Investing in Commodity: What is It & How to Invest - Benefits & More

Earlier in 2023, farmers expressed their agitation against SEBI’s extension of the trading ban placed on derivates of seven Agri commodities. SEBI claimed that this was an attempt to curb an unregulated price increase of agricultural products whereas the farmers’ argument was backed by various studies to show that trading on exchanges does not have a significant on prices. The farmers believe that a futures market supports price discovery of the commodities which helps them immensely. Farmer co-operative societies also leverage trading and hedging to secure their financial interests. Read more about the agri trading ban here. Now, let’s take a step back and understand what commodities are and how commodity trading works. Commodity trading has been an interesting way to diversify the portfolio and go beyond traditional investments in securities. A commodities market is essentially driven by the principles of demand and supply.This article will cover everything you need to know about investing in Indian commodities and empower you to make financially prudent choices.So, what even are commodities?

A commodity refers to a raw material or any standardised resource carrying an underlying value. These raw materials and resources are used to produce the final product. Two items will be categorised as the same commodity if they are substantially uniform, even if their origin or producer differ or have minor changes in quality. For example, wheat is a uniform commodity regardless of its place of origin.Commodities can be bought and sold directly or traded as derivates through a commodity exchange. They are classified into two categories: soft commodities and hard commodities.Soft commodities are typically grown like agricultural products. They include plant products as well as crops. Some of the vastly traded soft commodities are coffee, wheat, corn, cocoa, and sugar. Livestock and meat that are fed for consumption are also considered to be soft commodities.Hard commodities are obtained by mining or drilling. All metals are hard commodities. These include precious metals like gold and silver. Industrial metals like aluminium and copper also come under this category. Furthermore, metals needed for the future energy sector like cobalt and lithium are some of the commodities traded in the commodity exchange. Energy such as coal, crude oil, natural gas, ethanol, uranium, and propane are some of the hard commodities traded in the commodity exchange

A commodity market is simply a marketplace for commodities. It is where various units of commodities are physically traded or bought and sold as derivatives. Derivatives are financial contracts that take their value from an underlying asset, in this case, the commodity. There are more than a hundred commodities that are traded in the commodity market.Commodity markets can be a derivates market or spot market:

• A spot market is the physical market where the commodities are physically exchanged. This works on an immediate delivery system and is also referred to as cash markets. Here, the buyer and the seller enter a contract on the spot. This means the current market price of the commodity and the quantity traded is finalised during this time. It is important to note that it usually takes two working days for the final settlement of the contract (the delivery of the commodity and the cash transactions). The spot market falls under the jurisdiction of specific states, rather than being regulated by SEBI.
• A derivates market is for commodity derivates which can be either futures or forwards. Futures are standardised products traded on commodity exchanges while forwards can be custom-made and traded over the counter. These derivates contracts of an underlying commodity (from the spot market) are bought and sold. The contracts give the rights to the holder to exchange the contract for the physical commodity when the contract expires (at a future date). The value of the contract is decided in the present while the exchange takes place at a future date. Therefore, even if the price of the commodity has increased or decreased in the future, the terms of the contract have to be honoured based on the price agreed.

Also note:In 2017, the trading of commodity options was introduced in India. It's important to note that options trading is conducted on the commodity futures. The commodity trade options contracts are the rights to buy (call option) or sell (put option) at a predetermined price on or before the expiry date of the contract. The commodity exchange collaborates with various warehouses to facilitate the supply of commodities at specified prices.Traders and investors are offered two types of commodity futures trading options: speculative trading and delivery-based trading. The commodity exchange serves as a platform for the trade while the entire risk lies with the buyer or seller. The commodity option traders must pay a premium to buy a commodity option contract. Historically, the returns are higher, and the risk involved is considered to be lesser in options than in future contracts.The trading of commodities is done through a regulated market known as a commodity exchange. The buying and selling of commodity derivatives can be done online through these commodity exchanges. The six major commodity exchanges in India are:

• Multi Commodity Exchange of India (MCX)
• National Stock Exchange (NSE)
• Bombay Stock Exchange (BSE)
• National Multi Commodity Exchange India (NMCE)
• National Commodity and Derivative Exchange (NCDEX)
• Indian Commodity Exchange (ICEX)

You will need a trading account with a member of the exchange to facilitate online trading through the commodity exchanges. Your PAN (Permanent Account Number) will be your identity proof to open the trading account. Through the trading account, you can buy and sell commodity derivatives.These derivates are typically traded based on margins, which refers to paying a portion of the total trade value. The margin can change depending on the category of commodities and the commodity exchange. If the commodity is volatile or the trade carries a significant risk, the margin will be higher. Upon expiry, the contract can be settled or renewed. Settling the contract takes place by paying or receiving the difference between the contract price and the current market price.For instance, for a futures contract priced at Rs. 50,000 with a 5% margin, you will have to invest Rs. 2,500 at the time of purchasing the derivative. On the expiry date, let’s say the market price became Rs. 55,000. Therefore, the difference between the current price and the contract value (Rs. 55,000 – Rs. 50,000) is the profit in the transaction.Having significant knowledge about the economic dynamics of the market is crucial to trade in commodities derivatives since they are typically considered high-risk financial instruments.Here are the four methods in which you can participate in commodity trading in India through derivatives:

