A PROJECT ON:

“COMMODITY MARKET”

B.COM IN FINANCIAL MARKET.

SEMESTER – V

ACADEMIC YEAR: 2010-2011

SUBMITTED BY:

NITIN.S.KANDLAPALLI

ROLL NO: 22

G.N.KHALSA OF ARTS, SCIENCE & COMMERCE,

MATUNGA (E), MUMBAI- 400019

Commodity Market

A PROJECT ON:

“COMMODITY MARKET”

B.COM IN FINANCIAL MARKET.

SEMESTER – V

ACADEMIC YEAR: 2010-2011

SUBMITTED BY:

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF

DEGREE OF BACHELOR OF COMMERCE- FINANCIAL MARKET

NITIN.S.KANDLAPALLI

ROLL NO: 22

G.N.KHALSA OF ARTS, SCIENCE & COMMERCE,

MATUNGA (E), MUMBAI- 400019

2 | P a g e

Commodity Market

G.N.KHALSA OF ARTS, SCIENCE & COMMERCE,

MATUNGA (E), MUMBAI- 400019

CERTIFICATE

This is to certify that Mr. NITIN.S.KANDLAPALLI of B.Com (BFM) Semester V

(2010-2011) has successfully completed the project on COMMODITY MARKET

under the guidance of PROF. MANJIRI DATE.

COURSE CO-ORDINATOR:

INTERNAL EXAMINER

EXTERNAL EXAMINER

Principal

3 | P a g e

Commodity Market

DECLARATION

I MR. NITIN.S.KANDLAPALLI student of B.Com (BFM) Semester V (2010-2011)

hereby declare that I have completed the project on COMMODITY MARKET.

The information submitted is true & original to the best of my knowledge.

Signature of Student

NITIN.S.KANDLAPALLI

Roll No: 22

4 | P a g e

Commodity Market

Acknowledgement

I owe a great many thanks to a great many people who helped & supported me

doing the writing of this book.

My deepest thanks to lecturer, prof. Manjiri date guide of the project for

guiding & correcting various documents of mine with attention & care. She/he has

taken pains to go through my project & make necessary corrections as & when

needed.

I extend my thanks to the principal of, G.N.khalsa College of Arts, Science &

Commerce, Matunga (E), for extending her support.

My deep sense of gratitude to Principal dr.ajit sihgh of G.N.khalsa College of

Arts, Science & Commerce for support & guidance. Thanks & appreciation to the

helpful people at G.N.khalsa College of Arts, Science & Commerce, for their support.

I would also thank my institution & faculty members without whom this project

would have been a distant reality. I also extend my heartfelt thanks to my family &

well wishers.

5 | P a g e

Commodity Market

EXECUTIVE SUMMARY

This project is based on commodity markets, their significance in the economy

& their contribution towards the GDP of the country. Commodity markets are now

the buzz word all the investors are looking at the commodity market as a revenue

generator.

In includes FMC i.e. Forward Market Commissions & the Government played

in the markets, the global commodity dynamics as all these influence the Indian

commodity Markets their repercussions are seen in the local bourses.

It also throws light on highly traded commodities their volumes, margins &

more importantly volatility. It contains analysis of 3 commodities, demand & supply

scenario etc.

The soul of the project is the commodity boosters the reasons who will drive

the commodity bourses ahead.

Hence this project has covered the recognized exchanges & their

organizational trading & the regulatory setup for future trading in commodities.

Finally it covers all important points on the bases of which a person can

understand the commodity market & start trading in them.

6 | P a g e

Commodity Market

RESEARCH METHODOLOGY

The method of data collection for my project is based on both primary as well as

secondary data collection. I have adopted the following methodology of study

throughout the project.

Various internet websites.

Opinion of experts.

Reference books.

Newspaper magazines.

Objectives

The objective of this study is to understand.

1. What is commodity market?

2. Need & scope of commodity market?

3. How it trade in stock market of India & other countries?

4. Present status of commodity market in India?

5. Future of commodity market?

7 | P a g e

Commodity Market

INDEX

Sr. No. Topic Page No

1 Commodity Market Basics 1-15

2 Leading Commodity Markets Of World 16

3 Regulator 17

4 Leading Commodity Markets Of India 18

5 Commodity Future Trading in India 19-21

6 What makes Commodity Trading Attractive? 22

7 Commodity Trading 23

8 Need for Commodity Derivatives for India 23

9 History Of Development of Commodity Markets 24-26

10 Relevance & Potential Of Commodity Markets in India 27-28

11 Commodity Market Ecosystem 29-30

12 India’s place in World Market 31

13 Working of Commodity Market 32-34

14 Trading of Commodity Market 35-38

15 Merits & Demerits of Commodity Market 38-39

16 Study of Single Commodity Gold 40-45

17 Questionnaire on Gold 46-49

17 Gold Terminology 50

18 MCX Contract Specifications of Gold 51-57

19 Regulatory Body 58-59

20 Role Of Government in Commodity Market 60

21 National Multi-Commodity Exchange Of India 61-63

22 Multi-Commodity Exchange Of India 64-65

23 National Commodity & Derivatives Exchange LTD. 66-71

24 Suggestions 72-73

25 Conclusion 74

26 Bibliography 75

INDIA COMMODITY MARKET

8 | P a g e

Commodity Market

“We are moving from a world in which the big eat the small to one in which the fast

eat the slow”

-Klaus Schwab, 2000

(Founder of the World Economic Forum)

“A strong & vibrant cash market is a pre-condition for a successful & transparent

futures market.”

INTRODUCTION

India, a commodity based economy where two-third of the one billion

population depends on agricultural commodities, surprisingly has an under

developed commodity market. Unlike the physical market, futures markets trades in

commodity are largely used as risk management mechanism on either physical

commodity itself or open positions in commodity stock.

For instance, a jeweler can hedge his inventory against perceived short term

downturn in gold prices by going short in future markets.

The article aims at understanding commodity market & how are the

commodities traded on exchange. The idea is to study the importance of commodity

derivatives & learn about the market from an Indian point of view. The development

& growth was shunted due to numerous restriction in the early 70’s which resulted in

vibrant market.

COMMODITY

A commodity may be defined as an article, a product or material that is bought

& sold. It can be classified as every kind of movable property, except actionable

claims, money & securities. Commodity actually offers immense potential to become

a separate asset class for market-savvy investors, arbitrageurs & 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

9 | P a g e

Commodity Market

fundamentals of demand & supply are concerned. Retail investors should understand

the risk & advantages of trading in commodities futures before taking a leap.

In fact, the size of the commodities market in India is also quite significant. Of

the country’s GDP of Rs 13, 20,730 crore (Rs 13, 20 billion), commodities related (&

dependent) industries constitute about 58%.

Currently, the various commodities across the country clock an annual

turnover of Rs 1, 40,000 crore (1,400 Billion). With the introduction of futures

trading, the size of the commodities market grows many folds here on.

COMMODITY MARKET

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.

Turnover in Financial Markets and Commodity Market (Rs in Crores)

S No. Market segments 2002-03 2003-04 2004-05 (E)

1 Government Securities Market 1,544,376 (63) 2,518,322 (91.2) 2,827,872 (91)2 Forex Market 658,035 (27) 2,318,531 (84) 3,867,936 (124.4)3 Total Stock Market Turnover

(I+ II)

1,374,405 (56) 3,745,507 (136) 4,160,702 (133.8)I National Stock Exchange (a+b) 1,057,854 (43) 3,230,002 (117) 3,641,672 (117.1)

a)Cash 617,989 1,099,534 1,147,027b)Derivatives 439,865 2,130,468 2,494,645

II Bombay Stock Exchange (a+b) 316,551 (13) 515,505 (18.7) 519,030 (16.7)a)Cash 314,073 503,053 499,503b)Derivatives 2,478 12,452 19,527

4 Commodities Market NA 130,215 (4.7) 500,000 (16.1) Note: Fig. in bracket represents percentage to GDP at market prices Source: Sebi bulletin

10 | P a g e

Commodity Market

11 | P a g e

Ministry ofConsumer Affairs

FMC (ForwardsMarket Commission)

CommodityExchange

National Exchange

NCDEX MCX NMCE

Regional Exchange

NBOT20 other regional

exchanges

Commodity Market

12 | P a g e

Commodities

EcosystemMCX

Quality Certifica

tion Agencies

Hedger(Exporters / Millers Industry)

Producers (Farmers/Co

- operatives/In

stitutional)Traders

(speculators)arbi

-trageurs/client)

Consumers

(Retail/Institutio

-nal)

Transporters/

support agencies

Clearing

Bank

Warehouses

Commodity Market

DIFFERENT TYPES OF COMMODITIES TRADED:

World-over one will find that a market exits for almost all the commodities

known to us . These commodit ies can be broadly classified into the following:

METAL Aluminium, Copper, Lead, Nickel, Sponge Iron,

Steel Long

BULLION Gold, Gold HNI, Gold M, i-gold, Silver, Silver HNI,

Silver MFIBER Cotton L Staple, Cotton M Staple, Cotton S Staple,

Cotton Yarn,ENERGY Brent Crude Oil, Crude Oil, Furnace Oil, Natural

Gas, M. E.

