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What Is A Commodity Market And Why Invest In It?

The commodity market is an alternative to the stock market. This blog will help you understand how the commodity market works, what type of commodities are traded, and the benefits & risks.
January 15, 2021

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Diversification is an important part of an investment strategy. Some investors choose to diversify with stocks and mutual funds while others choose to invest in fixed deposits and recurring deposits. 

However, there’s a whole different market that allows investors to diversify their portfolio with exposure to silver, oil, natural gas, pulses, cereals, and more. It’s known as the commodity market. 

In this blog, we will explain the commodity market in a simple way so that you can understand how it functions, the players involved, and the benefits and risks. 

Important: This blog is meant to educate readers and the information furnished here is not to be construed as investment advice from Cube Wealth. 

What Is A Commodity Market?

A commodity market is a physical or digital platform that allows you to buy, sell, and trade products like oil, natural gas, gold, silver, cotton, rubber and more. These products are known as commodities.

In a commodity exchange market, you invest in a futuristic price of the product determined by a futures contract. When buying a regular stock, an investor has the right to either buy or sell. 

However, a futures contract carries an obligation rather than a right which means that both the buyer and seller must stick to the pre-agreed terms & conditions. 

Investment Fact

The Indian commodity market and commodity exchanges are regulated by the Forward Markets Commission (FMC). The futures contracts are governed by the Forward Contracts (Regulation) Act, 1952. 

Types Of Commodities Traded In The Indian Market

1. Bullion

Bullion generally refers to coveted metals that have been refined to a high degree of purity. The term is generally associated with gold and silver and unsurprisingly, those are the commodities included in this category. 

Commodities: Gold, Gold HNI, Gold M, i-gold, Silver, Silver HNI, Silver M.

2. Metals

This category includes a wide variety of base metals and alloys that are mostly used for heavy machinery or industrial activities. 

Commodities: Aluminium, Brass, Lead, Copper, Nickel, Tin, Zinc, Sponge Iron, Steel Flat, Steel Long.

3. Cereals & Grains

The commodities from this category are essential for both individual and business entities.

Commodities: Mentha Oil, Guar Seeds, Guar Gum, Gur Chaku, Potato, Sugar (M-30 & S-30), Maize.

4. Energy

Energy-related commodities are coveted by investors since they have a direct impact on major economies around the globe.

Commodities: Crude Oil, Natural Gas, Brent Crude Oil, Furnace Oil, M. E. Sour Crude Oil.

5. Fiber

Fibers from this category are mainly used for textile engineering but their use is found in individual homes as well.

Commodities: Cotton Staple (L, M, S), Cotton Yarn, Kapas.

6. Plantations

This cateogry includes commodities that are harvested on a large or small scale and are crucial to the economy.

Commodities: Rubber, Arecanut, Cashew, Coffee.

7. Petrochemicals

Petrochemicals are manufactured on a large scale and are derived from petrol and natural gas.

Commodities: PVC, HDPE, Polypropylene(PP).

8. Spices

Spices are crucial to almost every region in India. Hence, their production and even trade holds high value in the country.

Commodities: Red Chilli, Cardamom, Turmeric, Jeera, Pepper.

9. Oil & Oil Seeds

India is a major producer of oil and oil seeds and as a result, these commodities are traded on the commodity exchange.

Commodities: Mustard Oil & Seeds, Soy Bean & Seeds, Soymeal, Soy Oil, Rice Bran DOC & Refined Oil, Castor Oil & Seeds, Coconut Oil & Cake, Crude Palm Oil, Groundnut Oil, Cotton Seeds, Sesame Seeds, RBD Palmolein, Refined Sunflower Oil, Kapasia Khalli.

10. Pulses

Pulses are just as popular and widely produced in India as cereals and grains.

Commodities: Chana, Masur, Yellow Peas.

How To Invest In The Commodity Market?

You can invest in the commodity market in one of the following ways:

1. Physical Ownership 

An investor may choose to buy a commodity in its physical form, like gold or silver, hold it for a certain period of time, and then sell it off to another trader. 

