Commodity Trading? What is in it for me?

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Commodity trading, as an investment, is now a booming market for traders and investors. However, how to start investing in this financial instrument and continue investing in it with a decent profit margin is a mystery to many traders. The key point to remember here is that it is necessary to do a lot of research before investing in commodities. In this article, you will learn about some of the key points on commodities, trading them, the market for its trade, several commodity exchanges in India, and the pros and cons of investing in the commodity trading market.

Trading and investing in commodities in India started years ago, even before many other nations in the world. Yet, the commodities market faced a huge and significant decline in India due to certain government regulations, external invasions, natural catastrophes, and much more. However, now things have changed, and people hold a plentiful variety of market instruments to invest their funds, without any restrictions on trading in any particular kinds of investment.

This is the sole reason why commodity trading has revived itself in the stock market. A commodity can be defined as a collection of goods or assets that are essential in the day-to-day life of a person. These commodities can include elements like metals, grains, or any tangible object that is temporary and by nature replaceable. In this type of trading, traders invest in the primary economic sector as opposed to the manufactured products.

The commodity trading meaning can further be regarded as all sorts of goods that are movable and can be traded or purchased. However, it will not include money and actionable claims. Not every person can invest in commodities to perform well and earn huge profits since it necessitates immense familiarity regarding the stock market and the nature of the commodities they are investing in. If a person is new to commodity trading, they might lose a lot of funds if they don’t understand how to deal with them.

Hence it is extremely important to understand the commodity trading market carefully before investing in them. However, a novice person need not lose hope as there is also an option of investing in the commodities market through a fund manager. A fund manager can easily subdue the risk a person might otherwise face while investing in commodities all by themselves. Those looking to diversify their portfolio and be willing to take some risk after understanding the meaning of commodity trading will find investing in commodities to be fruitful.

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Commodity trading exchanges in India

If a person is willing to invest their funds in a commodity trading market, they must know that there are numerous commodity exchanges available in India. Since 2015 all these commodity exchanges are monitored by the Securities and Exchange Board of India a.k.a. SEBI, which is additionally the supervisory official for stock markets. Therefore, there is no risk in investing in commodities at these exchanges.

Before the year 2015, the Forward Market Commission (FMC) used to regulate the Indian commodities market, and this commission was further under the purview of the Ministry of Consumer Affairs. Mentioned below are some of the leading commodity trading exchanges in India for trading in various commodities.

  • Multi Commodity Exchange (MCX)

Multi Commodity Exchange (MCX) is the most popular commodity exchange in the country that was instituted back in the year 2003. They hold roughly 86% of the industry share in the country’s commodities exchange. Moreover, this commodity trading exchange has also managed to seize the top position worldwide for distinct commodities.

MCX is recognized as the biggest commodity exchange for trading in silver and gold, second highest for trading in natural gas, and third-largest for trading crude oil. There are around 40 commodities listed on this exchange. Some of the major commodities that people trade on this platform are crude oil, aluminum, copper, brass, gold, silver, nickel, lead, natural gas, zinc, and many more.

  • National Commodity & Derivatives Exchange (NCDEX)

Another commodity exchange in India is the National Commodity & Derivatives Exchange. This platform is popularly regarded as NCDEX and was instituted in the year 2003. Its head office is situated in Mumbai and owns its branches across the nation. Some of the leading brands like Life Insurance Corporation of India (LIC), NABARD, ICICI, and IFFCO are some of the founding members of NCDEX.

This commodity exchange is the most suitable place if a person wants to trade in agricultural commodities as 25 out of all the commodities listed with NCDEX are agricultural commodities. India, being the land of spices, traders use NCDEX as a model for pricing their spices. Some of the major commodities listed on the exchange are gold, silver, barley, wheat, cotton, gum, and castor.

  • Indian Commodity Exchange (ICEX)

Indian Commodity Exchange(ICX) is another Mumbai-based commodity trading exchange that is monitored by SEBI. Various prominent and leading financial organizations like IDFC Bank and Punjab National bank are some of the significant shareholders investing in commodities at ICEX. Apart from this, ICEX was the premier commodity exchange to launch diamonds for trading in the commodity market through derivative contracts.

It intends to barter in all commodities that hold financial significance for the Indian economy. Unlike NCDEX, this exchange trades in all agricultural and non-agricultural commodities. Moreover, this exchange joined hands with the National Council on Measurement in Education (NCME) in the year 2017 and positioned itself as the third-largest commodity exchange in India. Some of the major commodities are diamonds, steels, soya beans, jute, and rubber.

  • Ahmedabad Commodity Exchange (ACE)

Ahmedabad Commodity Exchange is another Indian Derivatives and Commodity Exchange that was instituted in the year 2010. This commodity exchange primarily started its working in Ahmedabad’s territorial commodity market, and with time, it grew as a leading commodity exchange in India. It presently holds a multitude of traders and brokers who are associated with this exchange. 51% of the stakes in the ACE are held by Kotak Mahindra bank. Some of the major commodities traded on ACE are gold, crude oil, copper, mustard, and silver.

How to invest in commodities

Trading in the commodity is not always confined to investing funds in the commodities through a stock exchange. Apart from this, a person can further invest in the stock and equity of commodity-producing companies along with investing in mutual funds or exchange-traded funds (ETF), whose primary job is to create commodities. Mentioned below are some of the ways through which a person can trade commodities.

  • Investment in commodities using mutual funds and index funds

While mutual funds and index funds cannot be directly employed to invest in commodities, they can be readily utilized to invest in the equities and stock of commodity manufacturing companies like mining, agriculture, etc. Comparable to the stocks, the mutual funds and index funds share can also be affected by numerous determinants other than varying rates of a commodity. It can further include regular share market price variations and other factors relate
d to a specific company.