• Bullion products are traded like Gold, Mini Gold, Gold Petal, Gold Guinea, Silver, Silver Micro, and Silver Mini.
• Base metals like Brass, Copper, Aluminium, Aluminium Mini, Lead, Lead Mini, Nickel, Zinc, and Zinc Mini.
• Agricultural items like Cotton, Cardamom, Black Pepper, Castor Seed, Rubber, Crude Palm Oil, RBD Palm olein, and Mentha Oil.
• Energy like Crude Oil, Crude Oil Mini, and Natural Gas.

• Paddy (Basmati Rice)
• Channa
• Barley
• Maize
• 29mm
• Moong
• Kapas
• Guar Seed 1mt
• Guar Seed 10 mt
• Guar Gum
• Soybean
• Refined Soya Oil
• Castor Seed
• Mustard Seed
• Crude Palm Oil
• Cotton Seed Oil cake
• Pepper
• Turmeric
• Jeera
• Coriander
• Sugar

1. Through the Commodity Exchanges in India A variety of commodities are traded on different exchanges in India. Investing in specific commodities can be done through the following commodity exchanges. The Multi Commodity Exchange of India Limited (MCX) is where the following products are traded:
2. The National Commodity and Derivative Exchange (NCDEX) is where the following products are traded:
3. The Indian Commodity Exchange (ICEX) allows trading in agricultural products, fibre (jute, and plantation (rubber). Along with this, trading of commodities like diamonds and steel also takes place here.
4. Through the Commodity Mutual Funds You can also opt for commodity mutual funds. These funds invest the corpus in a strategic combination of commodity-based companies and give a well-planned, indirect exposure to commodity trading. You can invest in these mutual funds through an asset management company or a broker.
5. Through Commodity Exchange-Traded Funds Commodity exchange-traded funds (ETFs) are a combination of commodities that are traded on the stock exchange. You can invest in these mutual funds through a broker.
6. Through Shares of Commodity Companies This is an indirect yet simple form of trading commodities. The investor or trader can buy the stocks of the company that deals with commodities like sugar stocks, oil stocks, etc. Investing in commodity stocks is less risky, as the investor is not putting the entire invested amount only in one commodity. If a company dealing with a particular commodity is well established, then the share price of the company would not have a huge and direct impact, even if there are drastic changes in the prices of the commodity.You can also invest in the commodity market by indulging in physical trades. However, this requires a careful analysis and deep knowledge of the market as well as access to the market and ancillary resources like storage and transportation facilities. Investors usually opt for a physical trade if it involves a valuable commodity. For example, gold can be bought in the form of jewelry, bars, or gold coins. The investor can physically deliver precious metals like gold, silver, and platinum. The transactional costs are high for such commodities.

As for any investment, it is imperative for investors to gain proper knowledge and do their research before trading or investing in commodities. To make this easier for you, here are some key factors you should consider before you begin your investment journey in commodities.

1. Which commodity exchange can you trade this commodity on?
2. What are the lot sizes that you will have to buy or sell?
3. What are the terms of the derivatives?
4. What is the liquidity you will get through this commodity?
5. How many contracts are available for trade?

1. Explore commodity fundamentals When you enter the commodities market, you essentially invest in the underlying commodity in different way (derivatives, physical). Therefore, your decision will also rely on the nature of the commodity itself. Exploring commodity fundamentals refers to the process of capturing all the relevant information about the categories that you might be interested in. To start with, you can take note of the following details:
2. Based on your analysis and preferences, you can choose the commodities that would be most beneficial for your financial goals.
3. Follow the latest news around the commodities market and the commodities that you’re interested An important aspect of financially sound investing decisions is staying up to date with the latest news around your investments. The same holds true for the commodities market as well. After choosing the commodities you are interested in, you must follow their latest activity. Since commodity trading relies on the underlying commodity, an incident or event around the commodity will impact it significantly. This could be a tax concession on production or even a new alternative entering the market. You can choose to rely on trusted websites and closed networks to get the latest updates. Even after making your investments, it is crucial to stay in touch with the latest updates so that you can tweak your strategies accordingly and maximise returns.
4. Analyse research reports When acquiring information on commodities, investors and traders may find it beneficial to consult expert research reports. Though these could get technical, the reports will contain some important metrics and insights that should be enough for investors to analyse whether or not the commodity fits their financial goals. It will be a good decision to get the reports reviewed by a trusted expert, if you have any doubts.
5. Assess the technical metrics Historical price movements can shed a lot of light on what triggers the commodity. This can be assessed through certain technical metrics. Resources available online can assist you in your journey to explore and understand how to compute these metrics and which metrics shed light on which aspect of the commodity. Metrics are usually presented as charts and percentages like moving averages and relative strength index. You can read more about them here.

