WHAT IS A COMMODITY?
A commodity refers to any material thing which has its own intrinsic value and can be exchanged for money or other goods and services. Commodities in the context of investment and trading include fuels, agricultural products and metals etc that are traded in bulk either on a spot market or a commodity exchange.
There are two types of commodities in the market, i.e. hard commodities and soft commodities. Hard commodities are often used as inputs make other goods and provide services while soft commodities are mainly used for initial consumption. Inputs such as metals and minerals are classified as hard commodities while agricultural products like rice and wheat are softer commodities.
As different producers produce the commodities available on the exchanges, the quality is variable, but it must be substantially uniform on some criteria across different producers.
Commodities are traded on the spot market or exchanges. The commodities must minimum standards set by the exchanges to be able to trade. These standards are often changed on a yearly basis.
Commodities can provide the right amount of portfolio diversification and hedge against market volatility to investors and traders. They can either buy these commodities on the spot market or through derivatives such as options or futures.
Understanding Commodities
The same commodity might be supplied by different producers but pricing varies based on the level of differentiation in the commodity. A barrel of oil is considered to be the same product regardless of whether it is coming from the oil well in Saudi or America or Russia.
On the other hand, the quality and features of an electronic product could be very different than its peers from other countries or producers. This is why commodity trade generally involves substantially similar goods which are virtually indistinguishable within their category.
Commodities can be classified as:
1) Agriculture: grains, pulses such as corn, rice, wheat etc
2) Precious metals: gold, palladium, silver and platinum etc
3) Energy: crude oil, Brent Crude and renewable energy etc
4) Metals and minerals: aluminium, iron ore, soda ash etc
5) Services: energy services, mining services etc
Commodities Buyers and Producers
One of the best ways to invest in commodities is through futures contracts on exchanges, which are pre-defined contracts for a baseline level of standardization of the quantity and quality of the goods in consideration.
There are two types of traders who use commodity futures. The former are buyers and producers of goods who use commodity futures for the purposes of hedging against price volatility in the future. These traders choose to buy futures contracts of commodities that they are interested in to make sure that they can avail a predefined price in the future even if the market is volatile. For example, a farmer can sell corn futures to protect himself against the risk of losing money if the price drops before harvest.
The second type of commodity trader is a commodities speculator. These are traders who engage in commodity trade to gain from the price volatility and grow their wealth. Since they are not interested in the actual production of goods or even taking delivery of their trades, they mostly invest through cash-settlement futures which provide them with substantial gains if the markets move according to their expectations.
Commodities are also using as a hedge against inflation. As the price of commodities often mirrors the inflation trends, investors often use them to protect their funds in times of rising inflation as the losses due to inflation can be offset by the rise in commodity prices.
Commodity trading in India
In India, one can trade commodities by going on any of the 20+ exchanges which facilitate this trade under the regulatory eye of the Securities and Exchange Board of India. Till 2015, the market was regulated by the Forward Markets Commission which was finally merged with SEBI to create a unified regulatory environment for commercial investing.
To start trading in commodities, you will need a Demat account with the National Securities Depository Limited. The Demat account will function as a keeper of all your trades and holdings but you will still need to go through a good broker to place orders on the exchanges.
The major exchanges functional in India right now are:
1) National Commodityand Derivatives Exchange – NCDEX
2) Ace Derivatives Exchange – ACE
3) Indian CommodityExchange – ICEX
4) National Multi CommodityExchange – NMCE
5) The Universal CommodityExchange – UCX
6) Multi CommodityExchange – MCX
Currently, many investors don’t trade in commodities but that is soon changing as the awareness is rising in the market.