Commodity Trading Basics
by 5paisa Research Team Last Updated: 2022-03-23T14:15:40+05:30
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What are Commodities?

A commodity is a raw material produced in large quantities and can be sold in bulk. Commodities are basic good used in commerce that is interchangeable with other commodities of the same type. Gold, silver, corn, wheat, coffee and oil are examples of commodities.

A commodity has uniform quality and quantity. The main characteristic is that it is produced by many sellers and bought by many buyers.

Several types of markets exist for commodities: futures markets, spot markets and options markets. In futures markets, delivery occurs at a specified future date. In spot markets, delivery happens at present. In options markets, the delivery may occur at any time before the option expires or becomes void.

Commodities can also be traded on exchanges or over-the-counter (OTC). Some commodities such as gold and silver can be owned directly; others must be owned indirectly through futures contracts or options contracts.

How does the commodity market work?

The different types of commodity market are the backbone of the economy, as it provides food grains, minerals, fuel, energy, capital goods to industries and services to consumers. Everything that you use every day has been traded on the commodity markets at some point in time.

The Indian commodity markets have witnessed remarkable growth over the last 15 years or so. The main reasons for this are the liberalisation of the Indian economy in 1991 and an increase in demand for raw materials by domestic industries and overseas buyers. Thus, India has emerged as one of the key players in the global commodities trade.

A commodity market is where all the buyers and sellers meet to trade their commodities or goods for cash or other commodities. Along with money, commodity exchanges also use futures contracts traded in standardised sizes, terms, conditions, etc.

The traders organise the commodity exchanges, who form a virtual auction house where buyers and sellers get together. The commodity exchange is responsible for providing a fair and accessible market for both parties to complete their transactions as smoothly as possible.

The commodity exchanges work as an auction house where buyers and sellers buy and sell their products. Along with money, these exchanges also use futures contracts traded in standardised sizes, terms, conditions etc.

The factors influencing a particular commodity's demand and supply are:

1) Raw materials: The availability of raw materials affects the price of a commodity at any given point in time. If raw materials are scarce, their cost will be high, and if raw materials are abundant, their cost will be below.

2) Demand in domestic/international market: The demand in domestic or international markets also affects the price of a commodity. When demand increases in the domestic or international market, it leads to a shortage in supply.

Type of Commodities Traded in India

In India Commodity Market has been divided into two major categories:

Physical commodity market: This type of market is physical and "face-to-face". The traders meet in the central market to buy & sell the commodities. The commodities traded in this type of market include agricultural products like grains, pulses and cereals; metals like gold, silver and copper; industrial products like textiles and fertilisers; petroleum products such as oil and diesel; electricity; etc.

Financial commodity market: This type of market is based on paper trading & contracts rather than a physical exchange of goods. The commodity markets include futures markets for natural resources such as agricultural products, metals, energy and weather.

Commodity markets have been flourishing in India for a long time and are still growing with time. Commodities like edible oil, cotton, cotton yarn, gold, salt, rice, sugar etc., are traded in these markets.

Types of Commodity Derivative Markets in India

A commodity market is a market in which commodity goods are traded. Commodity markets can be classified in various ways, such as goods sold or the monetary unit used to measure prices.

The two types of primary commodity markets in India are:

1. Agricultural markets: These markets are organised by local bodies called Agriculture Produce Market Committees (APMCs). Agricultural markets are usually organised at a regional level and sell various products, including fresh fruits and vegetables, grains, spices, seeds and livestock. Each APMC has a set of rules that define how different products must be handled and traded in the market.

For example, each APMC fixes the timing at which farmers can bring their produce to the market and how much they should be paid for it. In addition, these committees set minimum support prices for certain commodities such as milk and sugarcane.

2. Non-agricultural markets: These markets sell products from different sectors, including consumer goods, iron & steel, cement, petroleum, automotive parts & accessories, etc. These markets have been established either by industry associations or by private parties with government approval. These organisations follow specific guidelines to ensure that trading in these markets is organised and standardised.

The Commodity Exchange Mechanism

A commodity exchange enables spot trading by bringing together the buyers and sellers of various commodities under one roof to trade their products without worrying about quality issues or delivery.

Since the exchanges are centralised locations with dedicated warehouses for storage, physical deliveries are possible. The Indian commodity exchange differs from stock exchanges because instead of buying and selling shares of companies, people buy and sell commodities on it.

Wrapping Up

In India, the commodity market is a vital part of the economy. Its main objective is to stabilise the prices of commodities, which are subject to wide fluctuations in a free market. The exchanges provide a platform for sellers and buyers to meet and negotiate prices and then for buyers to take delivery of the goods.

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