History and Types of Commodity Markets

1. Chapter 4 comModitymarket

2. The term commodity refers to any material, which can be bought and sold. Commodities in a market‘s context refer to any movable property other than actionable claims, money and securities. Commodities represent the fundamental elements of utility for human beings. Commodity market refers to markets that trade in primary rather then manufactured products. Soft commodities are agricultural products such as wheat, coffee, cocoa and sugar. Hard commodities are mined, such as (gold, rubber and oil). The History of Commodity Exchanges The world's oldest established futures exchange, the Chicago Board of Trade, was founded in 1848 by 82 Chicago merchants. The first "to arrive" contracts were flour timothy hay "Forward "arrive flour, seed and hay. Forward contracts on corn were introduced in 1851. The Chicago Mercantile Exchange, was founded as the Chicago Butter and Egg Board in 1898. Most of the exchanges in the developing World were established in the 1980s and1990s in response to government liberalization of commodity markets. In the 21st century, online commodity trading has become increasingly popular, and commodity brokers offer front-end interfaces to trade these electronic-based markets.

3. It’s evolution in India Bombay Cotton Trade Association Ltd., set up in 1875, was the first organized futures market. Bombay Cotton Exchange Ltd. was established in 1893 following the widespread discontent amongst leading cotton mill owners and merchants over functioning of Bombay Cotton Trade Association. The Futures trading in oilseeds started in 1900 with the establishment of the Gujarati VyapariMandali, which carried on futures trading in groundnut, castor seed and cotton. Futures' trading in wheat was existent at several places in Punjab and Uttar Pradesh. But the most notable futures exchange for wheat was chamber of commerce at Hapur set up in 1913. Futures trading in bullion began in Mumbai in 1920. Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in raw jute and jute goods. But organized futures trading in raw jute began only in 1927 with the establishment of East Indian Jute Association Ltd. These two associations amalgamated in 1945 to form the East India Jute & Hessian Ltd. to conduct organized trading in both Raw Jute and Jute goods. Forward Contracts (Regulation) Act was enacted in 1952 and the Forwards Markets Commission (FMC) was established in 1953 under the Ministry of Consumer Affairs and Public Distribution. In due course, several other exchanges were created in the country to trade in diverse commodities. In India there are 3 regulate Authorities, They are • FCRA = Forward Contract Regulatory Authority. FMC = Forward Market Commission. CGDA = Contract Government Department of Affairs.

4. Different types of commodities Precious Metals: Gold, Silver, Platinum etcOther Metals: Nickel, Aluminum, Copper etcAgro-Based Commodities: Wheat, Corn, Cotton, Oils, Oilseeds. Soft Commodities: Coffee, Cocoa, Sugar etcLive-Stock: Live Cattle, Pork Bellies etcEnergy: Crude Oil, Natural Gas, Gasoline etc MEMBERSHIP IN COMMODITY MARKET To become member of commodity market the person should comply with the following eligibility criteria. • He should have completed 21 years of his age • He should guaranteed or having equivalent qualification. • He should not be bankrupt • He has not been declared from trading & commodity by statutory or regulatory authority. • He should not be involved in smuggling activities.

5. TYPES OF MEMBERSHIP IN COMMODITY MARKET • Trading come clearing member:- [TCM] TCM are entitled to trade on his own behalf as well as on account of his clients and they clear and settle trade himself. Example:- Partnership firm, co-operate Entitle Corporative society. • Institutional Trading come clearing member:- Only an institution of corporate are can be admitted by the exchange of a member, conforming up on them the right to trade and clear through the clearing house. • Professional Clearing Member:- A Professional clearing member entitle to clear and settle trade excise

6. Factors affecting to the commodity markets 1. Demand and Supply: Demand and supply are basic factors that effect the movement of commodity prices. 2. Demand Curve: It represents the relationship between the price of the commodity and purchasing power of consumer . 3. Risk and Return: High return is followed by high risk based on investment capacity of investors and capacity to take risk. 4. Economic growth: Economic growth of the world as well as domestic economy is an important fundamental that effect the demand and supply position of the country. 5. Extraordinary event; The extraordinary events like natural calamities deflation, inflation, earth quake ,flood ,war, etc effect the commodity prices in a domestic way.

