secured investments. Money has been moving from other traditional asset classes to commodity derivatives. In the absence of alternative avenues of investments, the new investing classes like hedge funds, pension funds, index funds, sovereign funds, endowments, banks, and other institutional investors are entering commodity exchanges in droves with their huge fund flows to invest in index futures and commodity swaps. It seems that the traditional historical pattern of commodity futures markets is undergoing a sea-change. Hitherto, commodity futures markets were viewed as essentially hedging markets, to use its familiar description by Holbrook Working, who pioneered the studies in economics of commodity futures trading before the Great Depression of 1929. Traders in the markets were classified as hedgers and speculators; the line of distinction between the two was quite thin, though. The CFTC too was all along classifying commodity futures market traders as hedgers and speculators, and monitoring their positions accordingly while regulating the markets. Of late, however, it has changed the classification into commercial and non-commercial traders. Institutions trading in commodity futures, index futures, and commodity swaps are grouped along with the physical commodity market functionaries, since many of the institutions to hold physical stocks of commodities. As a result, investment trading in various commodity futures and their derivatives are also being treated on par with hedge trading. The commodity futures markets have, as a result, acquired a new dimension altogether.
13

Introduction 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. A commodity is some good for which there demand is, but which is supplied without qualitative differentiation across a market. It is a product that is the same no matter who produces it, such as petroleum, notebook paper, or milk. In other words, copper is copper. The price of copper is universal, and fluctuates daily based on global supply and demand. Stereo systems, on the other hand, have many levels of quality. And, the better a stereo is [perceived to be], the more it will cost. One of the characteristics of a commodity good is that its price is determined as a function of its market as a whole. Well-established physical commodities have actively traded spot and derivative markets. Generally, these are basic resources and agricultural products such as iron ore, crude oil, coal, ethanol, salt, sugar, coffee beans, soybeans, aluminum, copper, and rice, wheat, gold, silver and platinum. Soft commodities are goods that are grown, while hard commodities are the ones that are extracted through mining. Commoditization occurs as a goods or services market loses differentiation across its supply base, often by the diffusion of the intellectual capital necessary to acquire or produce it efficiently. As such, goods that formerly carried premium margins for market participants have become commodities, such as generic pharmaceuticals and silicon chips. Size of the market The trading of commodities consists of direct physical trading and derivatives trading. The commodities markets have seen an upturn in the volume of trading in recent years. In the five years up to 2007, the value of global physical exports of commodities increased by 17% while the notional value outstanding of commodity OTC derivatives increased more than 500% and commodity derivative trading on exchanges more than 200%. The notional value outstanding of banks OTC commodities derivatives contracts increased 27% in 2007 to $9.0 trillion. OTC trading accounts for the majority of trading in gold and silver. Overall, precious metals accounted for 8% of OTC commodities derivatives trading in 2007, down from their 55% share a decade earlier as trading in energy derivatives rose. Global physical and derivative trading of commodities on exchanges increased more than a third in 2007 to reach 1,684 million contracts. Agricultural contracts trading grew by 32% in 2007, energy 29% and industrial metals by 30%. Precious metals trading grew by 3%, with higher volume in New York being partially offset by declining volume in Tokyo. Over 40% of commodities trading on exchanges was conducted on US exchanges and a quarter in China. Trading on exchanges in China and India has gained in importance in recent years due to their emergence as significant commodities consumers and producers.

14

Indian commodity market Commodity Trading in India started long time back, but the commodity trading in the country gained its momentum after removal of certain restrictions by the Indian Government. Governments approval for setting up four national level commodity exchanges, which would involve multi-commodity trading, has further strengthened the commodity trading market of India. History of Commodity Trading in India The Commodity Trading Market of established itself in India as a dominant market form much before the 1970s. In fact, in the last phase of 1970s, the commodity trading market of India started to lose its vibrancy. This happened because, from the late 1970s, numerous regulations and restrictions started to be introduced in the commodity market of India and these restrictions were acting as obstacles in the path of smooth functioning of the commodity trading market. In the recent years, many restrictions, which were negatively affecting commodity trading market, have been removed. So, now the commodity trading market of India has again started to grow in a fast pace. In order to promote the commodity futures trading in India, Forward Markets Commission has been formed. This Forward Markets Commission actually regulates the futures trade in commodities. In India, there are 21 commodity exchanges, which enhance the efficiency and competitiveness of the commodity trading market. Many of these commodity exchanges are regional, while many of them are commodity specific. Some of these 21 commodity exchanges provide online commodity trading facility. Government Initiatives for promoting Commodity Trading  In the year 2003, the Indian Government approved the establishment plan of four commodity exchanges of national level. These national commodity exchanges would operate futures trading contracts for multiple commodities. The Indian Government has included more commodities in the list of permitted commodities, constructed under the Forward Contracts (Regulation) Act.  Earlier there was a rule that every spot market transaction has to be completed within 11 days. In order to promote commodity trading, the Government of India has removed this restriction. Indian Government has removed NTSD (Non-Transferable Specific Delivery Contract) option from the Forward Contracts (Regulation) Act. History The opening of the sea route to India (once the name given to all of Indonesia, Malaya and the rest of south-east Asia) by the mariner Dom Vasco da Gama in 1499 established the colonial power of Portugal in the Indian Ocean. During the following 100 years, some 200 voyages were made around the Cape of Good Hope to the east. The spice trade was the main motivation
15

at first, but around 1,600 other commodities were discovered and these then took a more prominent role. But only around half of all the ships sent out by the Portuguese and the Dutch ever came back. That risk has been eliminated, although transport is still a bottleneck. The expeditions were constantly at risk from other nations and pirates, who blocked access to the eastern Mediterranean area. They were also the cause of subsequent alliances and East India Companies. The first cartel In 1580 the two great sea-faring nations, Spain and Portugal united. This combination ensured that the sea route to Asia remained closed to other European nations (today, this abuse of market power would be known as a cartel). Trade in Asian spices, and above all pepper, was subject to contracts set up by the crown with fixed prices that had to be followed by the traders (contradores). They then sold on the goods to retailers such as the Dutch trading house Cunertorf & Snel in Lisbon, which in turn supplied the north European market through trading agencies in Antwerp. The price volatility we see in markets today is nothing new. The term tulip mania originally came from a period in Dutch history when demands for tulip bulbs reached such a peak that enormous price were charged for a single bulb. At one point, people paid more for a single tulip bulb than for a house in the centre of Amsterdam. Today the phrase is a synonym for speculation in the financial markets. Towards the end of the 16th century, Dutch traders from various towns decided to take charge of spice imports from Asia. In order to finance the ships and equipment, companies were formed, which in turn merged. Within a few years these companies had equipped 65 ships spread across 15 fleets, of which around 50 returned packed with goods. National merger They fought the Portuguese, the English and each other. The result was a dramatic fall in the price of spices. Thus it was largely economic motives that forced the Dutch merchants to cooperate and organize a national merger. The new company, VOC, received a state charter which granted it sovereign rights, and this would be of great significance for its future development (the contemporary equivalent would be some of the national oil companies). VOC was the first, and soon became the largest, worldwide company to dominate trading. It displayed the basic attributes of a modern joint-stock company and initiated future economic and financial history. The original paid up share capital was 6,424,588 guilders. The key to success in raising capital was the decision taken by the owners to open up access to the public and accept shareholders as part-owners. The shares sold rapidly and were tradable, as any Dutchman could buy and sell them. Importantly, the share price was not set by the government, but by an independent joint-stock corporation interested in profit. The company shareholders (the term came into use in around 1606) had to produce the subscribed capital in four part payments that were called up by the VOC between 1603 and 1606. The shareholder received a
16