SPICES Cardamom, Jeera, Pepper, Red Chilli

PLANTATIONS Arecanut, Cashew Kernel, Coffee (Robusta), Rubber

PULSES Chana, Masur, Yellow Peas

P

ETROCHEMICALS

HDPE, Polypropylene(PP), PVC

OIL & OIL SEEDS Castor Oil, Castor Seeds, Coconut Cake, Coconut

Oil, Cotton Seed, Crude Palm Oil, Groundnut Oil,

Kapasia Khalli, Mustard Oil, Mustard Seed

(Jaipur), Mustard Seed (Sirsa), RBD Palmolein,

Refined Soy Oil, Refined Sunflower Oil, Rice Bran

DOC, Rice Bran Refined Oil, Sesame Seed, Soymeal,

Soy Bean, Soy Seeds

CEREALS Maize

OTHERS Guargum, Guar Seed, Gurchaku, Mentha Oil,

Potato (Agra),

Potato (Tarkeshwar), Sugar M-30, Sugar S-30

13 | P a g e

Commodity Market

TURNOVER OF INDIAN COMMODITY EXCHANGES

I n di an Commodi ty Fu tu res Mark et (Rs Crore)

Exchanges 2004 2005 2006 2007Multi Commodity Exchange 165147 961,633 1,621,803 2,505,206NCDEX 266,338 1,066,686 944,066 733,479NMCE(Ahmadabad) 13,988 18,385 101,731 24,072NBOT(Indore) 58,463 53,683 57,149 74,582Others 67,823 54,735 14,591 37,997All Exchanges 571,759 2,155,122 2,739,340 3,375,336

M AR KET SHAR E OF CO MM O DIT Y EX CHAN GE S IN IN DIA

14 | P a g e

Commodity Market

DIFFERENT SEGMENTS IN COMMODITIES MARKET

The commodities market exits in two distinct forms namely the Over the

Counter (OTC) market and the Exchange based market. Also, as in equities,

there exists the spot and the derivatives segment. The spot markets are essentially

over the counter markets and the participation is restricted to people who are

involved with that commodity say the farmer, processor, wholesaler etc.

Derivative t r a d i n g takes place t h r o u g h exchange-based markets with

standardized contracts, settlements etc.

EVOLUTION OF COMMODITY MARKET IN INDIA

Bombay Cotton Trade Association Ltd., set up in 1875 was the 1st organized

Futures Market. Bombay Cotton Exchange Ltd. was established in 1893 following

the widespread discontent amongst leading cotton mill owner’s merchants over

functioning of Bombay Cotton Trade Association. The Futures trading in oilseed

started in 1900 with the establishment of Gujarati Vyapari Mandali, which carried

on futures trading in groundnut, castor seed & cotton. Futures trading in wheat

were existent at several places in Punjab & Uttar Pradesh. But the most notable

futures exchange for wheat was Chambers Of Commerce at Hapur set up in 1913.

Futures trading in bullion in Mumbai began in 1920. Calcutta Hessain Exchange

Ltd. was established in 1919 for futures trading in raw jute & jute goods. But

organized futures trading in raw jute began only in 1927 with the establishment of

East Indian Jute Association Ltd. These two associations amalgamated in 1945 to

form East India Jute & Hessain Ltd. to conduct organized trading in both Raw Jute

& Jute goods. Forward Contracts (Regulation) Act was enacted in 1952 & the FMC

was established in 1953 under the Ministry of Consumer Affairs & Public

Distribution. In due course, several other exchanges were created in the country to

trade in diverse commodities.

15 | P a g e

Commodity Market

LEADING COMMODITY MARKETS OF WORLD

Some of the leading exchanges of the world are:

S. No. Global Commodity Exchanges

1 New York Mercantile Exchange (NYMEX)

2 London Metal Exchange (LME)

3 Chicago Board of Trade (CBOT)

4 New York Board of Trade (NYBOT)

5 Kansas Board of Trade

6 Winnipeg Commodity Exchange, Manitoba

7 Dalian Commodity Exchange, China

8 Bursa Malaysia Derivatives exchange

9 Singapore Commodity Exchange (SICOM)

10 Chicago Mercantile Exchange (CME), US

11 London Metal Exchange

12 Tokyo Commodity Exchange (TOCOM)

13 Shanghai Futures Exchange

14 Sydney Futures Exchange

15 London International Financial Futures and Options Exchange

(LIFFE)16 National Multi-Commodity Exchange in India (NMCE), India

17 National Commodity and Derivatives Exchange (NCDEX), India

18 Multi Commodity Exchange of India Limited (MCX), India

19 Dubai Gold & Commodity Exchange (DGCX)

20 Dubai Mercantile Exchange (DME), (joint venture between Dubai

holding and the New York Mercantile Exchange (NYMEX))

16 | P a g e

Commodity Market

REGULATORS:

Each exchange is normally regulated by a national governmental (or

semi- governmental) regulatory agency:

Country Regulatory agency

Australia Australian Securities and Investments Commission

Chinese mainland China Securities Regulatory Commission

Hong Kong Securities and Futures Commission

India Securities and Exchange Board of India and Forward

Markets Commission (FMC)Pakistan Securities and Exchange Commission of Pakistan

Singapore Monetary Authority of Singapore

UK Financial Services Authority

USA Commodity Futures Trading Commission

Malaysia Securities Commission

17 | P a g e

Commodity Market

LEADING COMMODITY MARKETS OF INDIA

The government has now allowed national commodity exchanges, similar

to the BSE & NSE, to come up and let them deal in commodity derivatives in an

electronic trading environment. These exchanges are expected to offer a

nation-wide anonymous, order driven, screen based trading system for

trading. The Forward Markets Commission (FMC) will regulate these exchanges.

Consequently four commodity exchanges have been approved to commence

business in this regard. They are:

S.NO. Commodity Market in India

1 Multi Commodity Exchange (MCX), Mumbai

2 National Commodity and Derivatives Exchange Ltd

(NCDEX),

3 National Board of Trade (NBOT), Indore

4 National Multi Commodity Exchange (NMCE), Ahmadabad

18 | P a g e

Commodity Market

COMMODITY FUTURES TRADING IN MARKET

Derivatives as a tool for managing risk first originated in the Commodities

markets. They were then found useful as a hedging tool in financial markets as

well. The basic concept of a derivative contract remains the same whether the

underlying happens to be a commodity or a financial asset. However there are some

features, which are very peculiar to commodity derivative markets. In the case of

financial derivatives, most of these contracts are cash settled. Derivatives as a tool

for managing risk first originated in the Commodities markets. They were then

found useful as a hedging tool in financial markets as well. The basic concept of a

derivative contract remains the same whether the underlying happens to be a

commodity or a financial asset. However there are some features, which are very

peculiar to commodity derivative markets. In the case of financial derivatives, most

of these contracts are cash settled.

Even in the case of physical settlement, financial assets are not bulky and do

not need special facility for storage. Due to the bulky nature of the underlying

assets, physical settlement in commodity derivatives creates the need for

warehousing. Similarly, the concept of varying quality of asset does not really exist

as far as financial underlying are concerned. However in the case of commodities,

the quality of the asset underlying a contract can vary largely. This becomes an

important issue to be managed.

Hedging the price risk associated with futures contractual commitments.

Spaced out purchases possible rather than large cash purchases and its storage.

Efficient price discovery prevents seasonal price volatility.

Greater flexibility, certainty and transparency in procuring commodities would

aid bank lending.

19 | P a g e

Introduction

B e n e fi t s t o i n d u s t ry from f utu r e s t r a d ing

Commodity Market

Facilitate informed lending.

Hedged positions of producers and processors would reduce the risk of default

faced by banks. * Lending for agricultural sector would go up with greater

transparency in pricing and storage.

Commodity Exchanges to act as distribution network to retail agri- finance

from Banks to rural households.

Provide trading limit finance to Traders in commodities Exchanges.

Access to a huge potential market much greater than the securities and cash

market in commodities.

Robust, scalable, state-of-art technology deployment.

Member can trade in multiple commodities from a single point, on real

time basis.

Traders would be t r a i n e d to be R u r a l Advisors and Commodity

Specialists and through them multiple rural needs would be met, like bank

credit, information dissemination, etc.

One answer that is heard in the financial sector is "we need commodity

futures markets so that we will have volumes, brokerage fees, and something to

trade''. We have to look at futures market in a bigger perspective -- what is the role

for commodity futures in India's economy?

In India agriculture has traditionally been an area with heavy

government intervention. Government intervenes by trying to maintain buffer

stocks, they try to fix prices, and they have import-export restrictions and a host

of other interventions. Many economists think that we could have major benefits

from liberalization of the agricultural sector.

In this case, the question arises about who will maintain the buffer stock, how

20 | P a g e

B e n e fi t s t o e xc h a n g e m e m b e r

W hy c o m mo d ity futures?

Commodity Market

will we smoothen the price fluctuations, how will farmers not be vulnerable that

tomorrow the price will crash when the crop comes out, how will farmers get

signals that in the future there will be a great need for wheat or rice. In all these

aspects the futures market has a very big role to play.

