People no longer prefer to invest solely in equities and debt instruments. Commodity trading has grown in popularity among traders in recent years due to its high-profit potential. But what exactly is commodity trading, are they beneficial, and what are the risks involved? Let’s find out here.
What is Commodity Trading?
Commodity refers to the standardised natural raw materials used to produce refined products. These items are movable and are bought and sold for profit on the open market. Commodity trading can be done in two ways: investing in the cash market, known as spot trading, or derivatives via the F&O market. Commodity market participants include arbitrageurs, hedgers, and speculators.
Types of Commodities
Commodity trading in India is permissible in five categories- agriculture, precious metals, energy, services, and metals & materials. Many products exist within these categories, but let’s focus on the most vital ones.
1. Agricultural products
- Spices: Turmeric, pepper, jeera, cardamom, and red chilli.
- Grains: Maize, wheat, and rice.
- Oil and oilseeds: Soy seeds, mustard seed, crude palm oil, cottonseed, castor oil, and groundnut oil.
- Pulses: Tur dal, urad, yellow peas, and chana
2. Precious metals
Palladium, platinum, gold, and silver
Thermal coal, natural gas, crude oil, Brent crude, and alternate energy
Mining and oil services
5. Metals and materials
- Bulk materials: Cooking coal, iron ore, steel, and bauxite
- Base metals: Nickel, tin, copper, zinc, and aluminium
- Others: Rare earth metals, chemicals, and soda ash
Where to trade Commodities in India?
More than 20 exchanges in India provide commodity trading services. The Securities and Exchange Board of India (SEBI) regulates these exchanges. The six most widely used exchanges for commodity trading are–
- Bombay Stock Exchange (BSE)
- National Stock Exchange (NSE)
- National Commodity and Derivative Exchange (NCDEX)
- Multi Commodity Exchange of India (MCX)
- National Multi Commodity Exchange India (NMCE)
- Indian Commodity Exchange (ICEX)
Benefits of Commodity trading
- Inverse Relation: Commodities share an inverse relationship with interest-bearing instruments and equities. A bearish trend in the equity market leads to an increase in the prices of exchange-traded commodities. The scenario allows traders to use commodity trading to offset the risks of holding equity in a falling market.
- Demand & Supply: If there is a high demand for a commodity but a low supply in the market, the price of that commodity will rise.
- Diversification: Commodities are the best way to diversify your investment portfolio because of their inverse relationship with the equity market.
- Inflation Hedge: The historical price chart shows that various commodities have outperformed inflation over time, with silver, gold, and crude oil as just a few examples.
Risk in Commodity Trading
- Political Risk: Tariffs on foreign trade in various commodities directly impact the price of securities, resulting in losses due to unexpected changes in value.
- Weather: Excessive rain or drought are uncontrollable events that significantly impact commodity prices.
- Counterparty Risk: This risk is primarily associated with derivatives, where one party to trade withholds the contract, allowing it to expire worthlessly.
- Volatility: Commodities are highly sensitive to external factors, so price fluctuations are always possible.
How to invest in Commodities?
You can invest in commodities through your Demat account using one of the following ways.
- Direct investment: You can buy commodities directly from the cash market via exchange. This is also known as spot trading.
- Derivatives: You can speculate on commodity movements and lock in a price in advance to buy or sell on a predetermined future date in the F&O market.
- Commodity ETF: You can buy commodities through exchange-traded funds.
- Commodity shares: Numerous companies produce commodities and are also exchange-listed. Investing in the stock of such companies is another way to trade commodities.
Trading commodities is an undeniably attractive investment. Moreover, they are a good choice due to their diversification, inverse relationship with the equity market, high demand for most commonly traded commodities, and inflation protection.