receipt (Part) for the payment to the nominal value of the share. A share certificate documenting payment and ownership such as we know today was not issued but was instead entered in the companys share register. Not so dissimilar to the way things are undertaken today. COMMODITY EXCHANGES IN INDIA Multi commodity exchange of India (MCX) Multi Commodity Exchange of India Ltd is a demutualised nationwide electronic commodity futures exchange set up by Financial Technologies (India) Ltd. With permanent recognition from Government of India for facilitating online trading, clearing & settlement operations for futures market across the country. The exchange started operations in November 2003. MCX has achieved three ISO certifications including ISO 9001:2000 for quality management, ISO 27001:2005 for information security management systems and ISO 14001:2004 for environment management systems. MCX offers futures trading in more than 40 commodities from various market segments including bullion, energy, ferrous and non-ferrous metals, oil and oil seeds, cereal, pulses, plantation, spices, plastic and fiber. The exchange strives to be at the forefront of developments in the commodities futures industry and has forged strategic alliances with various leading International Exchanges, including Tokyo Commodity Exchange, Chicago Climate Exchange, London Metal Exchange, New York Mercantile Exchange, Bursa Malaysia Derivatives, Berhad and others. Key shareholders Promoted by Financial Technologies (India) Ltd, MCX enjoys the confidence of blue chips in the Indian and international financial sectors. MCXs broad based strategic equity partners include, NYSE Euro next, State Bank of India and its associates (SBI), National Bank for Agriculture and Rural Development (NABARD), National Stock Exchange of India Ltd. (NSE), SBI Life Insurance Co. Ltd., Bank of India (BOI) , Bank of Baroda (BOB), Union Bank of India, Corporation Bank, Canara Bank, HDFC Bank, Fid Fund (Mauritius) Ltd. an affiliate of Fidelity International, ICICI Ventures, IL&FS, Kotak group, Citi Group and Merrill Lynch. NCDEX National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed on-line multi commodity exchange. The shareholders of NCDEX comprises of large national level institutions, large public sector bank and companies. Promoter shareholders ICICI Bank Limited (ICICI), Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India Limited (NSE).

17

Other shareholders Canara Bank, Punjab National Bank (PNB), CRISIL Limited, Indian Farmers Fertiliser Cooperative Limited (IFFCO), Goldman Sachs, Intercontinental Exchange (ICE) and Shree Renuka Sugars Limited. NCDEX is the only commodity exchange in the country promoted by national level institutions. This unique parentage enables it to offer a bouquet of benefits, which are currently in short supply in the commodity markets. The institutional promoters and shareholders of NCDEX are prominent players in their respective fields and bring with them institutional building experience, trust, nationwide reach, technology and risk management skills. NCDEX is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for Commencement of Business on May 9, 2003. It commenced its operations on December 15, 2003. NCDEX is a nation-level, technology driven de-mutualised on-line commodity exchange with an independent Board of Directors and professional management both not having any vested interest in commodity markets. It is committed to provide a world-class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency. NCDEX is regulated by Forward Markets Commission. NCDEX is subjected to various laws of the land like the Forward Contracts (Regulation) Act, Companies Act, Stamp Act, Contract Act and various other legislations. NCDEX headquarters are located in Mumbai and offers facilities to its members from the centers located throughout India. In May 2000, Intercontinental Exchange (ICE) was established, with its founding shareholders who represented some of the worlds largest energy traders. In June, 2001, in a bid to strengthen its business into futures trading, ICE acquired the International Petroleum Exchange (IPE), now ICE Futures, which operated Europes leading open-outcry energy futures exchange. Intercontinental Exchange (NYSE: ICE) is currently the leading global, electronic exchange for trading both futures and OTC energy contracts and some soft commodities. ICE offers contracts in energy crude oil and refined products, natural gas, power and emissions; soft commodities including cocoa, coffee, cotton, ethanol, orange juice, wood pulp and sugar; currency and index futures and options. ICE conducts its energy futures markets through its U.K. regulated London-based subsidiary, ICE Futures, one of the leading energy exchanges in Europe. ICE Futures, offers liquid markets in two of the globally benchmarked crude oil futures Brent Crude futures and West Texas Intermediate (WTI). Nearly half of the worlds global crude futures (by volume) are traded on ICE. ICE conducts trading on its soft commodity futures and options through its U.S. regulated subsidiary the New York Board of Trade, which it took over in January, 2007.

18

MAJOR PRODUCTS OF COMMODITY MARKET Gold Gold is the oldest precious metal known to man and for thousands of years it has been valued as a global currency, a commodity, an investment and simply an object of beauty. Major Characteristics
y y y y

Gold is unique as it is both a commodity and a monetary asset. Its stability and high value makes it virtually indestructible and ensures that it is almost always recovered and recycled. There is no true consumption of gold in the economic sense as the stock of gold remains essentially constant while ownership shifts from one party to another. Although gold mine production is relatively inelastic, recycled gold (or scrap) ensures there is a potential source of easily traded supply when needed, and this helps to stabilize gold price. Economic forces that determine the price of gold are different from, and in many cases opposed to the forces that influence most financial assets.

Global Supply Demand Scenario

y y

The total above ground stocks of gold is estimated to be around 1,63,000 tonnes by Gold Fields Minerals Services (GFMS) as on end of 2008 Out of this total stock, 51% is estimated to be present as jewellery, 18% as official reserves, 17% held as investment, 12% used for industrial purposes and 2% is unaccounted for. Jewellery accounts for almost two-thirds of annual gold demand with investment and industry being the other main drivers. The total annual global demand for gold has averaged 3530 tonnes in the last three years (2005 2008). However, it is expected to dip slightly in 2009, owing to the sharp rise in prices. Five countries, viz., India, China, USA, Turkey, Saudi Arabia and UAE account for above 60% of gold demand, with each market driven by a different set of socioeconomic and cultural factors. The total global mine production is relatively stable, averaging approximately 2,455 tonnes per year over the last three years. Recycling of old gold scrap and official sector sales are the other major sources of supply, which have averaged 1084 tonnes and 378 tonnes in the last three years. South Africa has been a major gold producer since 1880s and it is estimated that about 50% of all gold ever produced has come from this nation. While, during the early 1980s it produced about 1000 tonnes, the output in 2007 dropped to just 272 tonnes. China with a production of 276 tonnes, overtook South Africa as the worlds largest gold producer in 2007 for the first time since 1905 that South Africa has not been the largest. The other major producers are USA, Australia, Russia and Peru.