If we think there will be a shortage of wheat tomorrow, the futures prices

will go up today, and it will carry signals back to the farmer making sowing

decisions today. In this fashion, a system of futures markets will improve

cropping patterns.

Next, if I am growing wheat and am worried that by the time the harvest

comes out prices will go down, then I can sell my wheat on the futures

market. I can sell my wheat at a price, which is fixed today, which eliminates my

risk from price fluctuations. These days, agriculture requires investments -

- Farmers spend money on fertilizers, high yielding varieties, etc. They are

worried when making these investments that by the time the crop comes out prices

might have dropped, resulting in losses. Thus a farmer would like to lock in his

future price and not be exposed to fluctuations in prices.

The third is the role about storage. Today we have the Food Corporation

of India, which is doing a huge job of storage, and it, is a system, which -- in my

opinion -- does not work. Futures market will produce their own kind of

smoothing between the present and the future. If the future price is high and the

present price is low, an arbitrager will buy today and sell in the future. The

converse is also true, thus if the future price is low the arbitrageur will buy in the

futures market. These activities produce their own "optimal" buffer stocks, smooth

prices. They also work very effectively when there is trade in agricultural

commodities; arbitrageurs on the futures market will use imports and exports to

smooth Indian prices using foreign spot markets.

In totality, commodity futures markets are a part and parcel of a program for

agricultural liberalization. Many agriculture economists understand the need of

liberalization in the sector. Futures markets are an instrument for achieving

that liberalization.

21 | P a g e

Commodity Market

WHAT MAKES COMMODITY TRADING ATTRACTIVE?

A good low-risk portfolio diversifier

A highly liquid asset class, acting as a counterweight to stocks, bonds and

real estate.

Less volatile, compared with, equities and bonds.

Investors can leverage their investments and multiply potential

earnings.

Better risk-adjusted returns.

A good hedge against any downturn in equities or bonds as there is

Little correlation with equity and bond markets.

High co-relation with changes in inflation.

No securities transaction tax levied.

22 | P a g e

Commodity Market

COMMODITY TRADING

Commodity Trading in India is regulated by FMC headquartered at Mumbai; it

is a regulatory authority which is overseen by the Ministry of Consumer Affairs &

Public Distribution, Govt. Of India. It is a statutory body set up in 1953 under the

Forward Contract (Regulation) Act, 1952.

After Equity trading, commodity trading is going to be the next big thing for

investors. In India people have a love for Gold & Silver, trading is also going to pick

up in Gold & Silver. Globally, the commodity market is about three times the size of

equities trade market. In India, presently, the commodity market is still is the nascent

stage & is gradually picking up taking a cue from the global market.

NEED OF COMMODITY DERIVATIVES FOR INDIA:

India is among top 5 producers of most of the commodities, in addition to being

a major consumer of bullion & energy products. Agriculture contributes about 22% of

the GDP of Indian economy. It employees around 57% of the labor force on total of

163 million hectors of land. Agriculture sector is an imp factor in achieving a GDP

growth of 8-10%. All this indicates that India can be promoted as a major centre for

trading of commodity derivatives.

23 | P a g e

Commodity Market

HISTORY OF THE DEVELOPMENT OF COMMODITY MARKETS

It is widely believed that the futures trade first started about approximately

6,000 yrs ago in China with rice as a commodity. Futures trade first started in the 17th

century. In ancient Greece, Aristotle described the use of call options by Thales of

Miletus on the capacity of olive oil presses. The first organized futures market was the

Osaka Rice Exchange, in 1730.

Historically, organized trading in futures began in the US in the mid-19th

century with maize contracts at the Chicago Board Of Trade (CBOT) & a bit later

cotton contracts in New York. In the first few yrs of COBT, weeks could go by without

any transaction taking place & even the weeks could go by without any transaction

taking place & even the provision of a daily free lunch did not entice exchange

members to actually come to the exchange! Trade took off only in 1856, when new

management decided that the mere provision of a trading floor was not sufficient &

invested in the establishment of grades & standards as well as nationwide price

information system. CBOT preceded futures exchanges in Europe.

In the 1840’s Chicago had become a commercial centre since it had good

railroads & telegraph lines connecting it with the east. Around the same time good

agriculture technologies were developed in the area, which lead to higher wheat

production. Midwest farmers, therefore, used to connect to Chicago to sell their wheat

to dealers who, in turn, transports it to all over the country.

Farmers usually brought their wheat to Chicago hoping to sell at a good price. The

city had very limited storage facility & hence, the farmers were often left at the mercy

of the dealers. The situation changed for the better in 1848 when a central marketplace

was opened where farmers & dealers could meet to deal in “CASH” grain i.e. to

exchange cash for immediate delivery of wheat.

Farmers (sellers) & dealers (buyers) slowly started entering into contract for

24 | P a g e

Global Scenario:

Commodity Market

forward exchanges of grain for cash at some particular future date so that farmers

could avoid taking the trouble of transporting & storing wheat (at very high costs) if

the price was not acceptable. This system was suitable to farmers as well as dealers.

The farmer knew how much he would be paid for his wheat, & the dealer knew his

costs of procurement well in advance.

Such forward contracts became common & were even used subsequently as

collateral for bank loans. The contracts slowly got “standardized” on quantity &

quality of commodities being traded. They also began to change hands before the

delivery date. If the dealer decided he didn’t want the wheat, he would sell the contract

to someone who needed it. Also, if the farmer didn’t want to deliver his wheat, could

pass on his obligation to another farmer. The price would go up & down depending on

what was happening in the wheat market.

Slowly, even those individuals who had no intention of ever buying or selling

wheat began trading in these contracts expecting to make some profits based on their

knowledge of the situation in the market for wheat. They were called speculators. They

hoped to buy contracts at low price & sell them at high price or sell the contracts in

advance for high price & buy for lower price. This is how the future market in

commodities developed in US. The hedgers began to efficiently transfer their market

risk of holding physical commodity to these speculators by trading in future exchange.

History of trading in commodities in India dates back to several centuries. But

organized futures market in India emerged in 1875 when the Bombay Cotton Trade

Association was established. The futures trading in oilseed started in 1900 when

Gujarati Vyapari Mandali (today’s NMCX, Ahmadabad) was established. The futures

trading in Gold began in Mumbai in 1920. During the 1st half of the 20th century,

there were many commodity futures exchanges, including the Calcutta Hessain

Exchange Ltd. that was established in 1927. Those exchanges traded in jute, pepper,

potatoes, sugar, turmeric, etc. However, India’s history of commodity futures market

25 | P a g e

Indian Scenario:

Commodity Market

has been turbulent. Options were banned on cotton in 1939 by the Government of

Bombay to curb widespread speculation. In mid-1940’s, trading in forwards & futures

became difficult as a result of price control by Government. The Forward Contract

Regulation Act was passed in 1952. This put a regulatory guideline on forward

trading. In 1960s, the Government of India suspended forward trading in several

commodities jute, edible oil, seeds, cotton, etc. due to fears of increase in commodity

prices. However, the government offered to buy agricultural products at Minimum

Support Price (MSP) to ensure that the farmers benefited. The Government also

managed storage, transportation & distribution of agricultural products. These

measures weakened the agricultural commodity markets in India.

The Government appointed four committees (Shroff Committee in 1950,

Dantwala Committee in 1966, Khusro Committee in 1979 & Kabra Committee in

1993) to go into the regulatory aspects of forward & futures trading in India. In 1996,

the World Bank in association with United Nations Conference on Trade &

Development (UNCTAD) conducted a study on Indian Commodities Market.

In the post-liberalization era of the Indian economy, it was the Kabra

Committee & the World Bank-UNCTAD study that finally assessed the scope for

forward & futures trading in commodities markets in India & recommended steps to

revitalize futures trading.

26 | P a g e

Commodity Market

RELEVANCE & POTENTIAL OF COMMODITY MARKETS IN INDIA

Majority of commodities traded on global commodity exchanges are agri-based.

Commodity Markets therefore are of great importance & hold a great potential in case

of economies like India, where more than 65% of the population are dependent on

agriculture.

There is huge domestic market for commodities in India since India consumes a

major portion of its agricultural produce locally. Indian Commodities Market has an

excellent growth potential & has created good opportunities for market players. India

is World’s leading producer of more than 15 agricultural commodities & is also the

world’s largest consumer of edible oils & gold. It has major markets in regions of

urban conglomeration (Cities & Towns) & nearly 7,500 + Agricultural Produce

Market Cooperative (APMC) mandis. To add to this, there is a network of over

27,000+ haats (Rural Bazaars) that are seasonal market places of various

commodities. These marketplaces play host to a variety of commodities every day. The

commodity trade segment employs nearly five million plus traders.

The potential of the sector has been well identified by the Central Government

& the State Government & they have invested substantial resources to boost

production of agricultural commodities. Many of these commodities would be traded

on the futures markets as food-processing industry grows at a phenomenal pace.

