INTRODUCTION

 

The
study conducted on the Commodity market gives us an exhaustive idea regarding
the risks associated with commodities exchange and it emphasizes more on the hedging
and Arbitrage procedures by utilizing the futures, which helps in reducing the loss
to a negligible degree to shield the interests of the investors.

 

Commodities
markets have been portrayed as an all-round sales markets and as a clearing
house for the most recent data about the free market activities. They are like the
meeting places of purchasers and sellers of a consistently extending rundown of
the commodities that today incorporates agricultural items, metals, foreign
exchange, oil, various financial instruments etc.

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A
trade in commodity futures goes about as a commercial center for people interested
by arbitrage. The elements driving arbitrage are the differences and view of
differences of the equilibrium prices dictated by the free market activity at various
different locations.

 

For
the futures markets, the exercise of arbitrage are brought out through the
exchange of paper promissory notes to purchase or to sell an item at a settled
upon price at a future date. As people with various view of where demand and
supply right now and where demand and where supply will be in the future, the
prices of the commodity are headed towards equilibrium. As new data enters the
market, people recognize change and the way toward arbitraging starts once
more.

 

Price
risk can happen for various reasons. For rural items, price risk may happen
because of dry season, near record produce, an increased demand, diminished international
supply, and so on.

 

The
commodity futures markets give a way for the transfer of risks between people
holding the physical (hedgers) and different hedgers or people speculating in
the market.

 

Futures
trades do exist and are highly effective in light of the rule that hedgers may
do without some benefit potential in return for less risk and speculators will
approach increased profit potential from accepting this risk.

 

 

 

 

 

 

 

Indian Commodity Market

 

 

 

The
huge geographical extent of India and its large population is highly
complemented by the size of its market. The classification of the Indian Market
can be made in terms of: the commodity market and then the bond market. In this
study, we shall deal with the former in a little detail.

 

The
commodity market in India consists of all visible markets that we come across
in our day to day lives, and these markets act as institutions that help in the
facilitation of exchange of goods for money. Indian Commodity Market can be
subdivided into the following two categories:

 

 

•        
Wholesale
Market

 

•        
Retail
Market

 

 

 

 

The old or
orthodox wholesale Indian market dealt with whole-sellers who purchased goods
from the manufacturers and the agricultural farmers and then they sold the
goods to retailers after making profits or gains in the process. The goods were
then sold to the consumers by these retailers.

Lately, the retail market (both unorganized
and organised) has developed by a wide margin. This the development of the
commodity market of India as of late is mostly based on the development created
by the retail sector. Relatively all commodities, both agricultural and
industrial are currently being provided across retail outlets all through the
nation.

Additionally, these retail outlets
have a place with both the organised and also the unorganized areas. The unorganized
retail outlets do comprise of small shop proprietors who are the price takers
whereas, the customers confront an exceedingly aggressive price structure.

 

India, which is a commodity based
economy where approximately about two-third of entire population rely upon various
rural items, shockingly has a very under developed commodity market. Very unlike
the physical market, the futures market exchanges in commodities are to a great
extent utilized as a risk management (hedging) component on either physical
item itself, or the open positions in commodity market. For example, a jeweler
can hedge his stock against a expected short-term downturn in the gold prices
by going short in future markets.

 

 

 

 

Overview

 

 

 

The
gradual evolution of the Indian Commodity has actually been of high
significance for the country’s economic growth and also prosperity. The Indian
commodity market consists of varieties of products like- agricultural products
like rice, wheat, cattle, gold, silver, aluminum and many more. There are many
delicate commodities also such as sugar, cocoa, and coffees, which are
perishable, and so they cannot be put in stock for long time. The commodity
futures exchanges were evolved in the 1800’s with the primary objective of
meeting the demand for exchangeable contracts for trading agricultural
commodities. Commodities have gained importance along with the development of the
commodity futures indexes and also with the mobilization of greater resources
in the commodity market.

 

 

 

Commodity

 

 

“A
commodity can be defined as an article, a product or material that is bought
and sold. It can be classified as every kind of movable property, except
Actionable Claims, Money & Securities.”

