In this video, Edelweiss Professional Investor Research Team explains about the commodities market and commodities trading in a simpler way for even beginners to understand it.
Commodities are all around us. The fluctuation in the prices of a commodity affects our day to day lives. For example, someone who drives a car will be affected by the change in the price of crude oil. If average rainfall levels go below par, it affects the production and prices of crops, and hence our next meal.
A commodity market is a place which facilitates commodity trading of various types. In India, MCX trading is the exchange for commodity trading.
Commodities are divided into 3 categories: 1) Metals 2) Agriculture Produce 3) Energy
Metals can be divided into the following types: 1) Non-Precious metals (Like iron, steel, aluminium, copper) 2) Precious metals (Like Gold, silver, platinum, palladium)
Agricultural commodities are called soft commodities. Examples of which are coffee, cocoa, wheat, corn etc.
The energy on the other hand includes: 1) Crude oil 2) Natural gas 3) Coal
The direct way of commodities trading is through the futures market, while the indirect way of trading commodities is by buying or selling stocks that are related to commodities.
How can you trade in the futures market? In the futures market, commodities trading happen by two kinds of investors, institutional or commercial investors and speculators, who hedge risks and hope to earn money. Commercial traders take advantage of commodities trading for reducing their risk. For example, Aman runs a coffee shop and purchases coffee at Rs. 2000 per Kg. He speculates that coffee prices will go up in the next year to Rs. 2300 per kg. Now comes Ramesh, who owns a coffee plantation. His cost of production is Rs. 1800 per kg. He sells it at Rs. 1900 per kg. Ramesh fears that coffee prices may go down next year. He does not want to sell it at a price lower than his cost price. Summing things up, Aman fears that it will go up while Ramesh fears it will go down. To reduce the risk of both the parties they enter into a contract to sell coffee at Rs. 2100 in the next year.
Manufacturers and service providers both use futures as a part of their budgeting process to normalize expenses and reduce cash flow related expenses. Speculators, on the other hand, hope to earn profits from the change in prices of the futures contract. They close out their positions before the contract is due and never take the actual delivery of the commodity itself.
Commodities depend on various other factors. For example, 1) Irregularity of Monsoons 2) Domestic and international government policies 3) Technological Advancements & various other factors
Hence, it advisable that a person should only invest a limited portion in commodities in their portfolio. He/she should also understand the different factors involved in deciding a commodities’ price.
