Introduction of Commodity Market
A commodity market is a market where commodities are traded (i.e.) buying and selling of commodities like raw agricultural products, energy products, and metals.
In the commodities market, traders trade commodities just like how equities are traded in the stock market. Commodities are broadly divided into two categories – Hard commodities and soft commodities. Hard commodities are natural resources that are extracted from mining like precious metals – Copper, gold, silver, etc. and Energy products –Crude oil, natural gas, etc.
Soft commodities are agricultural products or livestock that are grown like coffee, sugar, wheat, rice, live cattle, pork, etc. Investors or traders can invest/trade in commodities by investing in companies that deal with commodities or by investing/trading in commodities directly through futures/options contracts on the commodities market. Investors choose to invest in commodities future to counterbalance the risk of adversative future price movements in the commodities.
How Does It Work?
Investors can invest in commodities by purchasing the shares of the company whose business line deals with commodities, commodity-based mutual funds, Exchange-traded funds (ETF) that deals with commodities, or they can directly trade with commodities by buying either in spot or through future contracts/ options contracts in the commodities market.
An investor who enters into futures contracts has an obligation to either buy or sell commodities at a predetermined price on a fixed date in the future. Option contracts has the right but not the obligation to trade in commodities. Investors invest in the commodity market to mitigate the risk and to hedge against the inflation rates in the economy.
Types of Commodity Market
Commodities are traded in the commodities market and every country has multiple commodity exchanges.The commodities market enables the trading of both physical goods and derivative contracts.
In India, the following are the commodity exchanges:
- Multi Commodity Exchange (MCX)
- Indian Commodity Exchange (ICEX)
- National Commodity and Derivatives Exchange (NCDEX)
- National Multi Commodity Exchange (NMCE)
Traders in the Commodity Market
There are two main categories of individuals in the commodity market based on commodity exchange operations.
- Hedgers: Hedgers invest in commodities by entering into futures contracts to reduce the risk of exposure to market volatility. Hedging the commodities price helps the investors to stay unaffected by price fluctuations. Hedgers trade physical goods in the commodities market as they need goods for their activities. Their prime purpose is to get commodities at the right price rather than trading for profits.
- Speculators: Speculators are investors who trade in the commodities market to generate profits from trading. They trade based on the price predictions and forecasts and enter into futures contracts or trade spot markets. They don’t do physical trading as they are interested only in profits. They choose to go for cash settlements rather than going for physical trading.
Commodity Market Timing
In India, the commodity exchange operates from 9 AM to 5 PM. Internationally commodities trade at different timings in exchange. Different commodities trade at different timings. Internationally markets operate even for 24 hours.
How to Invest in the Commodity Market?
Investors can invest in the Commodity market either by way of exchange of physical goods which is predominantly done by institutional investors and other sets of investors trade in the commodities market to generate profits. Investors can trade through the spot market or futures or options contracts.
Futures Contract: Futures contracts are entered in by sellers/buyers where they sign for future agreements with their counterparty to buy/sell a stipulated quantity of a commodity at a fixed price. When the market is moving towards downward trend sellers will enjoy profits, when the market is performing well with an upward trend, buyers will get more gain. If the trade is being carried out under the direction of commodity exchange, it is called a future derivative contract and if it happens between two parties without the direction of commodity exchange it is known as counter exchange trading.
Options contract: In options trading, investors enjoy the right but not an obligation to buy/sell a commodity derivative at a fixed price. It helps investors to make profits based on market fluctuations as there is no obligation to buy or sell the products.
Following are the advantages are given below:
- Commodities have good growth opportunities. When the demand for commodities increases in the market, the price of the same will be boosted and investors can earn a good return as well as a quick return through the commodity market.
- The Commodity market offers diversification (i.e.) investors and traders can put their money across various commodities like agricultural products, metals, energy products, etc. Diversification reduces the risk and helps to get decent returns from trading through various commodities.
- Investors who invest in bonds and stocks also choose to invest in commodities to manage the risk and returns of the overall portfolio.
- It is also useful at the time of market changes, like in case of inflation, stocks and bonds will perform low but at that time the price of commodities will increase, and investors can get good gains. Investors can always consider investing in commodities as part of their portfolio strategy.
- It is a liquid investment and the futures contract is a lot cheaper compared to the price of the underlying instrument.
Following are the disadvantages are given below:
- Commodities’ prices are highly volatile compared to stocks and bonds. There is always an element of risk associated with investments in commodities.
- It can so happen that the commodities market may not generate much gain to traders and investors considering the volatility nature and risk associated with it. Commodity market investments don’t offer any interest or dividend returns like bonds or equity as it provides only capital gains.
The Commodities market offers traders and investors to deal with commodities. Investors/ traders can enter the commodity market for the exchange of physical commodities or for generating profits through trading. It is used for hedging the risk of price fluctuations and market volatility. Investors can put money in the commodities market to manage the overall portfolio risk and returns.
This is a guide to Commodity Market. Here we also discuss the introduction and how does commodity market work? along with advantages and disadvantages. You may also have a look at the following articles to learn more –