The Government also has recognized three national level commodity exchanges,

which are trading in more than 85 commodities at present, & the list continues to

expand. According to the experts in commodity markets, global trends indicate that the

volume in futures trading trends to be 5-7 times the size of commodities spot trading in

the country (Internationally, the multiple for physical versus derivatives is much higher

at 15-20 times). Many nationalized & private sector banks have announced plans to

27 | P a g e

Commodity Market

disburse substantial amounts to finance commodity-trading business. The Government

of India has initiated several measures to stimulate active trading interest in

commodities. Steps like lifting the ban on futures trading in commodities, approving

new exchanges, developing exchanges with modern infrastructure & systems such as

online trading, & removing legal hurdles to attract more participants have increased

the scope of commodities derivatives trading in India. The trading volumes are

increasing as the list of commodities traded on NCE also continues to expand. The

volumes are likely to surge further as a result of the increased interest from the

international participants in Indian Commodity Markets. If these international

participants are allowed to participate in the markets (like in case of capital markets),

the growth in commodity futures can be expected to be phenomenal. It is expected that

Foreign Institutional Investors (FIIs), mutual funds & banks may be able to participate

in commodity futures is also expected after the amendments to the FCR Act, 1952.

Commodity Trading & commodity financing are going to be a rapidly growing

business in the coming years in India.

With the liberalization of the Indian economy in 1991, the commodity prices

(especially international commodities such as base metals & energy) have been subject

to price volatility in international markets, since India is largely a net importer of such

commodities. Commodity derivatives exchanges have been established with a view to

minimize risk associated with such price volatility.

28 | P a g e

Commodity Market

COMMODITY MARKETS ECOSYSTEM

After studying the importance of commodity markets & trading in commodity

futures, it is essential to understand the different components of the commodity markets

ecosystem. The following illustration shows the different components in the commodity

markets ecosystem:

The commodity markets ecosystem includes the following components:

1) Buyers/Sellers or Consumers/Producers: Farmers, manufacturers,

wholesalers, distributors, farmers co-operatives, APMC mandis, traders,

State Civil Suppliers Corporations, Importers, Exporters, Merchandisers,

Oil producing companies, etc.

2) Logistics Companies: Storage & transport Companies/operators, quality

testing & certifying companies, etc.

3) Markets & Exchanges: Spot Markets (mandis, bazaars, etc.) &

Commodity Exchanges (national & regional level)

4) Support Agencies: Depositories/de-materializing agencies, Central &

29 | P a g e

Commodity Market

State Warehousing Corporations & Private Sector Warehousing

Companies.

5) Lending Agencies: Banks & Financial Institutions.

The users are the producers & consumers of different commodities. They have

exposure to the physical commodities market, thus, exposing themselves to price risk.

In turn, they depend on logistic companies for transportation of commodities,

warehouses for storage, & quality testing & certification agencies for assessment &

evaluation of commodity quality standards. Commodity derivatives exchanges provide

a platform for hedging against price risk for these users.

30 | P a g e

Logistic Companies

Testing & Certifying Companies

Farmers & Farmers

Co-operatives

APMC Mandis

Traders

State Civil Suppliers Cooperation

Central & State

Warehousing

Corporation

Private Sector Warehousing

CompaniesSpot Market

Commodity Market

Warehouse Receipt System

Lending Agencies

Users Support Agencies

Storage & Transport Requirements & Quality

Certification Requirements

Commodity Market

INDIA’S PLACE IN WORLD MARKET

The following table shows the position of Indian Commodity Market in the

International Commodity Market with respect to certain significant commodities.

Commodity India World Share Rank

Rice(Paddy) 240 2049 11.17 3rd

Wheat 74 599 12.35 2nd

Pluses 13 55 23.64 1st

Groundnut 6 35 17.14 2nd

Rapeseed 6 40 15.00 3rd

Sugarcane 315 1278 24.65 2nd

Tea 0.75 2.99 25.08 1st

Coffee(Green) 0.28 7.28 3.85 8th

Jute & Jute

Fibers

1.74 4.02 43.30 2nd

Cotton(Lint) 2.06 18.84 10.09 3rd

31 | P a g e

Commodity Market

WORKING OF COMMODITY MARKET

There are two kinds of trades in commodities. The first is the spot trade, in

which one pays cash and carries away the goods. The second is futures trade. The

underpinning for futures is the warehouse receipt. A person deposits certain amount of

say, goods X in a warehouse and gets a warehouse receipt. Which allows him to ask

for physical delivery of the goods from the warehouse? But someone trading in

commodity futures need not necessarily possess such a receipt to strike a deal. A

person can buy or sale a commodity future on an exchange based on his expectation of

where the price will go. Futures have something called an expiry date, by when the

buyer or seller either closes (square off) his account or give / take delivery of the

commodity. The broker maintains an account of all dealing parties in which the daily

profit or loss due to changes in the futures price is recorded. Squiring off is done by

taking an opposite contract so that the net outstanding is nil.

For commodity futures to work, the seller should be able to deposit the

commodity at warehouse nearest to him and collect the warehouse receipt. The buyer

should be able to take physical delivery at a location of his choice on presenting the

warehouse receipt. But at present in India very few warehouses provide for specific

commodities.

Following diagram gives idea about working of the Commodity market.

Today Commodity trading system is fully computerized.

Traders need not visit a commodity market to speculate. With online commodity

trading they could sit in the confines of their home or office and call the shots.

The commodity trading system consists of certain prescribed steps or stages as

follows:

32 | P a g e

Commodity Market

1. Trading : - At this stage the following is the system implemented -

-Order receiving

-Execution

-Matching

-Reporting

-Surveillance

-Price limits

-Position limits.

2. Clearing: - This stage has following system in place -

-Matching

-Registration

-Clearing

-Clearing limits

-Notation

-Margining

-Price limits

-Position limits

-Clearing house.

3. Settlement: - This stage has following system followed as follows-

-Marking to market

-Receipts and payments

-Reporting

-Delivery upon expiration or maturity.

The future trading in commodities has emerged as a major investment option in India.

33 | P a g e

10 STEPS TO INVEST IN COMMODITY MARKET:

Commodity Market

Commodity market performances are equal to that of the stock market and analysts

predict that the commodities market will overtake the capital market in trade volumes

sooner than later. But since commodities futures market is a relatively new entrant in

India, not many investors know how to tap and benefit from trading in various

commodities.

Here are 10 steps that you need to know to invest in commodities market.

Step 1: Locate a brokerage house with a reputation for service.

Step 2: Fill a demat account opening form with a registered brokerage house and a

member with the national commodity exchanges. You could require PAN card,

address proof and passport size photos.

Step 3: Be clear of the rules and regulations especially transaction costs.

Step 4: Choose the right brokerage plan that optimizes your costs, brokerage fees

ranging from 0.03% to 0.08% on contract value.

Step 5: Be clear of the service deliverables from your broker.

Step 6: Insist on regular reports and special knowledge / training opportunities.

Step 7: Set aside funds for commodity investing, but remember not at the cost of other

traditional investing avenues.

Step 8: Focus on a few commodities, gather requisite knowledge and pay up the initial

amount for margin money, account opening charges and annual maintenance

charges.

34 | P a g e

Commodity Market

Step 9: Clear any or all doubts now - set stop loss and book profit levels.

Step 10: Get ready for investing and track your success and losses all the time.

TRADING OF COMMODITY MARKET

35 | P a g e

Commodity Market

“Money making is not a commodity, but commodity trading could earn you money!”

The future market in commodities offers both cash and delivery-based settlement.

Investors can choose between the two. If the buyer chooses to take delivery of the

commodity, a transferable receipt from the warehouse where goods are stored is

issued in favour of the buyer. On producing this receipt, the buyer can claim the

commodity from the warehouse. All open contracts not intended for delivery are cash-

settled. While speculators and arbitrageurs generally prefer cash settlement,

commodity stockiest and wholesalers go for delivery. The option to square off the deal

or to take delivery can be changed before the last day of contract expiry. In the case of

delivery-based trades, the margin raises to 0-25% 0f the contract value and the seller

is required to pay sales tax on the transaction.

Trading in any contract month will open on the twenty first day of the month, three

months prior to the contract month. For example, the December 2004 contracts open

on 21 September 2004 and the due date is the 20-day of the delivery month. All

contracts settling in cash will be settled on the following day after the contract expiry

date. Commodity trading follows a T+1 settlement system, where the settlement date is

the next working day after expiry. However, in case of delivery-based traders,

settlement takes place five to seven days after the expiry.

Commodity investment can be done in a number of ways:

36 | P a g e

Investors’ choice:

Investing in Commodities:

Commodity Market

By investing in companies that produce commodities. Many investors already

hold shares in such companies or hold units in collective investment schemes

such as unit trusts which invest all or part of the fund assets into such

companies.

By purchasing, or selling, the commodities themselves on the ‘spot market’ for

immediate delivery. This involves high transaction costs and is not a suitable

method of investment for individual investors.

By purchasing, or selling via the commodities exchanges for later delivery.

Most trading in commodities is done through ‘futures’ and ‘options’. Taking

positions in individual commodities is essentially speculative and should only

be undertaken by professional investors who can afford to lose large sums of

money if things go wrong.

It seems an obvious statement but commodities make a return for investors if

price rise after purchase. They generate losses if prices fall. Unlike financial assets,

commodities offer no gain from interest income or dividends.