 

 

Leading
Commodity Markets of the World

 

 

 

Some
of the leading exchanges of the world are New York Mercantile Exchange (NYMEX),
the London Metal Exchange (LME) and the Chicago Board of Trade (CBOT).

 

 

 

 

 

 

 

 

 

Leading Commodity Markets of India

 

 

 

 

The
government of India has now allowed various national commodity exchanges, similar
to BSE & NSE, to come up and to deal in commodity derivatives through the
creation of an electronic trading environment. These exchanges are expected to
offer nation-wide anonymous, order driven, screen based trading system. The
Forward Markets Commission (FMC) will regulate these exchanges.

 

 

Consequently
four commodity exchanges have been approved to commence business in this
regard. They are:

 

•        
Multi
Commodity Exchange (MCX) located in Mumbai

 

•        
National
Commodity and Derivatives Exchange Ltd. (NCDEX) located in Mumbai

 

•        
National
Board of Trade (NBOT) located at Indore

 

•        
National
Multi Commodity Exchange (NMCE) located in Ahmedabad.

 

 

 

Statutory Framework to Regulate
Commodity Futures in India

 

 

 

 

The
Commodity futures contracts and the commodity exchanges are regulated by the
government under the Forward Contracts (Regulation) Act, 1952. The nodal agency
to regulate the future market is the Forward Markets Commission (FMC), situated
in Mumbai, which functions under the aegis of the ministry of consumer affairs.

 

 

 

 

 

 

 

 

 

 

 

 

Commodities
Exchange

 

 

 

 

“A
Commodities Exchange is a place where different commodities and their
derivative items are traded.” Almost all commodity markets around the world
trade in agriculture products and also other items (like wheat, sugar, maize,
cotton, wheat cocoa, coffee, oil, metals etc.) and such contracts based on
them. These contracts can include spot prices, forwards, futures and options on
the futures.

 

Among
the four exchanges discussed above MCX and NCDEX are used more. These are
discussed below:

 

 

National Commodity & Derivative
Exchange Limited (NCDEX)

 

National
Commodity & Derivatives Exchange Limited (NCDEX) is a professionally
managed on-line multi commodity exchange. “The shareholders of NCDEX comprises
of large national level institutions, large public sector bank and companies.
It is promoted by ICICI Bank Limited (ICICI), Life Insurance Corporation of
India (LIC), National Bank for Agriculture and Rural Development (NABARD) and
National Stock Exchange of India Limited (NSE). Canara Bank, Punjab National
Bank (PNB), CRISIL Limited, Indian Farmers Fertiliser Cooperative Limited
(IFFCO), Goldman Sachs, Intercontinental Exchange (ICE), Shree Renuka Sugars
Limited, Jaypee Capital Services Limited and Build India Capital Advisors LLP,
Oman India Joint Invesmtnet Fund, IDFC Private Equity Fund III by subscribing
to the equity shares have joined the initial promoters as shareholders of the
Exchanges.”

    
(Source:https://www.ncdex.com/AboutUs/ShareHolders.aspx)

NCDEX is a
nation-level, technology driven de-mutualised on-line commodity exchange with
an independent Board of Directors and professional management – both not having
any vested interest in commodity markets. It is committed to provide a
world-class commodity exchange platform for market participants to trade in a
wide range of commodity derivatives driven by best global practices,
professionalism and transparency.

 

NCDEX is
regulated by Securities and Exchange Board of India. NCDEX is subjected to
various laws of the land like the Securities Contracts (Regulation) Act, 1956,
Companies Act, Stamp Act, Contract Act and various other legislations.

 

NCDEX
headquarters are located in Mumbai and offers facilities to its members from
the centres located throughout India. As of March 31, 2015, the Exchange
offered trading in 26 commodities, which included 21 agricultural commodities,
2 bullion commodities, 2 metals and 1 commodity in energy & polymer sector.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Multi Commodity Exchange of India
Ltd. (MCX)

 

 

 

 

The
Multi Commodity Exchange of India Limited (MCX), India’s first listed exchange,
is a state-of-the-art, commodity futures exchange which facilitates online
trading, and clearing and the settlement of the commodity futures transactions,
thereby providing a platform for risk management. The Exchange, which started
operations in November 2003, operates under the regulatory framework of
Securities and Exchange Board of India (SEBI).

