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