Absolute returns from stocks and bonds are definitely higher than pure

commodities. But commodity trading carries a lower downside risk than other asset

classes, as pricing in commodity future is less volatile compared to equities and bonds.

While the average annual volatility is 25-30% in benchmark equity indices like the

BSE Sensex or NSE’s Nifty, it is 12-18% in gold, 15-25% in silver, 10-12% in cotton

and 5-10% in government securities.

According to study, if an investor had put his money only in silver and bonds

from 1997-2003, his absolute returns would have been above 24%. Commodities are

also good bets to hedge against inflation. Gold offers good protection against

exchange rate fluctuations, and in particular, against fluctuations in the value of the

US dollar against other leading currencies.

37 | P a g e

Returns from Commodity trading:

Commodity Market

However, unlike stocks, commodity prices are dependent on their demand-

supply position, global weather patterns, government policies related to subsidies and

taxation and international trading norms as guided by the World Trade Organisation

(WTO).

A soft interest rate regime and a weak US dollar have increased the demand for

the commodities. In a short span of over a year, online commodity markets are

witnessing good growth in India. The daily volume of trading of Rs.2500 crore at

NCDEX alone has surpassed that of Rs.2000 crore on the Bombay Stock Exchange

(BSE). It registered a record daily traded volume of Rs.2617 crore on 8 December

2004. Commodities like chana, urad, soya bean oil, sugar, pepper, mustard seeds and

wheat contributed to the balance trading volume. MCX, on the other hand, has

achieved a peak daily turnover of Rs.1889 crore. Though the most popular

commodities for trading in India are gold, silver, soya bean and guar gum, the market

is divided equally between bullion and agricultural commodities in terms of trading

volumes.

Expecting the turnover on the three online commodity exchanges to spurt to

Rs.10000 crore per day, banks are keen to tap the commodity trade-financing front.

Commercial banks are chasing the commodity industry with attractive lending rates

between 8% and 8.5% as against the normal lending rate between 11% and 14%.

On Aug. 01, 2009; 432 members (1,851 users) participated in trading and put through

more than 99,198 trades. The volume for the trading session till 02:00 p.m. was Rs.

26.68 billion (one-way). Active trades were high in among others Guar seed,

Turmeric, Chana, Rape Mustard seed and Soya oil. The daily turnover volume at the

38 | P a g e

Growth of commodity trading:

Commodity Market

National Commodity and Derivative Exchange (NCDEX) stood at Rs.39.39 billion

(one- way). There were 457 members (1,970 users) users participated in trading on

Aug 3, 2009 up to 5:00 p.m. There were more than 93,638 trades put through by them.

Active trades were high among others Guar seed, Soya oil, Chana, Turmeric and

Soybeans.

ADVANTAGES & DISADVANTAGES OF COMMODITY MARKETS.

Advantages:

The commodity markets try to integrate the fragmented rural markets.

Multiple commodities can be procured at one centre.

Efficient spot price can be discovered and disseminated.

The bargaining power of the farmers would be increased.

Transportation and warehousing facilities would be increased.

There would be guarantees for trade and also payments.

Considering all these advantages, economic experts say that if the farmer and

the consumer are to be benefitted then future trading and spot trading in the rural

commodity markets should be encouraged.

Disadvantages:

Globally commodity markets are criticized for their part in indulging in

speculation and thus increasing the prices. Another major criticism is that the farm

gate price is very low when compared to the price paid by the consumer. Small

producers have no say in the market and traders dominate.

39 | P a g e

Commodity Market

STUDY ON SINGLE COMMODITY:

40 | P a g e

GOLD:

Commodity Market

GOLD

41 | P a g e

Intr o d u ct i o n

Commodity Market

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 gold’s total

accumulated holdings relate to “store of value” considerations. Holdings in this

category include the central bank reserves, private investments, and high-

caratage jewllery bought primarily in developing countries as a vehicle for

savings. Thus, gold is primarily a monetary asset. Less than one third of gold’s

total accumulated holdings can be considered a commodity, the jewellery

bought in Western markets for adornment, and gold used in industry.

The d i s t inc t ion be tween gold a n d c o m m o d i t i e s i s important. Gold

has maintained its value in after-inflation terms over the long run, while

commodities have declined.

Some analysts like to think of gold as a “currency without a country’. It is an

internationally recognized asset that is not dependent upon any government’s

promise to pay. This is an important feature when comparing gold to

conventional diversifiers like T-bills or bonds, which unlike gold, do have

counter-party risk.

Timeless and Very Timely Investment

Gold is an effective diversifier

Gold is the ideal gift

Gold is highly liquid

Gold responds when you need it most

The gold market is highly liquid. Gold held by central banks, other

42 | P a g e

W ha t m a k e s g o l d s p e c i al ?

M ar k e t C ha r act e r i s tics

Commodity Market

major institutions, and retail jewellery is reinvested in market.

Due to large stock of gold, against its demand, it is argued that the core

driver of the real price of gold is stock equilibrium rather than flow

equilibrium.

Effective portfolio diversifier: This phrase summarizes the usefulness of gold

in terms of “Modern Portfolio Theory”, a strategy used by many investment

managers today. Using this approach, gold can be used as a portfolio

diversifier to improve investment performance.

Effective diversification during “stress” periods: Traditional method of

portfolio diversification often fails when they are most needed, that is

during financial stress (instability). On these occasions, the correlations and

volatilities of return for most asset class (including traditional

diversifiers, such as bond and alternative assets) increase, thus reducing

the intended “cushioning” effect of the diversified portfolio.

China produced 276 metric tons of gold last year, equal to about 9.7

43 | P a g e

D e m a n d a n d s u p p l y

Commodity Market

million ounces, said London precious metals consultancy GFMS Ltd.

That's up 12% from the year-ago and represented just over one-tenth of the

world's supply.

The ranking pushes South Africa into second place, the first time the

Gold giant has lost its top ranking since 1905. South Africa, who’s late

19th century gold rush led to the founding of mining heavyweight Anglo

American Plc and is home to global producers Gold Fields Ltd and

AngloGold Ashanti Ltd; saw its production decline 8% to 272 metric

tons.

India is world largest gold consumer with an annual demand of 800

tonnes.

Demand and Supply of Gold in India (in tonnes)

2006 2007 % changeSupply

Mine Production 573 580 1Net Producer Hedging -140 -129 -Total mine supply 430 451 5Official sector sales 93 95 2Old gold Scrap 303 262 -13Total Supply 826 808 2

DemandFabrication - - -Jewellery 519 568 9Industrial & Dental 111 112 1Subtotal of above fabrication 630 680 8Bar & coin retail investment 89 116 31Other retail investment -3 -5 -ETFs and similar 113 36 -68

Total Demand 829 827 0Inferred Investment -3 -19 -Source: GFMS Ltd.

44 | P a g e

Commodity Market

The return from investments in gold may be compared with the return on

investment in Government bonds in the Indian markets. Illustratively, if gold had

been purchased at end- February 1996 and sold at end-February 2002 at the

prevailing rates in the local bullion market, the average annualized return would

work out to be negative. On the contrary, investment in a liquid risk-free Government

security on the same date would have fetched a comfortable positive return, and in

case capital gains through marked to market is also taken into account, the

annualized average return could be as high as 15 per cent.

Plain 22 carat jewellery is the core of consumption especially in the

rural areas, where gold is so important in judging a family's status at a

marriage. A basic marriage set for a bride is two earrings, one nose pin, one

ring, one necklace and two bangles, all in 22 carat gold and weighing up

to 200 grams (6.2 oz).

Studded (i.e. gem-set) 18 carat jewellery is increasingly popular in the

cities and is estimated to have used 31 tones (1 million oz) in 2001.

Medallions, charms and small gift items account for up to half of what is

loosely called jewellery. These items are popular as gifts at weddings and

other family events.

Gold thread, known as Jari used in high quality saris worn at weddings

and special occasions requires somewhere in the region of 20 tones (0.6 m

oz) annually.

The market is highly fragmented with an estimated 100,000 workshops

supplying over 300,000 retailers, mostly family-owned, single shop

operations. The industry is beginning to be modernized with large factories,

installing the latest equipment, in centers such as Mumbai, Ahmadabad and 45 | P a g e

Risk and Return on Gold Investments

Ind ia n Gold J e w e l l e ry M a r k e t

Commodity Market

Bangalore.

Hallmarking does not exist in India and under-caratage is commonplace.

The Bureau o f I n d i a n S t a n d a r d s has in t roduced a voluntary

scheme which, although not yet widely used, is becoming more popular.

The minimum legal caratage is 9 carat.

The number of retail jewellery outlets has increased greatly since the

abolition of gold control, as has the number of Indians possessing gold

jewellery.

Frequently Asked Questions on Gold

Q1. What is Gold and why is its chemical symbol Au?

46 | P a g e

Commodity Market

Gold is a rare metallic element with a melting point of 1064 degrees

centigrade and a boiling point of 2808 degrees centigrade. Its chemical

symbol, Au, is short for the Latin word for gold, 'Aurum', which literally means

'Glowing Dawn'. It has several properties that have made it very useful to

mankind over the years, notably its excellent conductive properties and its

inability to react with water or oxygen.