 

 

MCX
offers trading in varied commodity futures contracts across segments including
bullion, ferrous and also non-ferrous metals, energy and agricultural
commodities. The Exchange focuses on providing commodity value chain
participants with neutral, secure and transparent trade mechanisms, and
formulating quality parameters and trade regulations, in conformity with the
regulatory framework. The Exchange has an extensive national reach, with 1731
members, operations through 475,519 trading terminals (including CTCL), spanning
over 1811 cities and towns across India.

 

Benefits
to the Industry from Futures Trading

 

•        
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

 

•        
To facilitate an informed lending process.

 

•        
The hedged positions of processors would also reduce the risk
of default to a great extent which would be faced by the banks.

 

 

 

•        
Lending to the agricultural sector would increase due to
greater transparency in the pricing and storage.

 

 

Difference
Between Cash and Futures Market

 

“Cash
market is the market for buying and selling physical commodity at a negotiated
price. Delivery of the commodity takes place immediately.”

“Futures
market is the market for buying and selling standardized contract of the
commodity at a pre-determined price. Delivery of the commodity takes place
during a future delivery period of the contract if the option of delivery is
exercised.”

 

 

 

 

 

  Commodity Futures and Price Risk Management

 

The
two major economic functions of a commodity futures market are price risk
management and price discovery. Among these, the price risk management is by
far the most important, and is the backbone of a commodity futures market. The
need for price risk management, through what is commonly called “hedging”,
arises from price risks in most commodities. The larger, the more frequent and
the more unforeseen is the price variability in a commodity, the greater is the
price risk in it. Whereas insurance companies offer suitable policies to cover
the risks of physical commodity losses due to fire, pilferage, transport,
mishaps etc., they do not cover similarly the risks of value losses resulting
from adverse price variations. The reason for this is obvious. The value losses
emerging from price risks are much larger and the probability of the recurrence
is far more frequent than the physical losses in both the quantity and quality
of goods caused by accidental fires and mishaps, or occasional thefts.

 

 

In
a liquid market, the number of speculators (people looking to profit from price
fluctuations) far outnumbers the number of hedgers (those protecting themselves
against price risks)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedging

 

“It
is the act of reducing uncertainty about future (unknown) price movements in a
commodity (rubber, tea, etc.), financial security (share, stock etc.) and
foreign currency. This can be done by undertaking forward sales or purchases of
the commodity, security or currency in the forward market; or by taking out an
option which limits the option holder’s exposure to price fluctuations.”

 It avoids the risk of price shifts  and finds
solutions in the transaction , on the other hand speculations predicts
that  the risk of price changes by taking one position (either long or
short) in market, and cease the price of commodities to proceed in
“their” way. Hedging, simultaneously, has a perspective, either
long or short, mostly this is the case in the cash market, and aims to limit
the risk of price shifts loss by entering in an opposite and roughly equal
position in the second market (usually futures or options). For example, if a
manufacturer of copper wires assumes a rise in the price of copper in the
upcoming three months, he will bring a position in the futures market which is
at current prices to balance the likely price increase. Likewise, if the prices
are falling, he will sell in the futures market in the current prices against
the physical goods.

Every big buyer, seller and processor of commodities needs to
hedge against price volatilities round the year. Although year round price
variation  can be anticipated, the force of volatility cannot be
predicted. Besides, there are various factors apart from the seasonality which
causes price volatility. Thus, there is a continuous need for hedging. All big
buyers, sellers and processors and users of commodities need to hedge reason
being they all stand unguarded to price volatility. They comprise: commodity
producers, big consumers, manufacturers for whom a commodity is major raw
material, processors of commodities, importers, exporters, traders, etc. .

 In case of futures,
the party hedging would have to reimburse margin – some percentage cost of the
contract value (usually in the of 5-8%). For choice, they would have to
pay a premium, which is market-driven. Moreover, a brokerage fee is due. It is
usually not considered risky if formed on covering short-term demands. However,
if the hedging party places an incorrect bet, then they may miss out on potential
savings.

