What are commodities Exchange?
The Commodities exchange allows traders to buy and sell goods. It includes both simple goods and manufacturing goods. The function of Commodity exchange is to provide a centralized marketplace where commodity producers and commercials can directly sell to those who want them for consumption or manufacturing. Commodity future exchange connects buyers and sellers easily. It helps businesses to enhance while there is a buyer for every seller. It makes the economy much more efficient with standardized prices for a commodity. Commodities are into two broad categories: hard and soft. Hard commodities consist of natural resources that must be mined or extracted, whereas soft commodities are agricultural products such as grain, meat, dairy, and livestock. Investors use these commodities to diversify their portfolios. Commodities are considered a risky investment class.
It is affected by many uncertainties and risks, such as epidemics, natural calamities, or other unpredictable circumstances. Individuals can invest in commodities through futures, options, exchange-traded funds, and contracts. There are six major commodity trading exchanges in India:
1. Multi Commodity Exchange (MCX)
2. National Commodity and Derivatives Exchange (NCDEX)
3. National Multi Commodity Exchange (NMCE)
4. Indian Commodity Exchange (ICEX)
5. Ace Derivatives Exchange (ACE)
6. The Universal Commodity Exchange (UCX)
Types of commodities:
1. Metals Commodities – This includes the trading of precious metals such as gold, silver, copper, and platinum. Gold is traded by investors as it is the safest way to diversify their portfolios against any uncertainties like inflation or currency devaluation.
2. Energy – This includes commodities like gasoline, natural gas, heating oil, and crude oil. Normally, oil price fluctuates due to the increasing demand for energy commodities. However, individuals entering energy commodities should be aware of economic reforms, a shift in production by OPEC, and new advances in technology.
3. Agriculture commodities – Commodities such as soya, rice, wheat, coffee, corn, cocoa, sugar, and cotton come under agriculture commodities. These commodities are bought by the wholesaler or a firm that uses them as a raw material.
4. Meat and livestock – This includes commodities like feeder cattle, pork bellies, lean hogs, and live cattle. The trading of livestock is not popular in India. It is mostly done in the US, UK, China, etc.
Ways to Invest:
A derivative Contract (Financial Instrument) is a contract between two parties for deriving value from any underlying assets. As the Price of underlying assets changes, the value of underlying assets also fluctuates.
The types of Derivative Contracts:
Options – Options are contracts where the buyer has a right to buy or sell a particular security at a predefined price. It is commonly known as a strike price. However, they don’t have obligation to buy or execute the option. One who executes the contract is known as the option writer.
Forwards – It has an obligation in the contract, which is unstandardized and not traded on stock exchanges. Forwards are available over the counter only and cannot de traded directly on market. However, forwards can be customized according to the parties involved. Forwards contract has third party risk. There are chances that the other party defaults in the payment or delivery of the product are not done as there is no regulatory party involved.
Futures – This is the same as forwards, but futures are standardized and allow holders to sell or buy security at a specified price and date. Futures can directly be traded on market.
Swaps – It involves swapping of obligations between the two parties depending on cash flows which are depended on the rate of interest and agreed upon at the period while entering into the contract. Here, one cash flow is fixed and the other depends on the market interest rate and usually, these rates are swapped.
The best way to trade in commodities is through futures contracts. An agreement to buy or sell a commodity in the future agreed on a date at a pre-determined price.
Role of commodity market:
1. Food security – Farmers can use the future market more effectively by selling at a future price by fixing the price. This will ensure that they are not susceptible to future fluctuation in price. Hence, food security can be achieved using the commodity market. Many times commodity markets help farmers in hedging the commodity which is prone to uncertainties and risk.
2. Agricultural ecosystem – Substantial amount of food grains are lost in the transmission process. The commodity market helps farmers, brokers, middlemen, and customers. If the food gains are not stored properly they get attacked by rats and pests.
3. Aggregation – Currently, the middleman acts as an aggregator which is not a transparent mechanism. So, commodity exchange provides an organized and guaranteed mechanism for all the essential commodities.
4. Hedging and risk – One important role and function of the commodity market is to hedge and distribute the risk in the market.
5. Speculative excess – The commodity market absorbs speculative excess risk in the market, especially in the spot market. It helps various retail investors to participate in the new asset class.
