The present commodity market structure dates back its origin from the ancient agricultural community. The first such market was Chicago board of trade which was opened in 1848. This commodity market facilitates buyers and sellers formal and convenient platforms. It is an organization or association of individuals or groups which have a common place for trading in select commodities under some fixed agreed rules and regulation among the members.
The commodities related to the primary sector of the economy are mainly traded in the market. The commodities in the primary sector of the economy are under two categories. Hard commodities include all the goods extracted from the earth’s crust which requires mining process like gold, silvers metals crude oil, natural gas, and other precious stories, etc. Soft commodities comprise of all agricultural products like live stocks, coffee, wheat, grain, and pulses, etc. This trading is conducted either at organized platforms like a local market place. There are manly two organized markets. They are multinational commodity exchange (MCX) which mainly deals with hard commodities and national commodity & derivatives exchange (NCDEX) for soft commodities. The commodity market facilitates both physical trading and derivative trading, future, and options on futures.
A financial derivative is a type of financial instrument whose value is derived from a commodity which depends on some underlying variables like interest rates, foreign exchange rates, or price index, etc.
Speculators and traders buy and sell commodity derivatives for a profit before the delivery date. They act as a middleman between farmers and the end users. For example, a trader can buy a six-month contract for wheat. If the prices of wheat go up in between the delivery period, he can resell it a bread maker at a profit.
Commodities are more volatile in nature as compared to stocks or equity. Therefore commodity futures are considered a high-risk investment. They may have higher returns, but they can suffer huge capital losses also. The commodity market help hedge against inflation due to situations like wars or any other crises. They also protect against losses in stocks or bond, as both these options are more opposite to each other. Investors have options not to speculate directly in any specific commodity. On the other hand, they can opt for indirect alternatives such as commodity bonds or broad commodity index funds in order to minimize the risk of investing in any one commodity.
The future derivative market of commodities offers both cash and delivery based settlements. If the buyer chooses to take delivery of the commodity, a transferable warehouse receipt is issued in favor of the buyer. The buyer can claim and take the delivery from the warehouse on producing this receipt. All other open contracts which are not intended for delivery are settled in cash. Most of the speculators and arbitrageurs prefer the cash settlement while wholesalers and commodity stockists go for delivery options. For delivery based trading, settlement takes place five to seven days after expiry.
Commodity trading in the global economic scene is poised for a big leap. Very soon this market is likely to witness large scale involvement of retail investors.