For example, if a copper manufacturer has a capacity of 200
tons and decides to sell 300 tons on the futures exchange the remaining 100
tons is considered as speculation in the market. If prices fall then he stands
to benefit, however if prices go up the 200 tons he produces can be delivered
on the exchange but he would have to incur losses on the additional 100 tons.

 

 

 

 

 

 

Arbitrage

 

“Arbitrage denotes the purchase and simultaneous
sale of the same commodity in different commodity markets in order to take
advantage of differences in commodity prices between the two markets. Such a
transfer of funds is risk-free, because an arbitrageur will only switch from
one market to another if prices in both markets are known and if the profit
outweighs the costs of the operation.”

 

 

An Opportunity for an arbitrage will tend to be
self-correcting as, because of the increase in demand for the commodity, there
will be an upward pressure on its price in that market where it is purchased;
on the other hand the increased supply in that market where it is sold will
result in a downward price movement.

 

 

Modern computer technology has accelerated the
mechanism for using arbitrage, but at the same time reducing the opportunity
for making good of price differences.

 

 

In futures markets, “cash and carry arbitrage”
exploits a situation where the price of a particular future contract is more
than the spot price of the underlying commodity, namely by buying the physical
commodity and simultaneously selling a future.

 

 

 

Gaining
From Arbitrage

 

No risks and no returns, is one of the basic
investment theories. But even then, there are some instances wherein, the risks
could be lowered and at the same time the returns maximized.

 

 

In an arbitrage, mixes of coordinating arrangements
are struck that underwrite upon the imbalance, the benefit being the
distinction between the market prices. An arbitrageur would regularly purchase
a specific commodity at a lower price on one exchange and offer it on another
where it brings them a higher price. This makes a natural hedge and in this way
the risk is also low.

 

 

Arbitrage can happen in most of the markets like
equities, currencies and commodities. “One can expect on an average 25-30%
returns from arbitrage in commodities. However, at off-price aberrations, returns
can be as high as 50% and 70%.

 

 

Commodity Arbitrage

 

Arbitrageurs in the commodity markets look for
three places to make a killing. They look at the trapping price differences
between the spot and futures market, they then look for differences between two
different national exchanges and then between two international exchanges

 

 

For example, let us look at an instance, which
persisted on the exchanges a month ago.

 

 

 

 

Step 1: An investor buys a gold
futures contract listed on Multi-Commodity Exchange (MCX), a national commodity
exchange that offers investors access to various commodities. This contract is
supposed to mature in October 2016 and is available at Rs. 13,151 per 10 grams.

 

 

Step 2: At the same time the investor enters into a
contract to sell gold in September on the National Commodity and Derivatives
Exchange, another national commodity exchange in India. The price in this case
for a similar quantity of gold is Rs. 13, 187, which is higher than the amount
on the MCX.

 

 

Step 3: On August 14, it is seen that the rates for
the gold contracts on both the exchanges have moved. On the MCX the Gold
October contract became Rs. 13, 129, losing Rs. 22 per 10 gms, and on the
NCDEX, the price for the Gold September contract has gained by Rs. 75 from this
transaction.

 

 

Step 4: Now the arbitrageur will sell the contract
on MCX and lose Rs. 22. At the same time he will liquidate the Gold September
contract and gain Rs. 97. Totally, the investor will stand to gain Rs. 75 from
this transaction.

 

 

Factors causing imbalance in prices are caused by
several disparities. Structural disparity between exchanges is one such. Volume
on NCDEX is not deep. So a trader sells a commodity on this exchange, prices
fall steeply on the exchange.

 

 

On the other exchanges, this might not be the case.
These are specific commodities that have low volumes on different exchanges.
For example, agricultural commodities

 

 

 

like pepper have larger trading
volumes on the NCDEX while MCX in international commodities. So whenever there
are low volumes, there are volatile changes in prices, thereby creating
disparity.

 

 

Differences in the expiry dates of contracts on
exchanges can also create imbalances. Then there are technical possible demand
and supply disruptions that have a direct effect on commodity prices.