19

World Gold Markets OTC markets at London (LBMA), New York and Zurich Gold derivative exchanges at New York CME (COMEX), Tokyo (TOCOM), Mumbai (MCX) Istanbul, Dubai, Hong Kong and Singapore are doorways to important consuming regions. India in World Gold Industry (Rounded Figures) India (In Tons) World (In Tons) % Share (Rounded Figures) Total Stocks Central Bank holding Annual Production Annual Recycling Annual Demand Annual Imports Annual Exports Indian Gold Market
y y

India (In Tons) 15000 558 3 250 700 600 60

World (In Tons) 160000 30,100 2450 1100 3550 -----

% Share 9 2 0 23 20 -----

y y

y y

India is the worlds largest consumer of gold. Indians normally buy about 25 per cent of the worlds gold, purchasing around 700 750 tonnes of gold every year. However, the sharp price increase in 2008 and 2009 has impacted demand with total demand in 2008 dipping to 660 tonnes. It is further expected to shrink in 2009 with demand in first three quarters of 2009 totaling only around 265 tonnes against 553.5 tonnes in the same period of the previous year. As Indias domestic primary production of gold is very less, at around 2-3 tonnes a year, the country imports most of its domestic requirement. Thus, India is also the largest importer of the yellow metal and has averaged imports of around 600 tonnes a year. However, 2008 imports dipped to around 400 tonnes of gold and it is further expected to dip to around 200-220 tonnes in 2009 owing to high prices. Indias gold demand is firmly embedded in cultural and religious traditions. It is also valued in India as a savings and investment vehicle and is the second preferred investment after bank deposits. Gold hoarding tendency is well engrained in the Indian society and unofficial stocks held by Indians is estimated to be well above 15,000 tonnes, which is around 9% of the total global gold stocks. Domestic consumption is dictated by monsoon, harvest and marriage season. Indian jewellery offtake is sensitive to price increases and even more so to volatility. In the cities gold is facing competition from the stock market and a wide range of consumer goods.
20

Facilities for refining, assaying, making them into standard bars, coins in India, as compared to the rest of the world, are insignificant, both qualitatively and quantitatively. In July 1997 the RBI authorized the commercial banks to import gold for sale or loan to one rs and exporters. At present, 13 banks are active in the import of gold. This reduced the disparity between international and domestic prices of gold from 57 percent during 1986 to 1991 to 8.5 percent in 2001.

Market Moving Factors

y

y y y y

Indian gold prices are highly correlated with international prices. However, the fluctuations in the INR-US Dollar impact domestic gold prices and have to be closely followed. The global prices are driven by a host of factors with macro-economic factors like strength of the economy, rising importance of emerging markets, currency movements, interest rates being major influencing factors. Supply-demand is a major influencer, amid rising global investor demand and almost stable supplies. Shifts in official gold reserves, reports of sales/purchases by central banks act as major price influencing factors, whenever such reports surface. The investment in gold is influenced by comparative returns from other markets like stock markets, real estate other commodities like crude oil. Domestically, demand and consequently prices to some extent are influenced by seasonal factors like marriages. The rural demand is influenced by monsoon, agricultural output and health of the rural economy.

Aluminium Characteristics Of Aluminium

y

Aluminium is the third most abundant element in the Earths crust. In nature however it only exists in very stable combinations with other materials (particularly as silicates and oxides) and it was not until 1808 that its existence was first established. Aluminum is light. Its density is only one third that of steel. Aluminum is resistant to weather, common atmospheric gases and a wide range of liquids. Aluminum has a high reflectivity, and therefore finds more decorative uses. Aluminum has high elasticity, which is an advantage in structures under shock loads. Aluminium keeps its toughness down to very low temperatures, without becoming brittle like carbon steels. It is easily worked and formed. Aluminium conducts electricity and heat nearly as well as copper.

Supply and Demand Global Scenario y Aluminium ore, most commonly bauxite, is plentiful and occurs mainly in tropical
21

and sub-tropical areas Africa, West Indies, South America and Australia. There are also some deposits in Europe y The leading producing countries include the United States, Russia, Canada, the European Union, China, Australia, Brazil, Norway, South Africa, Venezuela, the Gulf States (Bahrain and United Arab Emirates), India and New Zealand; together they represent more than 90 percent of the world primary aluminium production. y The largest aluminium markets are North America, Europe and East Asia. y The global production of aluminium is about 27.7 and 28.9 million tons in 2003 and 2004 respectively. y China, Russia, Canada and United States produced about 6.1, 3.6, 2.64 and 2.5 million tons of aluminium in year 2004 respectively. Indian Scenario y India is considered the fifth largest producer of aluminium in the world. y It is estimated at about 3037 million one for all categories of bauxite (proved, probable and possible). With the present level of consumption of aluminum, the identified reserves would have an estimated life of over 350 years. Indias reserves are estimated to be 7.5 per cent of the total deposits and installed capacity is about 3 per cent of the world. y In terms of demand and supply, the situation is not only self-sufficient, but it also has export potential on a competitive basis. Indias annual export of aluminium is about 82,000 tonnes. y Indias annual consumption of Aluminum is around 6.18 lakh tons and is projected to increase to 7.8 lakh tones by 2007. y About a decade back, the primary Indian aluminium producers were BALCO, NALCO, INDAL, HINDALCO and MALCO. Of the five, two (BALCO and NALCO) were in the public sector while the other three were in the private sector y As a result of the process of liberalization of trade in aluminium, India has emerged as a net exporter of aluminium, on competitive terms. Government monopoly, in terms of aluminium production, removal of price and distribution control over aluminium, has been diluted in favor of private sector. The ownership pattern in private sector has undergone changes. With the takeover of INDAL by the HINDALCO, it has emerged as the major producer of aluminium in the country. Cotton M Staple General Characteristics y Cotton is the most important of all natural fibers, it accounts for half of all the world fibers used by the textile industry. Known also as White Gold Cotton enjoys a predominant position amonst all cash crops in India. y Kapas (also known as raw cotton or seed cotton) is unginned cotton or a white fibrous substance (lint) covering the seed that is obtained from the cotton plant (Genus Gossypium). rd y Ginning is a process, which separates the lint (about 1/3 in weight) from the seed rd (about 2/3 in weight). Lint, which is commonly known as rui in Hindi. Lint is
22

pressed and bound in a bale form. Each bale weighs around 165-170 kg each. Bale cotton is the raw material for making cotton yarn or thread, which is further woven to make fabrics. Global Scenario y The world cotton area and production are estimated at around 30-31 million hectares and 20 million tons respectively. y The biggest cultivators of cotton are America, India, China, Egypt, Pakistan, Sudan and Eastern Europe, with China, US and India being the three largest producers of cotton. y US has a considerable share in world exports. India and China both fall short of their domestic requirement and are net importers. y Among the consumers China leads the way being followed by India, Pakistan, US and Turkey. World Cotton Supply And Distribution World Cotton Production and Consumption Year Beginning August 1 2005-06 2006-07 Production 24.97 26.74 Consumption 24.91 26.64 Exports 9.76 8.12 Ending Stocks 12.70 12.70 Cotlook A Index 56.15 59.15