7. 6. Speculation: Speculation brings information to the system at time or in order to trigger the price movement in a particular direction. 7. Inflation: During time of inflation value of the price decreases & commodity price increases. it will also effect to the commodity market. 8. Political condition: Political factors have a direct as well as indirect effect on commodity price . 9. Deflation: During the time of deflation, the value of money increases & commodity price decreases. it will also effect to the commodity market.

8. Types of contract in commodity market. Spot market / physical market / cash market:- The term spot refers to a transaction for immediate delivery. The delivery of the commodity on the spot. It involves prompt exchange of goods for cash. Forward contract:- A forward contract is that specifies the transfer of ownership of commodity at future date in time. Today the buyer & seller agree on all contract term, including price, quantity, quality, location and delivery date. Future contract:- Future contract are specific type of followed contract which traded on organized exchanges. Such as ICX , NCX. Option market:- Commodity market provides option to the buyer & sellers to purchase the commodity / sell the commodity but there is no obligation to do so. Options are likely call option & put option.

9. RISK FACED BY PARTICIPANTS IN DERIVATIVE MARKET • FINANCIAL RISK: It include the cash settlement in commodity market, arrangement of finance and sources of finance to invest in commodity market • CREDIT RISK: Credit Risk an account of default by counter party. Credit Risk is very low in commodity market. Because exchange formulating rules for performance of contract. • MARKET RISK: It is a risk of loss on account of adverse movement of price. • LIQUIDITY RISK: It is the risk faced by the participator because of unwinding of transaction if the market is illiquid. • LEGAL RISK: It is that legal objection might be raised, regulatory frame work might disallowed some activity • OPERATIONAL RISK: It is the risk arising out of some operational difficulties like failure of electricity or connectivity due to which it become difficult to operate in market.

10. Participants in Commodity Derivative market • Hedgers: They use derivatives markets to reduce or eliminate the risk associated with price of a commodity. Some of the hedgers are listed below and their objective from trading in this market:- • Exporters: People who need protection against higher prices of commodities contracted from a future delivery but not yet purchased. • Importers: People who want to take advantage of lower prices against the commodities contracted for future delivery but not yet received. • Farmers: People who need protection against declining prices of crops still in the field or against the rising prices of purchased inputs such as feed. • Merchandisers, elevators: People who need protection against lower prices between the time of purchase or contract of purchase of commodities from the farmer and the time it is sold. • Processors: People who need protection against the increasing raw material cost or against decreasing inventory values. 2) Speculators: Speculators are those who may not have an interest in the ready contracts, etc. but see an opportunity of price movement favorable to them. 3) Arbitrageurs: Arbitrage refers to the simultaneous purchase and sale in two markets so that the selling price is higher than the buying price by more than the transaction cost, resulting in risk-less profit.

11. Advantages of commodity Derivatives • Management of risk: Risk management is not about the elimination of risk rather it is about the management of risk. Commodity derivatives provide a powerful tool for limiting risks that farmers and organizations face in the ordinary conduct of their businesses. • Efficiency in trading: Commodity derivatives allow for free trading of risk components and that leads to improving market efficiency. • Speculation: Commodity derivatives are considered to be risky. If not used properly, these can leads to financial destruction in an organization. • Price discover: Another important application of commodity derivatives is the price discovery which means revealing information about future cash market prices through the futures market. • Price stabilization function: Commodity Derivatives market helps to keep a stabilizing influence on spot prices by reducing the short-term fluctuations. In other words, derivative reduces both peak and depths and leads to price stabilization effect in the cash market for underlying asset

12. Role and Functions of commodity markets If you are an investor, commodity futures offers the following benefits:  • High leverage: You can take a position in a particular commodity by paying only a fraction of that value as margin. Moreover, the margins in the commodity futures market are lower than equity futures and options. • Less manipulation: Governed by international price movements, commodity markets are less prone to rigging or price manipulation. • Diversification: Commodity prices are prone to supply-demand dynamics, weather conditions, geo-political tensions and natural disasters. Accordingly, commodities are an independent asset class, and can prove to be an effective means of diversification in one’s investment portfolio. If you are an importer or exporter, you benefit in the following ways: • Hedge against price fluctuations: In today’s highly volatile scenario, wide fluctuations in prices of import and export products can directly affect your bottom-line. Commodity futures helps you to procure or sell commodities at a price decided months before the actual transaction, thereby ironing out any price changes that happen subsequently. 