Q2. Where does the word Gold come from?

The word gold appears to be derived from the Indo-European root 'yellow',

reflecting one of the most obvious properties of gold. This is reflected in the

similarities of the word gold in various languages: Gold (English), Gold

(German), Guld (Danish), Gulden (Dutch), Goud (Afrikaans), Gull (Norwegian)

and Kulta (Finnish).

Q3. How much gold is there in the world?

At the end of 2001, it is estimated that all the gold ever mined amounts to about

145,000 tonnes.

Q4. Why is gold measured in carats?

This stems back to ancient times in the Mediterranean /Middle East, when a

carat became used as a measure of the purity of gold alloys (see next

Question 5). The purity of gold is now measured also in terms if fineness, i. e.

parts per thousand. Thus 18 carats is 18/24th of 1000 parts = 750 fineness.

Q5. What is a Carat?

47 | P a g e

Commodity Market

A Carat (Karat in USA & Germany) was originally a unit of mass (weight)

based on the Carob seed or bean used by ancient merchants in the Middle East.

The Carob seed is from the Carob or locust bean tree. The carat is still used as

such for the weight of gem stones (1 carat is about 200 mg). For gold, it has

come to be used for measuring the purity of gold where pure gold is defined as 24

carats. How and when this change occurred is not clear. It does involve the

Romans who also used the name Siliqua Graeca (Keration in Greek, Qirat in

Arabic, and now Carat in modern times) for the bean of the Carob tree. The

Romans also used the name Siliqua for a small silver coin, which was one-

twenty-fourth of the golden solidus of Constantine. This latter had a mass of

about 4.54 grammes, so the Siliqua was approximately equivalent in value to the

mass of 1 Keration or Siliqua Graeca of gold, i.e. the value of 1/24th of a

Solidus is about 1 Keration of gold, i.e. 1 carat.

Q6. Who owns most gold?

If we take national gold reserves, then most gold is owned by the USA

followed by Germany and the IMF. If we include jewellery ownership, then

India is the largest repository of gold in terms of total gold within the national

boundaries. In terms of personal ownership, it is not known who owns the most,

but is possibly a member of a ruling royal family in the East.

Q7. If all the gold was laid around the world, how far would it stretch?

If we make all the gold ever produced into a thin wire of 5 microns (millionths of a

meter) diameter – the finest one can draw a gold wire, then all the gold would

stretch around the circumference of the world an astounding 72 million times

approximately!

Q8. How much new gold is produced per year?

48 | P a g e

Commodity Market

In 2001, mine production amounted to 2,604 tonnes or 67% of total gold

demand in that year. Gold production has been growing for years, but the real

acceleration took place after the late 1970s, when output was in the region of

1,500tpa. This year output will fall short of production levels in 2001. This is

partly for specific operational reasons at some of the larger mines (Grasberg

and Porgera), along with lower grades at some of the operations in Nevada. The

reduction in exploration and development expenditure over the past five years is

leading a number of analysts to suggest that, with other operations nearing the

end of their lives, global production is likely to drop slightly over the next two to

three years subject always of course to price.

Q9. How much does it cost to run a gold mine?

Gold mining is very capital intensive, particularly in the deep mines of South

Africa where mining is carried out at depths of 3000 meters and proposals to

mine even deeper at 4,500 meters are being pursued. Typical mining costs are US

$238/troy ounce gold average but these can vary widely depending on mining type

and ore quality. Richer ores mined at the surface (open cast mining) is

considerably cheaper to mine than underground mining at depth. Such mining

requires expensive sinking of shafts deep into the ground.

Q10. How does a gold mine work?

The gold-containing ore has to be dug from the surface or blasted from the rock

face underground. This is then hauled to the surface and milled to release the gold.

The gold is then separated from the rock (gangue) by techniques such as

flotation, smelted to a gold-rich doré and cast into bars. These are then refined

to gold bars by the Miller chlorination process to a purity of 99.5%. If higher

purity is needed or platinum group metal contaminants are present, this gold is

49 | P a g e

Commodity Market

further refined by the Wohlwill electrolytic process to

99.9% purity. Mine tailings containing low amounts of gold may be treated with

cyanide to dissolve the gold and this is then extracted by the carbon in pulp

technique before smelting and refining.

Q12. How big is a tonne of gold?

Gold is traditionally weighed in Troy Ounces (31.1035 grammes). With the

density of gold at 19.32 g/cm3, a troy ounce of gold would have a volume of 1.64

cm3. A tonne of gold would therefore have a volume of 51, 760 cm3, which

would be equivalent to a cube of side 37.27cm (Approx. 1’ 3’’)?

Gold Terminology

For the purpose of this standard, the following definitions shall apply:

Assaying: The method of accurate determination of the gold content of the

50 | P a g e

Commodity Market

sample expressed in parts per thousand (%).

Carat: One-twenty fourth part by mass of the metallic element gold.

Fineness: The ratio between the mass of gold content and the total mass

expressed in parts per thousand (%).

Find Gold: It is gold having fineness 999 parts per thousand (5) and above

without any negative tolerance.

Gold: The metallic element gold, free from any other element.

Standard Gold: Gold having fineness 995 parts per thousand (%) and above

without any negative tolerance.

Grain: One of the earliest weight units used for measuring gold. One grain

is equivalent to 0.0648 grams.

Hallmark: Mark, or marks, which indicate the producer of a gold bar and

its number, fineness, etc.

Karat: Unit of fineness, scaled from one to 24. 24 karat gold (or pure gold)

has at least 999 parts pure gold per thousand; 18-karat has 750, parts pure

gold and 250 parts alloy, etc.

Kilo Bar: A bar weighing one kilogram – approximately 32.1507 troy

ounces.

Legal Tender: The coin or currency which the national monetary

authority declares to be universally acceptable as a medium of

exchange; acceptable for instance in the discharge of debts.

Liquidity: The quality possessed by a financial instrument of being

readily convertible into cash without significant loss of value.

Troy Ounce : A un i t o f w e i g h t , e q u a l to abou t 1 .1 avo i rdupo i s

(ordinary) ounces. The word ounce when applied to gold refers to a troy

ounce. 1 troy ounce is equivalent to 31.1034768 grams.

MCX Contract specifications of gold:

51 | P a g e

Commodity Market

52 | P a g e

GOLD

Name of Commodity Gold

Ticker Symbol GLDPURMUMK

Trading System MCX Trading System

Trading Period Monday to Saturday

Trading Session Monday to Friday: 10:00a.m. to 11:30 p.m.

Saturday: 10:00a.m. to 2:00 p.m.

TRADINGTrading Unit 1 kg

Price Quote Rs. Per 10 g, ex-Ahmadabad (inclusive of all taxes

and levies relating to import and custom duty, but

excluding sales tax/VAT, any other additional tax or

surcharge on sales tax, local taxes and octroi)

Maximum order size 10 kg

Tick Size Re. 1 per 10 g (minimum price movement)

Daily price limit 3%

Initial Margin 4%

Special Margin In case of initial volatility, a special margin at such

percentage (as deemed fit), will be imposed immediately

on both buy and sell side in respect of all outstanding

positions, which will remain in force for next 2 days,

after which the special margin will be relaxed.

Maximum Allowable For individual client: 2 MT

For members collectively for all clients: 6 MT or

15%of the market position, whichever is high

DELIVERY

Delivery unit 1 kg

Delivery period margin 25% of the value of the open position during the

delivery period

Delivery center(s) At designated clearing house facilities of Group 4

Securitas at these centers and at additional delivery

centers at Chennai, New Delhi and Hyderabad.

Delivery Logic Compulsory

SETTLEMENT PERIOD

Tender Period 1st to 6th day of the contract expiry month.

Delivery Period 1st to 6th day of the contract expiry month.

Pay-in of commodities

(delivery by seller

member)

On any tender days by 6.00 p.m. except

Saturdays, Sundays and Trading Holidays. Marking of

delivery will be done on the tender days based on the

Commodity Market

REGULATORY BODY

At present there are three tiers of regulations of forward/future trading system exists

in India, namely, Government of India, Forward Markets Commission & Commodity

Exchanges. The need for regulation arises on account of the fact that the benefits of

futures markets accrue in competitive conditions. The regulation is needed to create

competitive condition. In the absence of regulation, unscrupulous participants could

use these leveraged contracts for manipulating prices. This could have undesirable

influence on spot prices, thereby affecting the interest of appropriate risk

management system. In the absence of such a system, a major default could create a

reaction. The reluctant financial crisis in a futures market could create systematic

risk. Regulation is also needed to ensure fairness & transparency in trading,

clearing. Settlement & management of exchange so as to protect & promote the

interest of various stakeholders, particularly non-member users of the market. Hence

there is a need of regulatory functions to be exercised by an exchange.

53 | P a g e

Ministry Of Consumers Affairs

FMC

Commodity Market

Commodity Market

FMC headquartered at Mumbai, is a regulatory authority which is overseen by

the Ministry Of Consumer Affairs & Public Distribution, Govt. of India. It is a

statutory body set up in 1953 under the Forward Contract (Regulation) Act, 1952.