2007-08 26.17 26.13 8.36 12.35 72.90

Million Bales 2008-09 2009-10 23.5 23.5 23.0 23.4 6.2 6.5 12.9 12.9 60 56

Indian Scenario y The northern region of India is the primary producer of short and medium staple cotton, while the southern states primarily grow long staples. The central region grows long and medium staples. y India with an annual production of 30 million bales (1 bale=170 kg) is the Worlds second largest cotton producer. India also has the largest area under cotton. India produces around 20% of the worlds cotton from 25% of the area. y Despite having the largest area under cotton in the world, India ranks third in world output of cotton due to its abysmally low average yield of 550 kg against a world average of 787 kg per hectare. y Although cotton is cultivated in almost all the states in the country, the 9 states of Maharashtra, Gujarat, Andhra Pradesh, Madhya Pradesh, Punjab, Haryana, Rajasthan, Tamil Nadu and Karnataka account for more than 95% of the area under and output. y In India cotton is sown during March to September and harvested during September to April. The peak marketing season for the crop is during November to March. Indian textile and apparel industry is one of the largest in the world with US$ 19 billion of export and US$ 30 billion of domestic textile and apparel during 2006-07 (P). It accounts for nearly 14% of the total national industrial production, 4% of the GDP contribution. It provides direct employment to about 35 million
23

people and another 56 million are engaged in allied activities. Cotton is the most important raw material for textile industry. Cotton accounts for more than 75% of the total fibre that is converted into yarn by the spinning mills in India and 58% of the total textile fabric materials produced in the country.

Crude Oil General Characteristics y Crude oil is a mixture of hydrocarbons that exists in a liquid phase in natural underground reservoirs. Oil and gas account for about 60 per cent of the total worlds primary energy consumption. y Almost all industries including agriculture are dependent on oil in one way or other. Oil & lubricants, transportation, petrochemicals, pesticides and insecticides, paints, perfumes, etc. are largely and directly affected by the oil prices. y Aviation gasoline, motor gasoline, naphtha, kerosene, jet fuel, distillate fuel oil, residual fuel oil, liquefied petroleum gas, lubricants, paraffin wax, petroleum coke, asphalt and other products are obtained from the processing of crude and other hydrocarbon compounds. y The prices of crude are highly volatile. High oil prices lead to inflation that in turn increases input costs; reduces non-oil demand and lower investment in net oil importing countries. Categories of Crude oil
y

y y

West Texas Intermediate (WTI) crude oil is of very high quality. Its API gravity is 39.6 degrees (making it a light crude oil), and it contains only about 0.24 percent of sulphur (making a sweet crude oil). WTI is generally priced at about a $2-4 per-barrel premium to OPEC Basket price and about $1-2 per barrel premium to Brent, although on a daily basis the pricing relationships between these can very greatly. Brent Crude Oil stands as a benchmark for Europe. India is very much reliant on oil from the Middle East (High Sulphur). The OPEC has identified China & India as their main buyers of oil in Asia for several years to come.

Crude Oil Units (average gravity)

y y y y y

1 US barrel = 42 US gallons. 1 US barrel = 158.98 litres. 1 tonne = 7.33 barrels . 1 short ton = 6.65 barrels . Note: barrels per one vary from origin to origin.

Global Scenario
y

Oil accounts for 40 per cent of the worlds total energy demand.
24

y y y

The world consumes about 76 million bbl/day of oil. United States (20 million bbl/d), followed by China (5.6 million bbl/d) and Japan (5.4 million bbl/d) are the top oil consuming countries. Balance recoverable reserve was estimated at about 142.7 billion tones (in 2002), of which OPEC was 112 billion tones.

OPEC fact sheet OPEC stands for Organization of Petroleum Exporting Countries. It is an organization of eleven developing countries that are heavily dependent on oil revenues as their main source of income. The current Members are Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. y OPEC controls almost 40 percent of the worlds crude oil. y It accounts for about 75 per cent of the worlds proven oil reserves. y Its exports represent 55 per cent of the oil traded internationally. Indian Scenario
y y

y y y y y y

India ranks among the top 10 largest oil-consuming countries. Oil accounts for about 30 per cent of Indias total energy consumption. The countrys total oil consumption is about 2.2 million barrels per day. India imports about 70 per cent of its total oil consumption and it makes no exports. India faces a large supply deficit, as domestic oil production is unlikely to keep pace with demand. Indias rough production was only 0.8 million barrels per day. The oil reserves of the country (about 5.4 billion barrels) are located primarily in Mumbai High, Upper Assam, Cambay, Krishna-Godavari and Cauvery basins. Balance recoverable reserve was about 733 million tones (in 2003) of which offshore was 394 million tones and on shore was 339 million tones. India had a total of 2.1 million barrels per day in refining capacity. Government has permitted foreign participation in oil exploration, an activity restricted earlier to state owned entities. Indian government in 2002 officially ended the Administered Pricing Mechanism (APM). Now crude price is having a high correlation with the international market price. As on date, even the prices of crude bi-products are allowed to vary +/- 10% keeping in line with international crude price, subject to certain government laid down norms/ formulae. Disinvestment/restructuring of public sector units and complete deregulation of Indian retail petroleum products sector is under way.

Prevailing Duties & Levies on Crude Oil Particulars Basic Customs Duty Cess
25

Rates 10% Rs.1800 per metric tonne

NCCD* Education cess Octroi War fedge Market Influencing Factors

y y y y y y

Rs.50 per metric tonne 2% 3% Rs.57 per metric tonne

OPEC output and supply. Terrorism, Weather/storms, War and any other unforeseen geopolitical factors that causes supply disruptions. Global demand particularly from emerging nations. Dollar fluctuations. DOE / API imports and stocks. Refinery fires & funds buying.

Copper Characteristics Of Copper

y y

Copper ranks third in world metal consumption after steel and aluminum. It is a product whose fortunes directly reflect the state of the worlds economy. Copper is the best non-precious metal conductor of electricity. The metals exceptional strength, ductility, and resistance to creeping and corrosion, makes it the preferred and safest conductor for building wiring. Copper is also used in power cables, either insulated or un insulated, for high, medium and low voltage applications. Copper is an essential component of energy efficient motors and transformers and automobiles.