Read this blog to learn more about the best ways to invest in gold in India.

2. Commodity Exchange 

The other way is to trade commodities listed on a commodity exchange by entering into a futures contract. A commodity exchange is like a stock exchange but for hard and soft commodities.

There are 3 main national commodity exchanges in India in terms of market share (apart from numerous regional exchanges):

1. Multi Commodity Exchange (MCX)

2. National Commodity & Derivative Exchange (NCDEX) 

3. National Multi Commodity Exchange of India (NMCE)

You can invest in approximately 100+ products listed on several Indian commodity exchanges. 

Watch this video to know the benefits of long term investing

Relationship Of The Commodity Market And Stock Market

The commodity market and the stock market are inversely related. If the price of a commodity in a particular sector goes up, the value of a stock in the same sector may go down. 

This implies that diversifying your investments by adding commodities into your portfolio either physically or through a futures contract, can help when the equity markets are bearish.

However, you must consult a Cube Wealth Coach before investing your hard-earned money in any market-related instrument to understand which investments are suitable for your needs. 

Read this blog to know how Purnartha and Cube help you invest in the best Indian stocks. 

Who Are The Traders In A Commodity Market?

A commodity trader can be an individual or company that trades in hard and soft commodities in the commodity market. A trader can hold commodities in the physical or non-physical form. 

By definition, a trader is someone who buys and sells assets for profits by focusing on the short term. This is the key difference between a trader and an investor.

Traders tend to capitalize on short term trends while investors tend to prefer a long term strategy. Here are different types of commodities traders: 

1. Speculators

Speculators are seasoned traders who thrive on taking risks. Speculators use the price movements of commodities to generate short term profits frequently. 

A speculative trader will have no intention of owning the commodity at the end of the futures contract. Instead, a speculative trader will enter into a futures contract at a low and sell it for high.

The overall aim of speculators is to beat the downsides of a long term investing strategy. 

2. Hedgers

Hedgers are conservative or safe traders who mostly deal in futures contracts. These traders use hedging techniques to protect themselves from erratic prices and future losses. 

A hedger may make lower profits compared to a speculator. However, a hedger will look to offset losses with inversely correlated investments and conservative strategies.

Prices Determined In Commodity Exchange

There are several factors that affect the price of a commodity:

1. Demand And Supply

The commodity market functions on supply and demand which may affect prices. If the demand for a commodity is high, the price of the commodity may be high. 

Conversely, lower demand may lead to lower prices. This principle holds true for both commodities and equities.  There’s also a chance that speculations may have an impact on the prices of commodities.

2. International Factors

We live in a global economy that is largely dependent on import and export. So certain commodities are influenced by international market conditions and trade relations.

If India imports a commodity from China, any negative trend in either China’s economy or the particular sector may affect the price of the commodity in India. 

3. Domestic Factors

A downward trend in a particular sector within the country or a slump in the country’s economy may have an impact on the price of the commodity.  

Why Invest in the Commodities Market?

1. Predetermined Prices

Commodity exchanges function on futures contracts where buyers and sellers agree to trade a commodity at a predetermined price. The process of determining the price of a commodity known as “price discovery”.

2. Diversification

The commodity market is negatively correlated with the equity market. Moreover, the Indian commodity market is relatively broad and contains oil, natural gas, silver, and even sugar, 

Thus, it offers investors a chance to diversify their portfolio and hedge against losses that they may experience in the equity market. 

However there are many better ways the Cube Wealth app helps you diversify your portfolio internationally. Download the Cube Wealth to invest in US stocks for as little as $1, invest in international mutual funds, digital gold & more!

Benefits And Risks Of The Commodity Market

 

Serial number

Benefits Of The Commodity Market

Risks Of The Commodity Market

1.

Diversification

Credit risk

2. 

Liquidity

High volatility 

3. 

Hedge versus inflation

Market-based risks

Summary


Shriram Shekhar
Shriram is a Consultant at CubeWealth. He has developed cutting edge IT products for over 2 years before turning to his passion for the written word. His love for philosophy, developing products, and empowering people through quality content is what got him to CubeWealth.

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