The functions of the FMC are as follows:

1. To advise the Central Govt. in respect of the recognition or withdrawal

recognition from any association or in respect of any other matter

arising out of the administration of Forward Contract(Regulation) Act,

1952.

2. To keep forward markets under observation & to take such action in

relation to them, as it may consider necessary, in exercise of the powers

assigned to it by or under the Act.

3. To collect & whenever the commission thinks it necessary, to publish

information regarding the trading conditions in respect of goods to

which any of the provisions of the act is made applicable, including

information regarding demand, supply & prices, & to submit to the

Central Government, periodical reports on the working of forward

markets relating to such goods.

4. To make recommendations generally with a view to improving the

organization 7 working of forward markets.

5. To undertake the inspection of the accounts & other documents of any

recognized association or registered association or any member of such

association whenever it considers necessary.

54 | P a g e

Forward Market Commission

Commodity Market

ROLE OF GOVERNMENT IN COMMODITY MARKET

The Government, too, may enter the game. The Government of India reckons

that it could create a minimum support price like mechanism using commodity futures

by entering into contracts for purchase of commodities covered under its programme

at the prescribed minimum support price.

Union consumer affairs secretary Labanyendu Mansingh believes this will help

the Government save on procurement 7 shortage cost of food grains, estimated to cost

it close to Rs 25,000 crore annually. Mansingh believes the Government could ferret

back a part of these savings to farmers to help pay for the cost of delivering & storing

food grains from the farms exchange accredited warehouses.

In the process, the Government will minimize corruption in the grains

management operations, give a major boost to commodity futures trading & take the

farmers to the e-age. Legislative changes have been proposed to enable farmers to get

loans against the receipt for goods deposited at accredited warehouses. If those

proposals become law, then farmers could get finance, which would enable them to

avoid distress sales of their produce at times of unfavorable market conditions.

With 45% of India’s GDP (or RS 11lakh crore) coming from commodities,

exchanges hope that eventually everyone involved in commodities trade across the

value chain – from the farmer to the processor – will be hedging their positions using

futures. To encourage large companies to trade in commodity futures, NCDEX has set

up a network of 100 warehouses where commodities are graded & certified & where

such commodity balances can be held electronically in demat form. Already, around

1,500 depository participant accounts have been opened with 32 depository

participants. The exchanges tieing with other players to provide warehouses services

to the traders 7 now NCDEX is to built 1,100 warehouses with all the facilities.

55 | P a g e

Commodity Market

NATIONAL MULTI-COMMODITY EXCHANGE OF INDIA

NMCE is the 1st demutualized, Electron Multi-Commodity Exchange in India.

NMCE was promoted by:

1. Neptune Overseas Ltd. (NOL)

2. Central Warehousing Corporation (CWC)

3. National Agricultural Co-operative Marketing Federation Of India

(NAFED)

4. National Institute Of Agricultural Marketing (NIAM)

5. Gujarat Agro-Industries Corporation Ltd. (GAICL)

6. Gujarat State Agricultural Marketing Board (GSAMB) (It got its

recognition in Oct ’02)

7. NMCE facilitates electronic derivatives trading through robust & tested

trading platform, Derivatives Trading Settlement System (DTSS).

It is the only Commodity Exchange in the world to have received ISO

9001:2000 certification from British Standard Institutions (BSI).

NMCE was the 1st commodity exchange to provide trading facility through

internet, through VIRTUAL PRIVATE NETWORK (VPN).

NMCE follows best international risk management practices. The contracts are

marked to market on daily basis. The system of upfront margining based on value at

Risk is followed to ensure financial security of the market. In the event of high

volatility in prices, special intra-day clearing & settlement is held.

NMCE was the 1st to initiate process of dematerialization & electronic transfer

of warehoused commodity stocks.

The unique strength of NMCE is its settlement via Delivery Backed System, an

imperative in the commodity trading business. These deliveries are executed through

56 | P a g e

Commodity Market

a sound & reliable Warehouse Receipt System, leading to guaranteed clearing &

settlement.

NMCE would bring about the converge of large-scale processors, traders and

farmers along with banks. NMCE would provide a common ground for fixation of

future prices of a number of commodities enabling efficient price discovery / forecast.

In addition, hedging using different and diverse commodities would also be possible

with help of NMCE.

In short, NMCE is leading transition of highly fragmented, controlled and

restricted commodity economy to globally integrated, efficient and competitive

environment in the 21st century.

On 25th July, 2001, the NMCEIL has been granted in-principle approval by the

Government to organize futures trading in the edible oil complex. The exchange is

operationalised from November 26, 2002.

NMCE’S Vision & Mission.

National Multi-Commodity Exchange of India Limited is committed to provide

world class services of on-line screen Futures trading of permitted commodities and

efficient Clearing and guaranteed settlement, while complying with Statutory

/Regulatory requirements. We shall strive to ensure continual improvement of

customer services and remain quality leader amongst all commodity exchanges.

Continual Improvement in Customer Satisfaction.

Improving efficiency of marketing through on-line trading in Dematerialization

form.

Minimization of settlement risks.

Improving efficiency of operations by providing best infrastructure and latest

57 | P a g e

INFORMATION:

Vision

Mission

Commodity Market

technology.

Rationalizing the transaction fees to optimum level.

Implementing best quality standards of warehousing, grading and testing in

tune with trade practices.

Improving facilities for structured finance.

Improving quality of services rendered by suppliers.

Promoting awareness about on-line features trading services of NMCE across

the length and breadth of the country.

“Innovation is the way of life at NMCE”

58 | P a g e

Commodity Market

MCX

MCX an independent and de-mutulised commodity exchange has permanent

recognition from Government of India for facilitating online trading, clearing and

settlement operations for commodity futures markets across the country. Key

shareholders of MCX are Financial Technologies (India) Ltd., State Bank of India,

Union Bank of India, Corporation Bank, Bank of India and Canara Bank.

Headquartered in Mumbai, MCX is led by an expert management team with

deep domain knowledge of the commodity futures markets. Through the integration of

dedicated resources, robust technology and scalable infrastructure, since inception

MCX has recorded many first to its credit.

Inaugurated in November 2003 by Shri Mukesh Ambani, Chairman &

Managing Director, Reliance Industries Ltd., MCX offers futures trading in the

following commodity categories: Agri Commodities, Bullions, Metals- Ferrous &

Non Ferrous, Pulses, Oils & Oilseeds, Plantations, Spices and other soft

commodities.

MCX has built strategic alliances with some of the largest players in

commodities eco-system, namely Bombay Bullion Association, Bombay Metal

Exchange, Solvent Extractors Association of India, Pulses Importers Association and

Shetkari Sanghatana.

Today MCX is offering spectacular growth opportunities and advantages to a

large cross section of the participants including Producers / Processors, Traders,

Corporate, Regional Trading Centers, Importers, Exporters, Cooperatives, Industry

Associations, amongst others MCX being nation- wide commodity exchange, offering

59 | P a g e

Commodity Market

multiple commodities for trading with wide reach and penetration and robust

infrastructure, is well placed to tap this vast potential.

Top Commodity futures traded across exchanges

Commodity Value of futures traded (Rs crore)

Guar seed 129,522.98

Silver 116,267.99

Soy oil 101,527.66

Gold 62,784.85

Mustard seed 19,422.46

Castor seed 14,327.34

Gaur gum 13,412.08

Pepper 8,334.28

Gur 7,891.49

Rubber 2,745.84

Crude oil 1,900.14

Cotton 779.16

Other metals 618.22

Jute 91.74

Sources: Forward Market Commission

60 | P a g e

SHOOTING STARS

Commodity Market

NATIONAL COMMODITY AND DERIVATIVES EXCHANGE LTD.

The NCDEX Commodity Index is an equal-weighted spot price index of 20

agricultural commodities covering different groups such as oils and oilseeds, fibres,

etc.

It is the first such index to be launched in India. Based on the components of the

spot price index, NCDEX also displays the national index futures-essentially, the no-

arbitrage price if one were to buy futures on the spot index. This price is derived by

tracking the futures prices of the index components at the same weightage as the spot

index. Currently, index futures are not allowed in India under the FCRA (Forward

Contracts Regulation Act, 1952), which requires compulsory physical settlement of

future contracts.

National Commodity & Derivatives Exchange Limited (NCDEX) is an online

commodity exchange based in India. It was incorporated as a private 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 has commenced its

operations on December 15, 2003. NCDEX is a closely held private company which is

promoted by national level institutions and has an independent Board of Directors

and professionals not having vested interest in commodity markets.

NCDEX is regulated by Forward Market Commission (FMC) in respect of

futures trading in commodities. Besides, NCDEX is subjected to various laws of the

land like the Companies Act, Stamp Act, Contracts Act, Forward Commission

(Regulation) Act and various other legislations, which impinge on its working. On

February 3rd, 2006, the FMC found NCDEX guilty of violating settlement price

61 | P a g e

Commodity Market

norms and ordered the exchange to fire one of their executive.

NCDEX is located in Mumbai and offers facilities in more than 550 centres in

India.