Supply and Demand Global Scenario y Economic, technological and societal factors influence the supply and demand of copper. As societys need for copper increases, new mines and plants are introduced and existing ones expanded. y Land-based resources are estimated at 1.6 billion tons of copper, and resources in deep-sea nodules are estimated at 0.7 billion tons. y The global production of refined copper is around 15 million tons. y The major copper-consuming nations are Western Europe (28.5%), the United States (19.1%), Japan (14%), and China (5.3%). y Copper and copper alloy scrap composes a significant share of the worlds supply. y The largest international sources for scrap are the United States and Europe. Chile, Indonesia, Canada and Australia are the major exporters and Japan, Spain, China, Germany and Philippines are the major importers. Indian Scenario y The size of Indian Copper Industry is around 4 lakh tons, which as percentage of world copper market is 3 %.
26

y y y

Birla Copper, Sterilite Industries are two major private producers and Hindustan Copper Ltd the public sector producers. India is emerging as net exporter of copper from the status of net importer on account of rise in production by three companies. Copper goes into various usages such as Building, Cabling for power and telecommunications, Automobiles etc. Two major states owned telecommunications service providers; BSNL and MTNL consume 10% of countrys copper production. Growth in the building construction and automobile sector would keep demand of copper high.

Silver General Characteristics y Silvers unique properties make it a very useful Industrial Commodity, despite it being classed as a precious metal. y Demand for silver is built on three main pillars; industrial uses, photography and Jewellery & silverware accounting for 342, 205 and 259 million ounces respectively in 2002. y Just over half of mined silver comes from Mexico, Peru and United States, respectively, the first, second and fourth largest producing countries. The third largest is Australia. y Primary mines produce about 27 percent of world silver, while around 73 percent comes as a by-product of gold, copper, lead, and zinc mining. y The price of silver is not only a function of its primary output but more a function of the price of other metals also, as world mine production is more a function of the prices of other metals. y The tie between silver and economic activity is strong, given that around twothirds of total silver fabrication is in the industrial and photographic sectors. y Often a faster growth in demand against supply leads to drop in stocks with government and investors. y Economically viable primary silver mine is a function of the world silver price level. World Silver Supply from Above-ground Stocks Million Ounces 2001 Implied Net Disinvestment -9.5 Producer Hedging 18.9 Net Government Sales 87.2 Sub-total Bullion 96.6 Scrap 182.7 Total 279.3 Indian Scenario
y

2002 20.9 -24.8 71.3 67.4 184.9 252.3

Silver imports into India for domestic consumption in 2002 was 3,400 tons down
27

y y y

25 % from record 4,540 tons in 2001. Open General License (OGL) imports are the only significant source of supply to the Indian market. Non-duty paid silver for the export sector rose sharply in 2002, up by close to 200% year-on-year to 150 tons. Around 50% of Indias silver requirements last year were met through imports of Chinese silver and other important sources of supply being UK, CIS, Australia and Dubai. Indian industrial demand in 2002 is estimated at 1375 tons down by 13 % from 1,579 tons in 2001. In spite of this fall, India is still one of the largest users of silver in the world, ranking alongside Industrial giants like Japan and the United States. By contrast with United States and Japan, Indian industrial off take for fabrication in hardcore industrial applications like electronics and brazing alloys accounts for only 15 % and the rest being for foils for use in the decorative covering of food, plating of Jewellery and silverware and jari. In India silver price volatility is also an important determinant of silver demand as it is for gold.

28

Commodity Derivatives Market in India: Development, Regulation and Future Prospects

Organized commodity derivatives in India started as early as 1875, barely about a decade after they started in Chicago. However, many feared that derivatives fuelled unnecessary speculation and were detrimental to the healthy functioning of the markets for the underlying commodities. As a result, after independence, commodity options trading and cash settlement of commodity futures were banned in 1952. A further blow came in 1960s when, following several years of severe draughts that forced many farmers to default on forward contracts (and even caused some suicides), forward trading was banned in many commodities considered primary or essential. Consequently, the commodities derivative markets dismantled and remained dormant for about four decades until the new millennium when the Government, in a complete change in policy, started actively encouraging the commodity derivatives market. Since 2002, the commodities futures market in India has experienced an unprecedented boom in terms of the number of modern exchanges, number of commodities allowed for derivatives trading as well as the value of futures trading in commodities, which might cross the $ 1 Trillion mark in 2006. However, there are several impediments to be overcome and issues to be decided for sustainable development of the market. After Independence, the Parliament passed Forward Contracts (Regulation) Act, 1952 which regulated forward contracts in commodities all over India. The Act applies to goods, which are defined as any movable property other than security, currency and actionable claims. The Act prohibited options trading in goods along with cash settlements of forward trades, rendering a crushing blow to the commodity derivatives market. Under the Act, only those associations/exchanges, which are granted recognition by the Government, are allowed to organize forward trading in regulated commodities. The Act envisages three-tier regulation: (i) The Exchange which organizes forward trading in commodities can regulate trading on a day-to-day basis; (ii) the Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government, and (iii) the Central Government Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution is the ultimate regulatory authority. The already shaken commodity derivatives market got a crushing blow when in 1960s, following several years of severe draughts that forced many farmers to default on forward contracts (and even caused some suicides), forward trading was banned in many commodities considered primary or essential. As a result, commodities derivative markets dismantled and went underground where to some extent they continued as OTC contracts at negligible volumes. Much later, in 1970s and 1980s the Government relaxed forward trading rules for some commodities, but the market could never regain the lost volumes. Change in Government Policy After the Indian economy embarked upon the process of liberalization and globalization in 1990, the Government set up a Committee in 1993 to examine the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodity groups. It also recommended strengthening of the Forward Markets Commission, and certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing options trading in goods and registration of brokers with Forward Markets Commission. The
29