Investing or trading in commodities can be beneficial in certain cases. You can assess whether these benefits match with what you’re looking for as part of your financial goals. Some of them are as follows:

1. Capable of giving good returns The prices of the commodities are influenced by the demand and supply of the commodities, the exchange rate, the inflation rate, and the overall economic scenario. During the past few years, much emphasis has been given to infrastructure projects and the development of the railway sector in India. The related industries have noticed increased commodity prices related to these sectors.
2. Hedge Against Inflation Any geopolitical events like riots, political instability, and so on in a country will impact the prices of the commodities. This will be due to the disruption of the supply chain of the commodity. The raw material will not be transported to the manufacturers. It would lead to shortage of resources and an increase in the price.From investors' point of view, the commodities are volatile and capable of giving good returns during inflation. The value of stocks and bonds is impacted by inflation. This can result in a rise in commodity prices. It has been observed that commodities with high inflation have performed strongly.
3. Helps In Diversifying Portfolio It’s always beneficial to have a diversified portfolio. This means allocating the funds to different investment plans. Investing in commodities, along with investments in bonds and equities, plays an important role in diversifying a portfolio. An investor may consider less-volatile commodities that give good returns and are less risky. The economic and geopolitical conditions impact the prices of the commodities.Commodities have a negative and low correlation with bonds and equities. The cost of production will typically result in an increase in commodity prices. This would mean a decrease in the manufacturer’s profit, as a lot of money will be spent on purchasing the raw materials. Inflation would result in the company’s share price going down and commodity prices going up. In such a scenario it would be beneficial if the portfolio is diversified. For example, if the fuel price (petrol and diesel) increases. People will avoid buying new vehicles so that the cost of living does not increase. This would result in auto sector share prices falling. A person who has invested in auto sector shares can diversify the portfolio by trading in fuel commodities (petrol and diesel).
4. Surety and Safe Form of Investment During inflation, there is a dip in the economy. The prices of raw materials increase. This results in a rise in commodity prices. Investing in such commodities will give good returns. Markets experience high volatility, which results in the prices of shares and bonds going down. During market fluctuations, many invest in commodities as the prices of the commodities go up. This gives good returns to the investor and protects their investment in a volatile market.Apart from this trading in commodities is done electronic platform. This helps in maintaining transparency. It also helps in large-scale participation by buyers and sellers, as they do not meet. The entire process of buying and selling commodities is simple and does not have any scope for manipulation.
5. Can Give Huge Profitable Returns Commodities are risky if liquidity is high. Companies may have either extremely high returns or suffer huge losses. An investor needs to research thoroughly and make the right decision. If the right decision is made, an investor can make huge profits by investing in commodities.
6. Trading Can Be Done on Low Margins As a trader, an individual is supposed to deposit 5% to 10% of the contract's total value with the broker as a margin. This would mean a trader can take significant positions even if the capital is less. Due to this high percentage of leverage, investors can make gains by any substantial movement in the commodity price.

Investors or traders should consider the risks of investing or trading in commodities. These are as follows:

1. They Are Highly Volatile Commodity prices in India are highly volatile, and this would mean the risk involved is on the higher side. They are impacted by several factors, such as Government regulations, events occurring worldwide, import and export controls, economic conditions, etc. There is a chance of the trader losing a considerable amount of money.
2. They May Be Highly Risky Directly investing in commodities can be highly risky, especially for new traders. Leverage determines the gains and losses, so one must be cautious while investing or trading in commodities. This would mean either it may be a huge profit or a significant loss. Investors need to research thoroughly before investing.

Trading in Commodity Derivatives can be done during market hours. The commodity markets are open on weekdays. Saturday and Sunday are holidays. Buying and selling can be done during the morning or evening sessions. The morning session timings are 9 a.m. to 5 p.m. Orders can be placed on securities and energy commodities, base metals and bullions.The evening session timings are from 5 pm to 11:30, sometimes 11:55 pm. The change in timings matches the beginning and end of daylight in the United States. The evening session closes at 11:30 pm during summer and at 11:55 pm during winter. During the session, the traders can trade on energy commodities, base metals and bullions. International traders can also trade in agricultural goods between 9 pm to 9:30 pm.

A commodity transaction tax is levied on both buyer and seller of the commodity contracts in any of the commodity exchange markets in India. It is taxed at 0.01% of the price of the trade. The tax imposed depends on the actual size of the commodity contract.In the commodity sector, GST (Goods and Service Tax) is paid on the physical delivery of goods. The Goods and Service Tax are paid based on brokerage, warehouse, and exchange charges. In addition to this, there is also a stamp duty that is levied.

India’s commodity trading market is well placed as one of the most significant and growth-oriented market in the world. It is one of the drivers of the economy and provides excellent opportunities for investors to diversify their portfolios. At present, both the government and the private organisations of the nation are putting their best minds at work to create a secure and efficient commodity trading market.
Investors can also read more about commodity trading here to enhance their knowledge before they start their investments.