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A Guide to Commodity Trading in India

commodity trading in India | marketfeed

Commodity trading is an exciting segment of financial markets that many traders in India are unaware of. While Indian equity markets operate from 9:15 a.m. to 3:30 p.m., the commodity market offers extended trading hours from 9:00 a.m. to 11:30 p.m., divided into two sessions. This is especially beneficial for working professionals who can trade after office hours. However, entering this market requires a clear understanding of its dynamics, benefits, and risks. In this article, we dive into everything you need to know about commodity trading in India.

What is Commodity Trading?

Commodity trading involves buying and selling commodities, such as natural resources or agricultural products, on exchanges. This can include energy sources like crude oil and natural gas, metals such as gold and silver, and agricultural products like wheat and cotton. The primary goal in commodity trading is to profit from fluctuations in the price of these commodities.

Why Does Commodity Trading Exist?

Unlike equity markets that exist for companies to raise funds, the commodity market primarily serves to allow businesses to hedge against price fluctuations. For example, consider a gold shop owner named Charlie. He holds 10 kg of gold, hoping to profit from making jewellery. If the price of gold falls significantly from ₹80,000 per 10g to ₹60,000, Charlie may incur losses that outweigh his profits from jewellery sales. But if the price of gold goes way up (say ₹1 lakh per 10g), he might earn more, but it will also cost him more to restock. Thus, commodity trading allows Charlie to hedge his risk by using futures contracts to balance potential losses or gains.

[A futures contract is an agreement to buy or sell something (like gold, oil, or stocks) at a fixed price on a future date. It helps buyers and sellers protect themselves from price changes—buyers lock in lower prices if they expect a rise, while sellers secure higher prices if they expect a drop.]

How to Get Started in Commodity Trading in India?

To begin trading commodities, you need to understand the basics, including the types of commodities available, how trading works, and the exchanges involved.

In India, there are two primary exchanges for commodity trading:

  • National Commodity & Derivatives Exchange Ltd (NCDEX): This platform primarily deals with agro-based commodities like wheat, spices, and cotton.
  • Multi Commodity Exchange (MCX): This is where non-agro commodities like gold, silver, zinc, and crude oil are traded.

Both exchanges are regulated and provide a safe environment for trading. It is crucial to avoid unregulated platforms or apps that do not adhere to SEBI guidelines!

All major brokers in India like Zerodha, Upstox, Fyers, etc. support commodities trading. You should activate the commodities segment separately in your broker/trading account.

Types of Contracts

Commodity trading mainly involves derivatives, specifically futures and options:

  • Futures Contracts: Agreements to buy or sell a commodity at a future date at a predetermined price.
  • Options Contracts: Rights to buy or sell a commodity at a specific price before a set date.

Unlike stocks, commodities can’t be held forever. Every futures or options contract has an expiry (settlement) date. As a thumb rule, never let your commodity trades enter into a settlement phase. It’s better to square off your positions at least 2-3 days before the settlement date.

Some of the most actively traded commodities include:

  • Gold: Available in various contract sizes, including 1 kg, 100 g, and 8 g.
  • Silver: Typically traded in contracts of 30 kg or smaller sizes.
  • Crude Oil: A significant commodity often influenced by global market conditions.
  • Natural Gas: Another volatile commodity that attracts traders.

The capital needed to trade commodities depends on the type of commodity and the broker’s policies. Brokers often have specific margin requirements for commodities.

Commodity trading offers high leverage. For example, a gold mini contract worth ₹7.2 lakh may only require ₹72,000 as margin. Leverage amplifies both profits and losses, so it’s essential to have proper risk management strategies in place!

Commodity Indices in India

Similar to equity indices like Nifty50, commodity markets also offer indices for trading:

  1. Bullion Index: Tracks gold and silver prices.
  2. Metal Index: Tracks aluminium, copper, lead, zinc, and nickel prices.
  3. Energy Index: Tracks crude oil and natural gas prices.

These indices allow traders to speculate on overall market movements rather than individual commodities.

Advantages of Commodity Trading

Commodity trading offers several benefits that can attract both individual and institutional traders:

  • High Liquidity: Many commodities, especially gold and crude oil, have high trading volumes. These markets tend to follow price action well.
  • People who are unable to trade during the daytime (office-goers) can use the opportunity to make potential extra income!
  • Less Price Manipulation: Commodities are traded globally, reducing the chances of price manipulation compared to more localised markets.
  • Hedging Opportunities: Businesses can hedge against price fluctuations to stabilise costs and revenues.