Government accepted most of these recommendations and futures trading were permitted in all recommended commodities. Commodity futures trading in India remained in a state of hibernation for nearly four decades, mainly due to doubts about the benefits of derivatives. Finally a realization that derivatives do perform a role in risk management led the government to change its stance. The policy changes favoring commodity derivatives were also facilitated by the enhanced role assigned to free market forces under the new liberalization policy of the Government. Unresolved Issues and Future Prospects Even though the commodity derivatives market has made good progress in the last few years, the real issues facing the future of the market have not been resolved. Agreed, the number of commodities allowed for derivative trading have increased, the volume and the value of business has zoomed, but the objectives of setting up commodity derivative exchanges may not be achieved and the growth rates witnessed may not be sustainable unless these real issues are sorted out as soon as possible. Some of the main unresolved issues are discussed below. Commodity Options Trading in commodity options contracts has been banned since 1952. The market for commodity derivatives cannot be called complete without the presence of this important derivative. Both futures and options are necessary for the healthy growth of the market. While futures contracts help a participant (say a farmer) to hedge against downside price movements, it does not allow him to reap the benefits of an increase in prices. No doubt there is an immediate need to bring about the necessary legal and regulatory changes to introduce commodity options trading in the country. The matter is said to be under the active consideration of the Government and the options trading may be introduced in the near future. The Warehousing and Standardization For commodity derivatives market to work efficiently, it is necessary to have a sophisticated, cost-effective, reliable and convenient warehousing system in the country. The Habibullah (2003) task force admitted, A sophisticated warehousing industry has yet to come about. Further, independent labs or quality testing centers should be set up in each region to certify the quality, grade and quantity of commodities so that they are appropriately standardized and there are no shocks waiting for the ultimate buyer who takes the physical delivery. Warehouses also need to be conveniently located. Central Warehousing Corporation of India (CWC: www.fieo.com) is operating 500 Warehouses across the country with a storage capacity of 10.4 million tones. This is obviously not adequate for a vast country. To resolve the problem, a Gramin Bhandaran Yojana (Rural Warehousing Plan) has been introduced to construct new and expand the existing rural godowns. Large scale privatization of state warehouses is also being examined. Cash versus Physical Settlement It is probably due to the inefficiencies in the present warehousing system that only about 1% to 5% of the total commodity derivatives trades in the country are settled in physical delivery. Therefore the warehousing problem obviously has to be handled on a war footing, as a good delivery system is the backbone of any commodity trade. A particularly difficult problem in cash settlement of commodity derivative contracts is that at present, under the Forward
30

Contracts (Regulation) Act 1952, cash settlement of outstanding contracts at maturity is not allowed. In other words, all outstanding contracts at maturity should be settled in physical delivery. To avoid this, participants square off their positions before maturity. So, in practice, most contracts are settled in cash but before maturity. There is a need to modify the law to bring it closer to the widespread practice and save the participants from unnecessary hassles. The Regulator As the market activity pick-up and the volumes rise, the market will definitely need a strong and independent regular; similar to the Securities and Exchange Board of India (SEBI) that regulates the securities markets. Unlike SEBI which is an independent body, the Forwards Markets Commission (FMC) is under the Department of Consumer Affairs (Ministry of Consumer Affairs, Food and Public Distribution) and depends on it for funds. It is imperative that the Government should grant more powers to the FMC to ensure an orderly development of the commodity markets. The SEBI and FMC also need to work closely with each other due to the inter-relationship between the two markets. Lack of Economy of Scale There are too many (3 national level and 21 regional) commodity exchanges. Though over 80 commodities are allowed for derivatives trading, in practice derivatives are popular for only a few commodities. Again, most of the trade takes place only on a few exchanges. All this splits volumes and makes some exchanges unviable. This problem can possibly be addressed by consolidating some exchanges. Also, the question of convergence of securities and commodities derivatives markets has been debated for a long time now. The Government of India has announced its intention to integrate the two markets. It is felt that convergence of these derivative markets would bring in economies of scale and scope without having to duplicate the efforts, thereby giving a boost to the growth of commodity derivatives market. It would also help in resolving some of the issues concerning regulation of the derivative markets. However, this would necessitate complete coordination among various regulating authorities such as Reserve Bank of India, Forward Markets commission, the Securities and Exchange Board of India, and the Department of Company affairs etc. Tax and Legal bottlenecks There are at present restrictions on the movement of certain goods from one state to another. These need to be removed so that a truly national market could develop for commodities and derivatives. Also, regulatory changes are required to bring about uniformity in octroi and sales taxes etc. VAT has been introduced in the country in 2005, but has not yet been uniformly implemented by all states. Recent Inflationary Trends in World Commodities Markets World economy featured recently robust real economic growth, averaging about 4.5-5.5 percent per year during 200307. However, inflationary pressures re-emerged. Commodities markets experienced highest inflation rates in post-war period with all commodities price index increasing at 23 percent per year during 200307.2 Crude oil prices hit US$119/barrel in April 2008 and might accelerate to dramatic levels. Parallel to commodities markets, real estate markets experienced phenomenal speculative price increases. In the same vein, the exchange
31

rate of the U.S. dollar has depreciated considerably during 200208, plummeting to US$1.6 per Euro in April 2008, and might fall further. Financial markets face high uncertainty stemming from rising inflationary expectations, credit risks, and depreciating currencies. Moreover, many vulnerable countries were recently shaken by food riots and may face alarming food crisis arising from exorbitant food prices. The strong economic growth and accompanying inflationary trends were brought about by overly expansionary monetary policies in leading industrial countries, particularly during 200204, with central banks forcing interest rates to record low, and in some instances, nearing the zero bound. Credit to economy has expanded at fast pace in many countries, including major industrial countries, at the expense of creditworthiness and credit quality, contributing to rapid increase in aggregate demand for real assets, goods and services. Credit expansion contributed to high speculation in many assets and commodities markets. While there is no bound to expanding demand for goods and services through credit expansion and unlimited money creation, supply of these goods is, however, constrained by fixed factors, such as cultivable land or existing plants, climatic conditions, availability of oil and other raw materials, entrepreneurship, and may not follow the expansion of demand; excess demand results in high pressure on prices. Most striking, consumer price indices (CPIs) in many industrial countries, a leading indicator for the conduct of monetary policy, were not sensitive to high increases in commodities or housing prices. In spite of fast rise in housing, energy, and food prices, CPIs continued to show small increase, by about 23 percent in industrial countries during 200307, indicating puzzling price stability and almost no inflation. Such was not the case during the seventies, when CPIs were highly sensitive to oil shocks and rapid increase in energy prices. Insensitivity of CPIs to commodities prices and to low nominal interest rates may lead policymakers to downplay the risk of inflation while there is ongoing abnormally high asset and commodities price inflation. With monetary policy remaining accommodative and real interest rates being eroded by inflation, commodities price inflationary trends might not subside. Acceleration of inflation rates will certainly slowdown economic growth, and will aggravate financial instability by eroding rapidly real value of financial assets, and deteriorating the quality of loans. The financial crisis in the subprime market could be easily traced to lax monetary policy and could have serious financial and economic implications. Similar financial crisis can be easily predicted in future as a consequence of overly expansionary monetary policy. Accelerating inflation may disrupt commodities supplies, and, as seen recently, may cause widespread food riots. To bring inflationary trends under control, central banks will have to strictly reduce money supply as strongly prescribed by Friedman and proponents of the quantity theory of money.3 Such policy will imply significant temporary increase in interest rates and will necessarily cause recession and major debt crisis, owing to monumental outstanding loans accumulated during monetary expansion and low creditworthiness, as reflected recently by the subprime market; its merit, however, would be to extricate inflationary dynamics. Monetary authorities will face political conflicts stemming from debtors pressure to keep inflating the economy in order to increase their wealth and lower their debt burden, and public pressure to rein inflation, considered as public enemy number one, and avoid its severe economic and financial dislocation.4 Commodities prices, along other asset prices, such us exchange rates, are instantly and accurately observed. Their evolution, along other indicators, should be fully
32

taken into account for sound policy making and stable world economy growth. Neglecting information from commodities prices may lead to maintaining unsustainable monetary policies