13. If you are a large-scale consumer of a product, here is how this market can help you: • Control your costs: If you are an industrialist, the raw material cost dictates the final price of your output. Any sudden rise in the raw material cost can compel you to pass on the hike to your customers, making your products unattractive in the market. On the other hand, if you are unable to pass on the costs, your margins and profitability will be hit. Through commodity futures, you can lock-in the price of your raw materials. • Ensure continuous supply: Any shortfall in the supply of raw materials can stall your production and make you default on your sale obligations. You can avoid this risk by buying a commodity futures contract by which you are assured of supply of a fixed quantity of materials at a pre-decided price at the appointed time. If you are a producer of a commodity, futures can help you in the following ways: • Lock-in price for your produce: If you are a farmer, there is a possibility that the price of your produce may come down drastically at the time of harvest. By taking positions in commodity futures, you can effectively lock-in the price at which you wish to sell your produce at harvest time. • Assured demand: Any glut in the physical market could mean an endless wait for a buyer. Selling commodity futures contracts can give you assured demand at the time of harvest.

14. Total transparency: an electronic trading platform helps in creating a transparent price discovery mechanism on the commodity futures exchanges without any intervention by sellers or buyers. It is driven totally by market fundamentals and the risk factor associated with manipulation is effectively negated.  Protection against Inflation: When the economy is dipping, money is worth less – inflation occurs. The prices for commodities usually go up during high inflation accordingly the price of raw materials also sees an upward trend. Therefore, a few commodities in your portfolio will help you benefit from this upswing. Governing body Just as SEBI regulates the stock market in India, SEBI also regulates commodity derivative markets since September 28, 2015. Prior to that period, there was another regulatory body known as Forward Markets Commission (FMC) which overseen by the Ministry of Consumer Affairs regulated commodities. It was a commodity futures market regulator of India before September 2015 which headquartered in Mumbai. FMC once recognized as a chief regulator of forward and futures markets in India who once regulated 17 trillion rupees of commodity trades in India. Forward Markets Commission (FMC) established in the year 1953 under the provisions of the Forward Contracts (Regulation) Act, 1952.

15. Types of Commodity Derivatives Two important types of commodity derivatives are • Commodity futures. • Commodity options Commodity Futures Contracts: A futures contract is an agreement for buying or selling a commodity for a predetermined delivery price at a specific future time. Futures are standardized contracts that are traded on organized futures exchanges. For example, suppose a farmer is expecting his crop of wheat to be ready in two months time, but is worried that the price of wheat may decline in this period. In order to minimize his risk, he can enter into a futures contract to sell his crop in two months‘ time at a price determined now. This way he is able to hedge his risk arising from a possible adverse change in the price of his commodity. Features of commodity Futures • Trading in futures is necessarily organized under the recognized association so that such trading is conducted with the procedure laid down in the Rules and Bye-laws of the association. • The units of price quotation and trading are fixed contracts, parties to the contracts not being capable of altering these units. • The delivery periods are specified. • The seller in a futures market has the choice to decide whether to deliver goods against outstanding sale contracts

16. 2) Commodity Options contracts: Like futures, options are also financial instruments used for hedging and speculation. The commodity option holder has the right, but not the obligation, to buy (or sell) a specific quantity of a commodity at a specified price on or before a specified date. Option contracts involve two parties – the seller of the option writes the option in favor of the buyer (holder) who pays a certain premium to the seller as a price for the option. There are two basic types of commodity options: a call option and a put option. 1) A call option gives the buyer, the right to buy the asset (commodity) at a given price. This given price is called ‘strike price‘. For example: A bought a call at a strike price of Rs.500. On expiry the price of the asset is Rs.450. A will not exercise his call. Because he can buy the same asset form the market at Rs.450, rather than paying Rs.500 to the seller of the option. 2) A put option gives the buyer a right to sell the asset at the ‘strike price‘ to the buyer. Here the buyer has the right to sell and the seller has the obligation to buy. For example: B bought a put at a strike price of Rs.600. On expiry the price of the asset is Rs.619. A will not exercise his put option. Because he can sell the same asset in the market at Rs.619, rather than giving it to the seller of the put option for Rs.600.