Disadvantages of Commodity Trading

While there are many advantages, there are also significant risks and drawbacks to consider:

  • High Price Volatility: Commodity prices can change rapidly due to geopolitical factors or supply and demand shifts, which may result in substantial losses for unprepared traders.
  • Leverage Risks: Trading with leverage can amplify losses. Commodity traders must understand how to manage leverage effectively.
  • Liquidity Issues: Not all contracts have the same level of liquidity, which can complicate trades and lead to slippage.
  • Geopolitical Sensitivity: Commodity markets are often the first to react to global events, requiring traders to stay informed about international affairs.

Conclusion

Commodity trading presents a unique opportunity for investors looking to diversify their portfolios and take advantage of market fluctuations. Also, profits from commodity trading are treated as business income (same as F&O). You’ll have to pay tax based on your tax slab.

Approach the commodities market only after a thorough understanding of the risks involved, the mechanics of trading, and the specific commodities you wish to trade. Always start small, educate yourself continuously, and consider consulting with financial advisors to navigate the commodities market effectively.

As you venture into commodity trading, remember to keep your capital allocation conservative, especially if you’re new to the field. With the right strategies and knowledge, you can successfully navigate the volatile waters of commodity trading and potentially achieve significant returns. Happy trading!

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Editorial

China and the Fall in Commodity Prices

Since the beginning of 2021, many countries have reopened their economies and introduced large stimulus packages amidst the (ongoing) Covid-19 pandemic. There was also strong demand for various industrial raw materials from large importers such as China. As a result, the prices of commodities such as iron, steel, copper, and crude oil had skyrocketed and hit record highs. marketfeed had prepared a detailed article in February on the various factors that led to the rally in commodity prices. 

However, the monumental gains posted by certain commodities since January have been wiped out over the past week or so. Copper prices have corrected over 15% from their all-time highs. The prices of palladium, platinum, and even corn futures have also fallen sharply. Let us understand the primary reason behind the fall in commodity prices.

China’s Efforts to Slow Inflation

On June 16, the Chinese government asked state-owned companies to limit their exposure to foreign commodities markets. These firms will be forced to release strategic reserves of metals such as zinc, copper, and aluminium in batches to industrial consumers in order to stabilise prices. When China (the world’s top consumer of metals) cuts down on imports, it will surely lead to a decline in global prices. Soon after this announcement took place, the prices of metals fell heavily. We saw the Nifty Metal index fall by around 9% last week! 

Now, why did China introduce such a measure?

China’s Producer Price Index (PPI) increased by 9% in May, the highest growth in nearly 13 years. However, the rising prices of various industrial raw materials (inputs) are making Chinese products less competitive. The companies that manufacture these industrial commodities are unable to pass on their high costs to consumers. This is because inflationary pressures pose a risk to overall economic growth in China. 

The Chinese Communist Party’s Global Times (a state-owned publication) had reported that the country’s manufacturers were suffering because high input costs were deeply affecting their margins. For example, home appliances are usually sold at a discount around April, but companies were forced to raise prices. They can hike prices as their costs go up, but this practice/trend cannot last for a long period. Moreover, the end price is subject to certain contracts and other factors, which cannot be altered quickly. Thus, a strategic release of metal reserves will help China control prices and keep inflation in check.

Other Measures Taken by China

On May 24, 2021, Chinese regulators had warned metal manufacturers to maintain good market order. The regulators began to strengthen inspections of both futures and spot markets while cracking down on irregularities and malicious speculation. This had led to a sharp fall in metal prices. [Spot markets are where commodities are traded for immediate delivery. A commodity futures contract is an agreement to buy or sell a predetermined amount of a commodity at a specific price on a specific date in the future].

Why are Actions Taken by China so Important?

As most of you are aware, China is a major player in the global commodities markets. They import large quantities of iron ore, steel, and other metals for their development activities. The country is also notorious for hoarding steel and driving up its prices. Markets around the world keenly watch out for every statement or action made by Chinese authorities. When the country was industrialising rapidly at the turn of the century, its demand for raw material triggered a commodities supercycle. A supercycle is an extended period of high demand growth that producers (or suppliers) struggle to match. This ultimately leads to an increase in commodity prices.