33

CHAPTER -3 RESEARCH METHODOLOGY

Exploratory research design is used to determine the effect of the recession on commodity price movement as well as on commodity market. One of the most important users of research methodology is that it helps in identifying the problem, collecting, analyzing the required information data and providing an alternative solution to the problem. Data Collection Data used in the study is secondary data. The secondary data has been collected through various journals, magazines, news papers and websites. Important sites of data collection are MCX website, SEBI website, NCDEX website, Zen money website, Money control, London commodity market, Index mundi website and many more. Data is divided into three parts  Pre recession period data from December 2006 to November 2007.  Recession period data from December 2007 to February 2009.  Post recession period data from March 2009 to November 2009. Four commodities are used for study purpose:  Gold  Crude oil  Aluminium  Copper Three sets of data have been collected  Commodity price movement in that period  Traded value of commodity in MCX.  Traded volume of commodity in MCX. Analysis Microsoft excel is used for the trend analysis purpose. The study is done with the help of line graphs. Limitations of the study  Data for only a short period is taken that is for three years.  Research is based only on secondary data.

34

CHAPTER 4
DATA ANALYSIS AND INTERPRETATION

35

DATA ANALYSIS AND INTERPRETATION

Crude oil Crude oil price movement Crude Oil (petroleum) Monthly Price Commodity Prices Month Value Dec-06 61 Jan-07 53.4 Feb-07 57.58 Mar-07 60.6 Apr-07 65.1 May-07 65.1 Jun-07 68.19 Jul-07 73.67 Aug-07 70.13 Sep-07 76.91 Oct-07 82.15 Nov-07 91.27 Dec-07 89.43 Jan-08 90.82 Feb-08 93.75 Mar-08 101.84 Apr-08 109.05 May-08 122.77 Jun-08 131.52 Jul-08 132.55 Aug-08 114.57 Sep-08 99.29 Oct-08 72.69 Nov-08 54.04 Dec-08 41.53 Jan-09 43.91 Feb-09 41.76 Mar-09 46.95 Apr-09 50.28 May-09 58.1 Jun-09 69.13 Jul-09 64.65 Aug-09 71.63 Sep-09 68.38 Oct-09 74.08 Nov-09 77.56
36

Interpretation From the graph it is clear that, crude oil price increased during recession period. In post recession period it decreased and then attained nearly a less fluctuating level in the last half of year 2009. Crude oil traded value
Month Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 37 Value (Rs. In Lakhs) 1640493 2529212 2730830 3325370 2538790 2444850 2791854 3512485 4071387 3176323 4684781 5154108 5153277 4671822 4468045 5275426 5446577 9230304

Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

11287931 10822279 7502892 8953859 6138823 5377675 6771616 7938402 6849426 10782771 9238346 9712547 11477869 12887544 11608057 9671082 10850630 10801599

Interpretation Crude oil traded value in the market in last three years was continuously fluctuating. But during recession period it was severely affected. During the period Jun 2008 to February, 2009, it decreased continuously.

38

Crude oil traded volume

Crude oil traded volume Month Quantity(In 000 s BBL) Dec-06 58661.2 Jan-07 103373.2 Feb-07 104077.5 Mar-07 122016.9 Apr-07 92202.3 May-07 93311.2 Jun-07 101415.9 Jul-07 117592.4 Aug-07 137808.4 Sep-07 100389.4 Oct-07 139231.8 Nov-07 138833.5 Dec-07 143628.8 Jan-08 127284 Feb-08 118887.7 Mar-08 125174.1 Apr-08 121697.6 May-08 174580.3 Jun-08 196809.1 Jul-08 187748.5 Aug-08 148558.5 Sep-08 190092.5 Oct-08 159833.4 Nov-08 188318.7 Dec-08 311715.7 Jan-09 377430.1 Feb-09 343419.8 Mar-09 437969.2 Apr-09 365069.2 May-09 338925.8 Jun-09 343075.7 Jul-09 412233 Aug-09 336427.6 Sep-09 286796.1 Oct-09 306588.3 Nov-09 296807.3

39

Interpretation Crude oil traded volume was not affected by recession. It grow slowly but constantly during recession period also. Gold price movement
months Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 gold price per ounce 629.79
631.17 664.75 654.9 679.37 666.86 655.49 665.3 665.41 712.65 754.6 806.25 803.2

889.6 922.3 968.43 909.7 888.66 889.49 939.77 839.02 40

Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

829.93 806.62 760.86 816.09 858.69 943.16 924.2 890.66 928.64 945.67 934.23 949.38 996.59 1043.16 1127.04

Interpretation Gold prices had not been affected by the recession. Even in recession period also they were continuously increasing. Gold traded value
Gold traded value Value (Rs. In Lakhs) 4680552 5460044 6032850 6659343 41

Month Dec-06 Jan-07 Feb-07 Mar-07

Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

4253189 5192200 4532595 4660228 4095761 5633572 8034309 10026539 7397031 15979120 13659712 13303710 9783637 10057080 12407210 18939267 15149049 19956929 15051936 12313028 14873513 18612360 20429157 24137358 13914323 13139779 12430826 10072292 8105615 12607367 12519294 17474644

42

Interpretation There was a huge fluctuation in the gold traded value in last three years. Fluctuation is more in recession period in comparison to pre and post recession period. Gold traded volume
Gold traded volume Month Quantity(In 000 s gms) Dec-06 505630 Jan-07 600618 Feb-07 629094 Mar-07 708177 Apr-07 450454 May-07 581860 Jun-07 515264 Jul-07 531775 Aug-07 461872 Sep-07 603153 Oct-07 828364 Nov-07 975945 Dec-07 718315 Jan-08 1418670 Feb-08 1160081 Mar-08 1059692 Apr-08 829869 May-08 829999 Jun-08 1004607 Jul-08 1452622 Aug-08 1283255 Sep-08 1626039 43

Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

1181828 1018935 1158620 1381281 1369977 1582115 962913 903509 849566 685993 543199 803479 789597 1021794

Interpretation Gold trade volume also shows severe fluctuation in the recession period. These fluctuations are very high in comparison to pre and post recession era.