17. Structure of commodity market

18. Forward Market Commission( FMC) FMC was established in 1952 to prohibit insider trading in commodities. it is a regulatory body of commodity market. it is located at Mumbai and regional office at Kolkata. Functions of FMC • It advises to the central government in respect of grant of recognition. • It keeps commodity market under observation. • It collect and publishers information relating to trading condition in respect of goods. • It makes a recommendation for improving the organization. • It understand in inspection of books of a/c & document of commodity market. • It controls the commodity market. • It regulates and provides guideline to commodity market.

19. Powers and regulatory measures of FMC • Power to approving memorandum and article of association. • Power to direct & to make rule & regulation of commodity market. • Power to suspend governing body of recognized Association. • Power to inspect the commodity exchange. • Power to cancel the license of business increase of considered or illegal trading. COMMODITY EXCHANGE It is an association or a company or any other body corporate organizing future trading in commodity for which license has been granted by regulated authority

20. The Multi Commodity Exchange of India Limited (MCX)  It started operations in November 2003.  It is India’s first listed commodity future exchange.  It operates within the regulatory frame work of the Forward Contracts Regulation Act, 1952(FCRA 1952) and regulations there under  It facilitates online trading and clearing settlement  It offers trading in more than 30 commodity futures including gold and other metals and agricultural commodities  It focuses on providing neutral, secure and transparent trade mechanisms and formulating quality parameters and trade regulations.  Key Facts about MCX  It is regulated by the Forward Markets Commission  It is India’s No.1 commodity exchange with 83% market share in 2009  Its main competitor is NCDEX

21.  Globally, MCX ranks no.1 in silver, no.2 in natural gas, no.3 in crude oil and gold in futures trading  It has several strategic alliances with leading exchanges across the globe  As of early 2010, the normal daily turnover of MCX was about US$ 6 to 8 billion  It now reaches out to about 800 cities and towns in India Following commodity traded In MCX • Bullion- gold, silver etc. • Minerals- copper, iron, steel etc. • Oil and oil seeds - coconut oil, Sunflower oil etc. • Pulses-yellow Peas, Channah etc. • Grains – rice, wheat etc. • Spices- paper, red chili, jeera etc. • Fiber and others –cotton, cloth etc. • Natural gas- crude oil etc.

22. National Commodity and Derivatives Exchange Limited (NCDEX) • It is an online multi commodity exchange based in India. • It was incorporated as a private limited company incorporated in April 2003 under the Companies Act, 1956. • It obtained its Certificate for commencement of business in May 2003 It has commenced its operations 0n 15 December 2003. • It is a closely held private company which is promoted by national level institutions and has an independent Board of Directors and professionals • It is regulated by FMC It is subjected to various laws like the Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various other legislations. • It has offices in Mumbai, Delhi, Ahmadabad, Indore, Hyderabad, Jaipur and Kolkata. Key facts about NCDEX • It has 848 registered members and client base of 20 lakh as on 31 July 2013. • Trading conducted on more than 49000 terminals across 1000 centers in India as on 31 July 201. • Facilitates deliveries of commodities through a network of over 594 accredited warehouses. • Average deliveries of 1 lakh MT at every contract expiry

23. NMCE National Multi Commodity Exchange of India  It was promoted by commodity-relevant public institutions, viz, Central Warehousing Corporation(CWC), National Agricultural Cooperative Marketing Federation of India(NAFED), Gujarat Agro-Industries Corporation Limited(GAICL), Gujarat State Agricultural Marketing Board(GSAMB), National Institute of Agricultural Marketing(NIAM) and Neptune Overseas Limited(NOL)  Punjab National Bank (PNB) gives financial assistance to NMCE  It is a zero-debt company  It follows widely accepted accounting and auditing practices  It is backed by compulsory delivery based settlement to ensure transparent and fair trade practices Vision and Mission of NMCE: Improving efficiency of marketing through online trading in DE metallization form. The promoters of NMCE are • Punjab National Bank. • Central warehousing Corporation. • Gujarat Agro Industries Corporation.

24. ICEX/ICX Indian Commodity Exchange  It is a public-private partnership with Reliance Exchange next Ltd  It provide fair, transparent and efficient trading to all participants  Provide equal opportunity and access to investors all over the country through the modern communication modes  It’s a major trading hub for most of the commodities  It is ideally positioned to influence the huge potential of the commodities market and encourage participation of farmers  Shareholders of ICEX  Reliance Exchange next Ltd  Indiabulls Financial Services Ltd  Indian Potash Ltd  IDFC Vision and Mission of ICEX “It provide for hair transparent and deficiency trading platform to all participants.”