Government of India, in 2002-03, has demonstrated its commitment to revive the Indian agriculture sector and commodity futures markets. Prime Minister’s Independence Day address to the nation on August 15, 2002, which enlisted nation-building initiatives, included setting-up of national commodity exchange among the important initiatives. The year 2002-03, certainly, was an eventful year in terms of regulatory changes and market developments that could set the agenda for development for the years to come.
Futures trading is an agreement between a buyer and a seller obligating the seller to deliver a specified asset of specified quality and quantity to the buyer on a specified date at a specified place and the buyer, in turn, is obligated to pay to the seller a pre-negotiated price in exchange of the delivery.
In futures trading the contracting parties negotiate on, not only the price at which the commodity is to be delivered on a future date but also on what quality and quantity to be delivered and at what place.
Futures trading perform two important functions—price discovery and hedging of price risk in a commodity. Presently, futures trading is permitted in 41 commodities in India. Some of them barred recently by the Government due to increased inflation and steep price hike in the essential commodities.
The Indian commodity market is estimated to be around Rs. 11,00,000 crore, which includes agricultural commodities (rice, wheat, soya, groundnut, tea, coffee, jute, rubber, spices, cotton, etc), precious metals (gold and silver), base metals (iron ore, aluminum, nickel, lead, zinc, etc.) and energy commodities (crude oil and coal).
Trade pundits are betting big bucks on the commodity trade. And many believe that it would be the next big thing for investors. Surely, bigger than the stocks because globally the commodity trade is about three times the size of equities.
Currently, the various commodities traded across the exchanges clock an annual turnover of Rs. 2,90,000 crore, which includes the high-volume crude oil trade listed recently on the MCX. This figure can grow multifold with the introduction of futures trading and participation of more retail investors.
Commodity Trading created much controversy recently
According to an estimate the commodity market is expected to grow at an annual rate of 40% over the next five years. The lucrative commodity futures volumes touch $800 million a day on an average. This is expected to grow at 100% every year. With FIIs eying the Indian markets in a big way, commodities can also gain unfathomable depth.
With a minimum investment of as low as Rs. 5,000 and more than 42 traded commodities (now few are restricted) on offer for the investor, commodity trading is a hot option. The trading has been further boosted by the emergence of a highly evolved national commodity markets on the lines of NSE.
Besides the three national exchanges—National Commodity and Derivative Exchange, the Multi Commodity Exchange and the National Multi Commodity Exchange—there are 22 more exchanges and trading boards recognised by Forward Markets Commission (FMC), the market regulator.
Several high-profile equity brokers have become members with NCDEX and MCX. The names include Refco Sify Securities, Sharekhan, ICICI Commtrade, ISJ Comdesk and Sunidhi Consultancy, and are already offering commodity futures services. Some of them also offer trading through the Internet just like the way they offer equities.
With the WTO regime ushering in a new era in global trade, commodity trading becomes a global phenomenon as price issues cannot be manipulated easily, hence futures and options can be used in trading.
India being a major user of crude oil, (which is the world’s most traded commodity), edible oil and gold can become the hub of such commodities. Every year, India buys $25 billion worth of crude oil, $8.5 billion worth of gold and $9 billion of edible oils.
BENEFITS
To producer: A producer of a commodity can sell the futures of the commodity, thereby ensuring that he can sell a particular quantity of his commodity at a particular price at a particular date.
To investors: An investor has alternative investment instruments where he can take a position as to future price and the spot price at a particular date in future and buys and sells options. He is not interested in taking deliveries of the commodities.
To commodity trader: A commodity trader can use these to ensure that he is protected against any adverse changes in the prices. He can enter into a futures contract for purchase of a certain quantity of the underlying at a particular price on a particular date, or he can enter into a futures contract for sale of a particular quantity on a particular date at a particular price and be assured of the margins because both his purchase price as well as the sale price are fixed. Traders do a good arbitrage in Gold and Silver. Whenever they find Gold moving up, they short silver and similarly whenever they find silver moving up and gold likely to move down, they hedge.
To exporters: Future trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market. Having entered into an export contract, it enables him to hedge his risk by operating in futures market.