 

 

Investment Opportunities Through Arbitrage

 

The
investment opportunities for traders in the Indian Commodity Market under

 

Arbitrage
are:

 

1.      Arbitrage
b/w Physical & Futures

 

When market trend is formed speculators often buy
futures of commodity at premium. In these situations an investor can buy that
commodity in physical and sell it future through commodity exchanges.

 

 

2.      Arbitrage
b/w Exchange to Exchange

 

At sometimes in a particular exchange a particular
commodity is available at discount as compared to other exchanges in these
circumstances a prudent investor can buy that particular commodity in exchange
where it is available at cheaper rate and sells the same at other exchange
where it gets the higher returns.

 

 

 

 

 

 

 

 

 

 

 

 

 

Products
in Indian Commodity Market

 

 

 

 

•      
Bullion

 

Ø  Gold

 

Ø  Gold
Guniea

 

Ø  Gold HNI

 

Ø  Gold M

 

Ø  i-Gold

 

Ø  Silver

 

Ø  Silver
HNI

 

Ø  Silver M

 

Ø  Platinum

 

 

 

 

•      
Oil &
Oil Seeds

 

Ø  Castor
Oil

 

Ø  Castor
Seeds

 

Ø  Coconut
Oil

 

Ø  Cotton
Seed

 

Ø  Crude
Palm Oil

 

Ø  Groundnut
Oil

 

Ø  Kapasia
Khalli

 

Ø  Mustard
Oil

 

Ø  Mustard
Seed (Jaipur)

 

Ø  Mustard
Seed (Sirsa)

 

Ø  PBD
Plamolein

 

 

 

Ø  Refined
Soy Oil

 

Ø  Refined
Sunflower Oil

 

Ø  Rice Bran
DOC

 

Ø  Rice Bran
Refined Oil

 

Ø  Seasame
Seed

 

Ø  Soymeal

 

Ø  Soy Bean

 

Ø  Soy Seeds

 

 

 

 

•      
Spices

 

Ø  Cardamom

 

Ø  Coriander

 

Ø  Jeera

 

Ø  Pepper

 

Ø  Red
Chilli

 

Ø  Turmeric

 

 

 

 

•      
Metal

 

Ø  Aluminum

 

Ø  Copper

 

Ø  Lead

 

Ø  Nickel

 

Ø  Sponge
Iron

 

Ø  Steel
Long (Bhavnagar)

 

Ø  Steel
Long (Govindgarh)

 

 

 

 

Ø  Steel
Flat

 

Ø  Tin

 

Ø  Zinc

 

 

 

 

•      
Fiber

 

Ø  Cotton L
Staple

 

Ø  Cotton M
Staple

 

Ø  Cotton S
Staple

 

Ø  Cotton Y
Yarn

 

Ø  Kapas

 

Ø  Raw Jute

 

 

 

 

•      
Pulses

 

Ø  Chana

 

Ø  Masur

 

Ø  Yellow
Peas

 

 

 

 

•      
Cereals

 

Ø  ATF

 

Ø  Brent
Crude Oil

 

Ø  Crude Oil

 

Ø  Electricity

 

Ø  Furnace
Oil

 

Ø  Heating
Oil

 

Ø  Natural
Gas

 

 

 

 

Ø  M. E.
Sour Crude Oil

 

 

 

 

•      
Plantations

 

Ø  Arecanut
Jahaji

 

Ø  Cashew
Kernel

 

Ø  Coffee
(Robusta)

 

Ø  Red
Arecanut Raashi

 

Ø  Rubber

 

 

 

 

•      
Petrochemicals

 

Ø  HDPE

 

Ø  Polypropylene
(PP)

 

Ø  PVC

 

 

 

 

•      
Others

 

Ø  Guargum

 

Ø  Guar Seed

 

Ø  Gurchaku

 

Ø  Mentha
Oil

 

Ø  Potato
(Agra)

 

Ø  Potato
(Tarkeshwar)

 

Ø  Sugar
M-30

 

Ø  Sugar
S-30

 

 

 

 

 

 

 

 

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