Copper price movement

Copper, grade A cathode Monthly Price Commodity Prices Month Value Dec-06 6,680.97 Jan-07 5,689.34 Feb-07 5,718.15 Mar-07 6,465.30 Apr-07 7,753.34 44

May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

7,677.95 7,514.24 7,980.93 7,500.21 7,671.35 8,020.59 6,957.43 6,630.74 7,078.91 7,941.14 8,434.32 8,714.18 8,356.13 8,292.00 8,407.02 7,633.80 6,975.11 4,894.89 3,729.19 3,105.10 3,260.36 3,328.41 3,770.88 4,436.93 4,594.90 5,013.30 5,240.83 6,176.88 6,195.75 6,305.99 6,682.44

45

Interpretation Copper prices increased during recession period. After that they decreased in post recession period. Copper traded value
copper traded value Month Value (Rs. In Lakhs) Dec-06 1941185 Jan-07 3109797 Feb-07 3145449 Mar-07 3682018 Apr-07 5188834 May-07 5253177 Jun-07 4903242 Jul-07 3906874 Aug-07 4457746 Sep-07 3075008 Oct-07 3207587 Nov-07 3175309 Dec-07 2433187 Jan-08 3576213 Feb-08 4312335 Mar-08 3387137 Apr-08 3551767 May-08 3098724 Jun-08 2682308 Jul-08 3236470 46

Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

2988560 3291336 4018916 3495672 2388656 3479377 3106712 4247624 6053345 6042842 7611567 7502574 9371734 7741091 6855829 6687494

Interpretation Copper traded value decreased during recession period. February 2008 to august 2008, shows heavy decline in traded value of copper. Copper traded value
COPPER TRADED VOLUME Month Quantity(In 000 s Kgms) Dec-06 636579 Jan-07 1205754 Feb-07 1223224 Mar-07 1280007 47

Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

1577270 1672952 1607857 1225331 1480144 1007536 1023183 1159320 912928 1276483 1378689 1007753 1032376 896748 769001 914542 920891 1044217 1694342 1847627 1495127 2141842 1877051 2175657 2692519 2672464 3148890 2940752 3130380 2549646 2293803 2138686

48

Interpretation Traded volume of the copper in commodity market also declined in recession period. It again increased in the second half of the year 2009, which is in post recession period. Aluminium price movement
Aluminum Monthly Price Commodity Prices Month Value Dec-06 2,823.67 Jan-07 2,799.06 Feb-07 2,839.05 Mar-07 2,757.08 Apr-07 2,817.05 May-07 2,804.61 Jun-07 2,681.31 Jul-07 2,738.09 Aug-07 2,512.60 Sep-07 2,394.96 Oct-07 2,444.53 Nov-07 2,507.15 Dec-07 2,382.83 Jan-08 2,456.13 Feb-08 2,784.89 Mar-08 3,012.05 Apr-08 2,968.03 May-08 2,908.28 Jun-08 2,967.87 Jul-08 3,067.46 Aug-08 2,762.56 Sep-08 2,524.15 49

Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

2,122.03 1,857.13 1,504.42 1,420.36 1,338.06 1,338.08 1,431.81 1,464.42 1,586.34 1,674.33 1,927.64 1,835.60 1,875.66 1,956.55

Interpretation The effect of recession on aluminium price movement is not very much clear. The price increased in the beginning of the recession that is from December 2007 to August 2008. After that price declined, even in recession period also. Aluminum Traded value
Aluminium traded value Month Value (Rs. In Lakhs) Dec-06 40687.59 Jan-07 61318.54 Feb-07 76538 Mar-07 182755.6 Apr-07 66965.74 50

May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

76146.14 54846.54 33742.67 29986.36 43924.31 41902.21 28000.55 10941.87 46541.1 70600.64 84508.58 25307.66 42332.84 34271.16 105884.1 41504.24 38458.57 26694.17 26175.94 45653.98 45683.56 30122.09 43722.28 70063.12 71753.49 263663 276706.8 592556.5 322638.7 295053.1 207078.8

51

Interpretation In pre recession and recession period, the trading value of the Aluminium is very low. But it increased extensively in post recession period. The effect of recession on Aluminium traded value is not so much clear. Aluminum traded volume
Aluminum traded volume Month Quantity(In 000 s Kgms) Dec-06 32228 Jan-07 49776 Feb-07 61974 Mar-07 148422 Apr-07 54888 May-07 65136 Jun-07 49336 Jul-07 30196 Aug-07 28780 Sep-07 44632 Oct-07 42510 Nov-07 27848 Dec-07 11492 Jan-08 47098 Feb-08 61985 Mar-08 68530 Apr-08 21215 May-08 33985 Jun-08 26420 Jul-08 79075 Aug-08 34500 52

Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

33120 25885 28415 62525 65395 45240 62550 96440 102195 346205 331330 631405 359045 332425 225440

Interpretation In case of traded volume also, the effect of recession is not so much clear. Traded volume was low in recession and pre recession period. But in post recession period it increased extensively.

53

CHAPTER 5
FINDINGS AND CONCLUSION

54

FINDINGS  Gold prices are continuously increasing. There was no effect of recession on the gold prices. The increase in gold price is natural. There is no deviation in gold price movement in recession period when we compared with pre recession or post recession period. The same aspect is also true for the traded value and volume of the gold in commodity market also. Hence gold trading was not affected by recession. People had high demand of gold even in recession period also.  Aluminium did not so any significant aspect about the effect of recession on price of the aluminium or on trading volume of the aluminium. They were low in case of the pre recession and post recession period. But recession became a path of high demand of aluminium, as after recession demand of aluminium increased. This may be due to increase in restructuring and rebuilding activities after recession.  Copper price increased during recession. But the traded value and volume both had been adversely affected by recession. It shows that due to rise in price of copper during recession the demand of the copper decreased during recession.  Crude oil prices, trading volume and trading value all increased during recession. But there was a huge fluctuation. It shows that recession did not decrease demand of crude oil although there were fluctuations in the crude oil market. CONCLUSION Recession had not so much effect on commodity market. In case of essential commodities like oil, the recession was least influencing. Bullions trading were also not affected by recession due to its traditional demand in India. Other commodities felt the heat of recession on price and trading both. The trading volume and value decreased during this period. It indicates that the demand of commodities decreased. Overall we can say that recession had mixed effect on Indian commodity market. Some commodities were severely but some other commodities were not affected at all. The effects of recession on commodity market vary from commodity to commodity.

55

Bibliography  Recession, its cause and effects, article base, December 11, 2008.  Commodities: opportunities during recession, www.seeking alpha.com ,may 4, 2009.  IMF International Financial Statistics.  Global: Impact of Financial Crisis on GCC Oil & Gas Projects, November 28, 2008.  Copper meltdown, Vol. 4 Issue 4, p19-19, Shilling, A. Gary.  Commodity Crash: How US recession will affect the commodities super cycle, Today financial news, January 26, 2008.  Encash the opputunity during recession in commodity, Vandana Bharti, Delhi, April 28, 2009  www.investopedia.com  www.mcxindia.com  www.ncdex.com  www.zenmoney.com  www.indexmondi.com

56