Commodity Trading in India

– Shantnu Bansal

Any goods that are unbranded and are commonly traded in the market are called commodities. Globally, the commodity trade market is roughly three times the size of the equity trade market. In India, the commodities market is still evolving and is going to be the nexus for investors. The expected growth rate of the commodity market is 25% annually over the next five years. In the last few years, the volume of business of the country’s 24 commodity exchanges, including three national exchanges namely Bombay Stock Exchange (BSE), National Stock Exchange (NSE) and Calcutta Stock Exchange (CSE) has run into several lakhs of crores of rupees annually.

Commodity markets are quite like equity markets. It also has two constituents – spot market and derivative market. In the case of a spot market, the commodities are bought and sold for immediate delivery while in the case of a commodity derivative market, various financial instruments are traded on the exchanges.

A Commodity Future is a derivative instrument for the future delivery of a commodity on a fixed date at a particular price. For example, if an investor purchases crude oil future, he is entering into a contract to buy a fixed quantity, which is called the contract size of crude oil at a future date which is called the contract expiry date. Such a contract is called a Forward Contract which can be bought and sold on the commodity exchanges.

A Futures Contract is a kind of forward contract. Futures are exchange-traded contracts to buy or sell physical commodities for delivery on a specified future date at an agreed price. Futures trading, which provides for greater transparency in the prices, are used generally for protection (hedging) against adverse price fluctuations in basic commodities.

An exchange-traded fund (ETF) is a security traded on stock exchanges that deals in assets such as stocks, commodities, or bonds and operates with an arbitrage mechanism originated, similar to stocks, to keep it trading near to its net asset value whereas Over-the-counter (OTC) refers to the process of trading of securities of companies that are not listed on an exchange and are traded via a broker-dealer system. 

History of Commodity Trading in India

India has an eventful past of futures trading in commodities. Once, 110 regional exchanges were conducting forward trade in commodities. It was the time when the equity market was hapless as there were not many companies whose shares were traded. However, in the late 1950s, India saw a period of shortages in many essential commodities which resulted in inflationary situations and with accompanying government intervention, resulted in its decline since the mid-1960s. Futures trading came to be prohibited in some important commodities and many traders migrated to the securities market. The interest in commodity futures trading revived in the early 1990s. Though futures trading is not new to India, we have missed more than three decades within which tremendous leaps have been made in the field worldwide.

Types of Commodities

A commodity exchange facilitates an online platform for trading in futures contracts in various commodities, by practising professionalism and transparency. The items are traded on the commodity exchange include agricultural commodities – spices, soya, groundnut, coffee, rubber, tea, jute; energy commodities – crude oil and coal, and precious and base metals – gold, silver, nickel, zinc, iron ore, lead, aluminium etc. More than 100 commodities are traded in the national exchanges.

Commodity Exchanges in India

The objective of establishing national exchanges is to ensure that trade operates at a macro level with economies of scale and adopt fair practices in exchange management like demutualization (i.e., they are not owned or managed by brokers), automation, and settlement guarantee.

An individual, partnership firm, private and public limited company and co-operative society are eligible to become members of the national exchanges subject to the conditions for the membership.

The major commodity exchanges in India are Multi Commodity Exchange (MCX), Indian Commodity Exchange Limited (ICEX), National Commodity and Derivatives Exchange Limited (NCDEX), National Spot Exchange Limited (NSEL), National Multi Commodity Exchange of India Limited (NMCE), Universal Commodity Exchange (UCX) etc.

Securities & Exchange Board of India (SEBI) regulates the commodity market in India since September 2015. Before that, it was the Forward Market Commission (FMC) that oversaw the working of the sector.

Stocks vs. Commodities

BASIS	STOCKS	COMMODITIES
Volume	There are thousands of stocks traded at an exchange.	The number of commodities traded is just over a hundred
Deposit Requirements	With stocks, you need to put up the full amount of the stock value to buy the stock.	With commodities, you control commodity futures contracts with a margin deposit which is normally between 5% – 10% of the value of the commodity.
Value	Stocks are fictitious and there is no real basis for their value other than earnings. They can be delisted anytime and become meritless.	Commodities have intrinsic value which means they will always have worth.
Fluctuation	Stock prices often move slowly. Frequently, stock prices may linger in a narrow trading range causing unproductive use of finances.	Commodities frequently have fast price movement, thus providing increased profit potential.
Taxation	Owning a stock invites tax twice; when the company pays corporate tax on its income, and again when one pays personal taxes on capital gains.	With commodity profits, one is only taxed on income.

As the World Trade Organization (WTO), looks at opening up the agricultural sector and other commodity markets for global competition, India being a major consumption market, will be an extremely attractive market. Indian producers and traders will have a big opportunity to be a part of the thriving global market.