COMMODITIES TRADED:

NCDEX currently facilitates trading of 57 commodities:-

Agri- Based commodities:

Castor Seed

Chana

Chilli

Coffee – Arabica, Coffee –Robusta

Cotton Seed Oilcake

Crude Palm Oil

Expeller Mustard Oil

Groundnut (in shell)

Groundnut Expeller Oil

Guar gum

Guar Seeds

Gur, Jeera

Jute sacking bags

Kidney Beans

Indian 28 mm Cotton

62 | P a g e

Commodity Market

Indian 31 mm Cotton

Masoor Grain Bold

Medium Staple Cotton

Mentha Oil

Mulberry Green Cocoons

Mulberry Raw Silk

Rapeseed- Mustard Seed

Pepper

Raw Jute

RBD Palmolein

Refined Soy Oil

Rubber

Sesame Seeds

Soy Bean

Sugar- small

Sugar- medium

Turmeric

Urad (Black Matpe)

V-797 Kapas

Yellow Peas

Yellow Red Maize

Yellow Soybean Meal.

Bullion:

Gold 1 kg

63 | P a g e

Commodity Market

Gold 100 gm

Silver 30 kg

Silver 5 kg

Energy:

Brent Crude Oil

Furnace Oil

Light Sweet Crude Oil.

Ferrous metals:

Mild Steel Ingot

Plastics:

Polypropylene

Linear Low Density Polyethylene

Polyvinyl Chloride.

Non-ferrous metals:

Aluminium Ingot

Copper Cathode

64 | P a g e

Commodity Market

Nickel Ingot

Zinc Cathode

Facilities offered:

NCDEX also offers as an information product, an agricultural commodity

index. This is a composite index, called NCDEXAGRI that covers 20 commodities

currently being offered for trading by NCDEX. This is a spot-price based index.

NCDEX also offers as an information product, the index futures, called FUTEXAGRI.

This is essentially a what-if index. It indicates that if futures on the index could be

traded, then the current FUTEXAGRI value should be the no-arbitrage value for the

index futures. However, indexes and index futures are not allowed to be traded under

the current regulatory structure. Hence, these are only available for information, as of

now.

Governance:

The governance of NCDEX vests with the Board of Directors. The Board

comprises persons of eminence, each an authority in his own right, in the areas very

relevant to the Exchange.

The institution-shareholders – Canara Bank, CRISIL Limited, ICICI Bank

Limited, IFFCO, Life Insurance Corporation of India, National Bank for Agriculture

and Rural Development, National Stock Exchange of India Limited and Punjab

National Bank, in tune with the highest norms of corporate governance, have decided

65 | P a g e

Commodity Market

that they will not be taking part in the day-to-day activities of the Exchange.

In NCDEX, Board of Directors comprises 8 Directors who are well known,

highly experienced and is independent. The Managing Director is the only whole-time

Director.

Worldwide commodity markets.

SOME INFORMATION ABOUT WORLD WIDE COMMODITY EXCHANGE.

In the middle of the 19th century in the United States, businessmen began

organizing market forums to make the buying and selling of commodities easier.

In 1982, a group pf Manhattan diary merchants got together to bring chaotic

condition in New York market to a system in terms of storage, pricing and transfer of

agricultural products.

In 1933, during the Great Depression, the Commodity Exchange, Inc. was

established in New York through the merger of four small exchanges—the National

Metal Exchange, the Rubber Exchange of New York, the National Raw Silk Exchange

and the New York Hide Exchange.

London metal exchange (LME), Chicago Mercantile exchange (CME), Chicago

Board of Trade (CBOT), New York Mercantile exchange (NYME) is amongst the

world’s largest and best exchanges.

The major commodity markets are in the United Kingdom and in the USA

major commodity markets are in London, Chicago, Sydney and Singapore.

In London,- still the major international centers for transactions in a vast range

of commodities-such markets include the London commodity Exchange (LCE) trading

sugar, spices, cocoa, rubber, etc. The Tea Market, The London Wool Exchange, The 66 | P a g e

Commodity Market

London Metal Exchange (LXM), The London Gold Market, The London Diamond

Market and International Petroleum Exchange (IPE).

In the USA, the New York Mercantile Exchange (NYMEX) deals in metals, the

Chicago Board of Trade (CBOT) in metals, soft commodities and financial futures,

and the Chicago Mercantile Exchange in Livestock and Livestock futures.

The two main futures exchanges, which traded gold, are COMEX in New York

and TOCOM in Tokyo.

According to experts:-

“Volumes on commodity exchanges are growing because there is transfer from

the mandis to the exchange platform,” says Sanjiv Shah, executive director of

Benchmark Asset Management Company.

“National exchanges have succeeded in creating trust in the minds of

stakeholders as they are hi-tech, corporatized and employ modern management. A

farmer has to trust the exchange the way he trusts State Bank of India. Modern

exchanges have also reduced information asymmetry, which has resulted in their

growth,” says Jignesh Shah, managing director, MCX.

67 | P a g e

Commodity Market

SUGGESTIONS:

As majority of Indian investors are not aware of organized commodity market;

their perception about is of risky to very risky investment. Many of them have wrong

impression about commodity market in their minds. It makes them specious towards

commodity market. Concerned authorities have to take initiative to make commodity

trading process easy and simple. Along with Government efforts NGOs should come

forward to educate the people about commodity markets and to encourage them to

invest into it. There is no doubt that in near future commodity market will become Hot

spot for Indian farmers rather than spot market. And producers, traders as well as

consumers will be benefitted from it. But for this to happen one has to take initiative to

standardize and popularize the Commodity Market.

Some Suggestions to make futures market as a level playing field for all stake

holders:-

Creation of awareness among farmers and other rural participants to use

the futures trading platform for risk mitigation.

Contract specifications should have wider coverage, so that a large number

of varieties produced across the country could be included.

Development of warehousing and facilities to use the warehouse receipt as a

financial instrument to encourage participation farmers.

68 | P a g e

Commodity Market

Development of physical market through uniform grading and

standardization and more transparent price mechanisms.

Delivery system of exchanges is not good enough to attract investors. E.g.:-

In many commodities NCDEX forces the delivery on people with long

position and when they tend to give back the delivery in next month contract

the exchange simply refuses to accept the delivery on pretext of quality

difference and also auctions the product. The traders have to take a delivery

or book losses at settlement as there are huge differences between two

contracts and also sometimes few contracts are not available for trading for

no reason at all.

Contract sizes should have an adequate range so that smaller traders can

participate and can avoid control of trading by few big parties.

Setting of state level or district level commodities trading helpdesk run by

independent organization such as reputed NGO for educating farmers.

Warehousing and logistics management structure also needs to be created

at state or area level whenever commodity production is above a certain

share of national level.

Though over 100 commodities are allowed for Derivatives trading, in practice

only a few commodities derivatives are popular for trading. Again most of the trade

takes place only on few exchanges. This problem can possibly be solved by

consolidating some exchanges.

Only about 1% to 5% of total commodity derivatives traded in country are

settled in physical delivery due to insufficiencies in present warehousing system. As

good delivery system is the back bone of any Commodity trade, warehousing problem

has to be handled on a war footing.

A difficult problem in Cash settlement of Commodities Derivatives contract is

that, under Forward Contracts regulation Act 1952 cash settlement of outstanding

contracts at maturity is not allowed. That means outstanding contracts at maturity

should be settled in physical delivery. To avoid this participants square off their 69 | P a g e

Commodity Market

positions before maturity. So in practice contracts are settled in Cash but before

maturity. There is need to modify the law to bring it closer to the wide spread practice

and save participants from unnecessary hassle.

C ON CLU S I O N

After almost two years that commodity trading is finding favour with

Indian investors and is been seen as a separate asset class with good

growth opportunities. For diversification of portfolio

beyond shares, fixed deposits and mutual funds, commodity trading offers a

good option for long-term investors and arbitrageurs and speculators. And, now,

with daily global volumes in commodity trading touching three times that of

equities, trading in commodities cannot be ignored by Indian investors.

Online commodity exchanges need to revamp certain laws governing

futures in commodities to make the markets more attractive. The national multi-

commodity exchanges have unitedly proposed to the government that in view of the

growth of the commodities market, foreign institutional investors should be given

the go-ahead to invest in commodity futures in India. Their entry will deepen

and broad base the commodity futures market. As a matter of fact, derivative

instruments, such as futures, can help India become a global trading hub for

select commodities.

70 | P a g e

Commodity Market

Commodity trading in India is poised for a big take-off in India on the back

of factors like global economic recovery and increasing demand from China for

commodities. Considering the huge volatility witnessed in the equity markets

recently with the Sensex touching 21000 level commodities could add the

required zing to investors’ portfolio. Therefore, it won't be long before the market

sees the emergence of a completely redefined set of retail investors.

BIBLIOGRAPHY

www.mcxindia.com

www.indiamba.com

www.commodityindia.com

www.business.mapsofindia.com

www.bseindia.com www.ncdex.com

www.sebi.gov.in, SEBI Bulletin

www.indiaexpress.com

www.nmce.com www.nbotind.org

71 | P a g e

Commodity Market

www.gold.org

72 | P a g e