However, to provide investors with added exposure to the prices of the commodities, there are a limited number of commodity index funds and mutual funds for investing in commodity-linked borrowed investments and futures contracts. Investing in commodities through these funds can further benefit the investor in getting a diverse portfolio, expert money administration, and liquidity.

  • Employing commodity pools and managed futures to invest in commodities

Taking the help of commodity pools and managed futures is another way to invest funds in a commodity after accumulating funds from the investors. People can invest in these commodity pools with the help of a Commodity Pool Operator (CPO). A CPO is an individual who combines all the accumulated amounts and creates a pool of funds for further investing in commodities and futures contracts. The operator must maintain a record of all the transactions made by an investor and also prepare annual financial statements.

Furthermore, to assist and advise on the trade of commodity pools, a commodity pool operator can take the help of a Commodity Trade Advisor (CTA). However, a CPO must keep in mind that they must only take the assistance of a CTA with an inspected and verified background and enroll with Commodity Futures Trading Commission (CTFA).

Investing in a commodity pool and managed futures holds various benefits for the investors, like a commodity pool, which renders more opportunities for your pool manager to invest the funds and generate profit for you. Apart from this, a person can also receive professional trading advice from CTA.

  • Investing in commodities with notes and ETFs

Another great way to invest in commodities is by employing Exchange Traded Notes (ETN), and Exchange Traded Funds (ETFs). These two work similarly to stocks as they enable the investors to gain earnings from the inconsistencies of the rates of a commodity without making a direct investment in the futures contracts. Commodity Exchange Trade Funds normally trace the rate of a single commodity or a pool of commodities that constitute a feature termed as an index–for all futures contracts.

An investor also holds the option of backing up the ETFs with the commodity they hold with them. On the other hand, ETNs are a kind of unprotected debt securities that are created to impersonate the variation of rates shown by a particular commodity or an index. All ETNs are always upheld by their issuer. Investing in the commodity by utilizing ETFs and ETNs can enable investors to partake in the price variation of a single commodity or maybe a group of commodities.

Also, the biggest advantage of investing with these ETFs and ETNs is that there are zero redemptions and management charges as they are traded just similar to stocks. However, the number of commodities carrying ETFs and ETNs is very limited.

  • Investing in commodities using stocks

Multiple investors in the market invest in the stocks of the company, which is related to the commodity they would like to trade-in. For instance, investors who like to trade in a commodity of oil can invest their amount in the stocks of some oil refining companies, or if a person holds an interest in gold, then they can buy socks of some gold bullion or maybe some gold refineries. The main reason why people invest in commodities with the help of stocks is that investment in stocks is considered to be less prone to market variations than investing in a futures contract for a commodity.

Additionally, the stock is extremely easy to purchase, sell, and trace. However, before making any investment, the investors must do proper market research about the stocks of the company they intend to invest the amount in. Failing to do this can lead to erroneous investments and losses.

Another benefit of investing in stocks to access the market of commodities is that trading becomes easier due to previously held broker accounts, as all information and the financial position of the company can be readily available on the broker’s account.

Advantages and disadvantages of commodity trading in India

There are numerous advantages and disadvantages of commodity trading. While on the one hand, it produces a better chance to gain profits, on the other hand, it is regarded as a high-risk investment leading to higher returns. Mentioned below are some advantages and disadvantages of investing in a commodity.

Advantages of commodity trading in India

  • More eminent growth possibilities

Investing in a commodity trading market can result in an increased profit, as there is an immense demand for commodities nowadays, and prices tend to increase significantly with time. Hence investing in commodities can be a great way to earn some quick funds if the investor knows what they are doing.

  • Portfolio Diversification

Investing in commodities holds a lot of avenues and opportunities when a person is looking to diversify his portfolio. Diversification means investing funds in a variety of stocks and schemes to avoid huge losses and stabilize profits. If a person is seeking to hedge against investment in bonds and stocks, then, in that case, investing funds in commodities can be the appropriate alternative for mitigating the stock market risk.

  • Render protection against inflation

If a person is a regular trader, then inflation can adversely affect his trading. However, trading in commodities can be a good way to protect the investments from inflation, as when the price of any commodity increases, only then does the inflation tend to rise, and if the inflation rises, so will the price of the commodity in which the person invested, giving protection against inflation.

Disadvantages of commodity trading in India

  • Extremely volatile market

The commodity trading market is extremely volatile and requires lots of precision and experience for any person to earn profits in the commodity market. Moreover, investors need to know about the market to make the right investment. Many investors do not take the risk of investing in a volatile market and sometimes refrain from investing in a commodity.

  • Often there is less income generation

Investing in a commodity can be a risky venture for people who are looking for a fixed income similar to what they used to get in stocks or bonds. There is no certainty of a fixed income in a commodity trading market, as it can sometimes generate fewer earnings. As such, it is not an option for those looking for a steady income after retirement.

There is a mixed opinion in the market when it comes to investing in a commodity. Commodity trading brings in the same amount of advantages and disadvantages, leading to hesitance in traders, especially those who are new to the market. Investment in commodities can be a risk-taking venture as the prices of a commodity keep on fluctuating due to several factors like government regulations or maybe climate change. Hence, the investor needs to know the commodity market at the back of his hand before investing.

FAQs

1. Are commodities high risk?

The constant demand and supply of a commodity is the main reason behind the quick price fluctuations in the commodity trading market. Due to such price fluctuations, commodities are considered to be riskier than any other market instruments like stocks and bonds.

2. What is the highest-selling commodity in the world?

Due to its vast usage and presence in every sector of the global economy, crude oil is considered to be the highest-selling commodity worldwide.

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