Importance and Role of Commodity Markets in India

7 min read • Published 6 December 2022
Written by Krishna Deshmukh
role of commodity markets in India

Commodity trading is the process of buying and selling raw materials like crude oil, gold, silver, wheat, and rice. In the form of barter trade, commodity trading has remained a quintessential part of human civilization. 

Today, commodities exchange happens in a more disciplined form in commodity markets. As a result, these markets play a vital part in the functioning and development of the Indian economy. 

The following sections will take you through the essential roles of commodity markets in India. 

What is the Commodity Market?

A commodity market is a hub or marketplace where commodities are exchanged or traded. These exchanges can happen nationally and internationally between the commodity markets of two or more nations. 

Commodity markets help investors gain exposure and diversify their portfolios across different commodities. One can classify commodity markets into two broad categories:

  • Spot Market: These are physical marketplaces where traders sell or purchase commodities in their physical form. One can expect instant delivery of products while trading in spot commodities.
  • Derivative Market: These markets deal with trading using future contracts. The main purpose of commodity derivative contracts is to reduce risk arising out of future price uncertainty.

What Role Does the Commodity Market Play in India?

This list covers the important roles that commodity markets play in India:

  • Risk Distribution and Hedging

Investors can protect their investments by using commodities as hedging instruments. This minimises risk by distributing it to a large group of investors. For instance, FMCG companies can lock in the input price of raw materials by buying futures based on the commodities price today. 

This hedging protects investors from inflation when commodity prices spike or fall significantly. During such times, they can purchase commodities at the pre-defined amount. 

  • Offers Better Investments in Agricultural Environment

Businesses can lose money and fail by not monitoring their production, storage, warehousing, and transportation facilities. The agricultural sector in India is particularly vulnerable to these problems, which result in the spoilage of massive quantities of food grain.

However, well-regulated commodity markets benefit everyone, from farmers to brokers and other stakeholders. These markets encourage better investment opportunities in an agricultural ecosystem, which improves the infrastructure of this sector. 

  • Plays the Role of a Transparent Aggregator

The farming population is spread across India. . Aggregators must serve as mediators in this situation. However, many aggregators take advantage of this situation by not focusing on transparency and fair pricing. Due to this, farmers are vulnerable to exploitation and cheating. 

An organised commodity market reinstalls its faith in the system by maintaining transparency. This can boost the sale of goods and better aggregation. Investments in the agricultural market improve farmers’ finances and their livelihoods.  

  • Makes Pricing Easy to Anticipate

Commodity markets help manufacturers ensure price stability.  However, because this is an elastic market, there are chances of frequent short-term price shifts. Commodity futures ensure more predictability in price changes and allow for fairer price discovery.

  • Ensures diversification of portfolios

Investors must make the most of every opportunity available to diversify their portfolios. However, most opt for traditional investments like mutual funds and stocks to attain this goal. Commodity markets, too, offer a plethora of chances for investors to diversify their portfolios. 

Moreover, one does not need to invest here physically to participate in commodity trading. Instead, they can invest here with ETFs or future contracts. Finally, it is important to remember that commodity markets allow traders to safeguard their investments during inflation.

  • Assists in Reducing Speculative Demand

Speculative demand indicates the demand for any commodity for transaction purposes more than other utilisation. Let’s understand this with the example of gold as a commodity.  Much of the demand for gold comes from speculative purposes.

Like cash, speculative demand for gold is very high because gold plays a crucial role in transactions with foreign nations. A robust commodity market helps to absorb this speculative demand and protect the resources necessary for foreign exchange. 

Who Are the Participants of Commodity Trading?

Traders who participate in the commodity market are classified into the following categories: 

  • Hedgers

Producers, manufacturers, and investors under this category hedge their bets with future contracts in commodity markets. For instance, if prices dip during harvest, farmers will suffer significant losses owing to market volatility. 

To safeguard themselves from this risk, farmers can opt for commodity futures. With these, farmers can compensate for their losses in the local market with gains from the future market. If the opposite happens, they can profit from the local markets. 

  • Speculators

As the name suggests, speculators help hedgers move the commodity market ahead by predicting prices for futures. They speculate on these prices by analysing certain factors in the commodity market, such as international transactions, supply/demand speculation, etc. For example, if they believe the price of a commodity will rise, they will buy commodities futures and sell them later when prices rise.

Types of Commodities That Are Traded in India

Gold, soybeans, crude oil, silver, and corn are a few of the most widely traded commodities globally. As a result, the prices of these commodities change globally, regardless of their home nation. For instance, political disturbances in Middle-Eastern nations will impact every country’s petroleum and crude oil prices. 

It is important to note that some commodities are popular among traders in their nation. Here is a list of commodities that dominate commodity trading in India:

  • Agriculture Commodities: Rubber, mentha oil, castor oil, black pepper, barley, wheat, channa, cardamom, turmeric, and coriander
  • Energy: Natural gas, thermal coal, Brent crude, and crude oil
  • Precious Metals: Palladium, platinum, gold, and silver
  • Base Metals: Zinc, copper, aluminium, tin, and nickel

How Important Are Commodity Markets in India?

The following pointers highlight the importance of commodity markets in India:

  • Maintain Transparency

Commodity trading helps farmers to trade with accurate product prices. The presence of well-regulated commodity markets will safeguard farmers’ interests from exploitation by shrewd mediators and aggregators.

  • Provides Easy Access to Information

Stakeholders at every level can gain information about the rise and fall of the prices of goods in commodity markets. There are many channels that provide these updates via the internet, radio, or television.

  • Substantial Returns

Commodity markets are subject to frequent volatility owing to geopolitical issues or supply disruptions of certain commodities. 

Speculators make the most of returns during volatile situations by purchasing futures contracts at lower prices and selling them when prices soar.

  • Low Trading Margin

This marketplace offers a low trading margin for investors as compared to the stock market. This minimal trading margin allows traders to invest in bulk items while purchasing or selling them physically. 

Final Thoughts

The commodity market can bring substantial gains for investors and traders. However, one needs complete knowledge and expertise to stay afloat in this marketplace. Proper research and guidance can lead you to the bright side of commodity trading, whereas the contrary can lead to massive losses.

Frequently Asked Questions

What are the significant commodity exchanges in India?

There are four major commodity exchanges in India where commodity trade happens. These are the Indian Commodity Exchange, Multi Commodity Exchange of India, National Commodity, and Derivative Exchange and National Multi Commodity Exchange of India.

How to invest in commodity markets in India?

There are many ways to invest in commodity markets in India. You can invest in ETFs that track specific commodity indexes, futures, options, and physical commodities. 

What are basic commodities?

Products and goods that fulfil the daily requirements of an individual are basic commodities. Examples of basic commodities are livestock, cattle, natural gas, sugar and eggs.  

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Krishna Deshmukh

Investment Principal
Krishna is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.E. (Hons) in Computer Science Engineering from BITS Pilani and MBA (Finance) from JBIMS, Mumbai. He is currently working as Investments Principal at Wint Wealth. Previously he worked at Kotak Mahindra Bank at their DCM desk and Northern Arc Capital at their Structured Finance desk.

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