Despite its high influence, experts say China may not be able to take on market forces (or cool down prices) in the long term. Investment banking firm Goldman Sachs believes that China ‘does not have the muscle to change the price trend’ of commodities. The firm further said prices were rising because of a global demand-supply mismatch. On June 22, ace investor Rakesh Jhunjhunwala said the steel supercycle had just begun and will last for 5-7 years. He is super bullish on the metals sector as a whole.

There is a complete lack of transparency over the quantity of reserves China holds, and how much would be sold over a certain period. Thus, experts and traders are unable to make an accurate forecast. Even though China does not have enough inventory to change the global outlook for commodities, it can certainly influence overall sentiment. 

Let us know your views on the topic in the comments section of the marketfeed app.

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Editorial

5 Reason Why Commodity Prices Are Increasing and Impact on Stock Market

Last year, the prices of commodities such as crude oil, silver, copper, etc saw a significant fall due to the Covid-19 pandemic. All major economic activities were disrupted as countries went into complete lockdowns. Now, the situation has more or less turned for the better, and commodity prices are witnessing a strong recovery. Copper prices have rallied by over 60% since the beginning of the year and have hit their 10-year high. The price of Brent crude oil, which fell to $20 per barrel in April 2020, has shown a sharp rise to ~$65 (as of Feb 23). The prices of Silver and Platinum have also shown monumental gains over the past year. 

Let us understand some of the reasons behind this surge in commodity prices.

Factors Behind the Rally in Commodity Prices

  • During a period when countries were under strict lockdowns, China began to open up its factories. They had a headstart in manufacturing activities. In fact, the Chinese factory output in November 2020 hit a 20-month high. Thus, there was a huge rise in demand for commodities from the country, which led to a rise in its prices. There were also reports stating that China has been hoarding steel and is controlling its prices.
  • As lockdown restrictions were lifted globally, the demand for industrial commodities started rising. The different sectors of the economy began to ramp up production activities. At the same time, supply chain disruptions or logistical issues continued. Commodity traders blamed the global container shortage as a major reason for high transportation costs. This ultimately led to a surge in the prices of essential commodities such as steel, copper, tin, and aluminium.
  • Recently, oil-producing nations have limited their supply to energy-dependent countries such as India. This has caused crude oil prices to increase exponentially.
  • The passing of the $1.9 trillion US stimulus package can also be attributed to the sharp rise in commodity prices. Financial analysts state that the package would lead to further demand for commodities as people will spend more (or more money will be in circulation).
  • Investing in the commodities market is a great way to diversify your portfolio. Over the past few months, hedge funds have invested billions of dollars into this market. This is primarily due to the optimism surrounding vaccine rollouts and economic recovery. It has been recommended as one of the best asset classes to hedge against inflation, leading to a sharp increase in returns.
  • As most countries are on the path towards building renewable energy infrastructure, the demand for metals is at an all-time high. This is driven by an increase in the production of batteries, solar panels, and electric vehicles (EVs).

What is the Impact of Rising Commodity Prices?

The commodities market is receiving a lot of attention from investors around the world. They are collectively pulling money from the stock markets and infusing billions into commodities (due to its high returns). Investment groups and hedge funds are also investing heavily in bonds due to higher yields. However, this may be a short-term phenomenon until financial institutions reshuffle their portfolios.

As India came out of its Covid-related lockdowns, we witnessed pent-up demand for commodities- which led to a further rally in its prices. This has caused fears of inflation in our domestic market. The high price of steel has heavily impacted the automobile and infrastructure sector. We saw companies such as Maruti Suzuki, Tata Motors, Mahindra & Mahindra, and Hero MotoCorp introducing price hikes for their vehicles in January. The continuous surge in prices of raw materials would also affect the real estate sector in the long term. Developers would face an increase in overall project costs, and homebuyers would have to pay more for acquiring assets. The general rise in demand with a fall in supply is helping no one.

One of the most serious issues that Indians face today is the continuous increase in fuel prices. The price of petrol has even crossed the psychological barrier of Rs 100 per litre in several cities. The rise in global crude oil prices and high taxes (or excise duties) are concerning. This ultimately leads to a surge in prices of essential items such as food. With no solution in sight, the middle-class and poor sections of society continue to suffer. Let us look forward to seeing how the situation unfolds in the weeks to come.