COMMODITY MARKET

1 Commodity and Commodities market

1.1Difference Between Commodity and Financial

Derivatives
1.2Commodities Traded
1.3Evolution of the commodity market in World

1.4Evolution of the commodity market in India

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INTRODUCTION

Derivatives as a tool for managing risk first originated in the commodities markets. They
were then found useful as a hedging tool in financial markets as well. In India, trading in
commodity futures has been in existence from the nineteenth century with organized trading
in cotton through the establishment of Cotton Trade Association in 1875. Over a period of
time, other commodities were permitted to be traded in futures exchanges. Regulatory
constraints in 1960s resulted in virtual dismantling of the commodities future markets. It is
only in the last decade that commodity future exchanges have been actively encouraged.
However, the markets have been thin with poor liquidity and have not grown to any
significant level.

COMMODITY

Commodity is defined as any bulk good traded on an exchange or in the cash market.
One of the first forms of trade between individuals began by what is called the barter system
wherein goods were traded for goods. Lack of a medium for exchange was the sole initiator
of this system. People sold what they had in excess and bought what they lacked. Animals
were the first few commodities to be exchanged.
Some examples of commodities include grain, oats, gold, oil, beef, silver, and natural gas.

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These markets are the meeting places of buyers and sellers of an ever-expanding list of
commodities that today includes agricultural goods, metals and petroleum, but also products
such as financial instruments, foreign currencies and stock indexes that trade on a commodity
exchange.

Commodity Exchange is a platform where different types of market participants trade in wide
spectrum of commodity derivatives. In other words, prices of contracts can be determined at
present for goods to be delivered in future. This helps people to avoid wide fluctuations in the
prices of the commodities. The Government issued notifications on
1.4.2003 permitting futures trading in the commodities, with the issue of these notifications
futures trading is not prohibited in any commodity. Options trading in commodity are,
however presently prohibited.

In fact, the size of the commodities markets in India is also quite significant. Of the
country’s GDP of Rs 13, 20,730 crore (Rs 13,207.3 billion), commodities related (and
dependent) industries constitute about 58 per cent.

Currently, the various commodities across the country clock an annual turnover of Rs 1,
40,000 crore (Rs 1,400 billion). With the introduction of futures trading, the size of the
commodities market grows many folds here on.

1.1 Difference between commodity and financial derivatives

The basic concept of derivative contract remains the same whether the underlying happens be
a commodity or a financial asset. However there are some features which are very peculiar to
commodity derivative markets. In the case of financial derivatives, most of these contracts
are cash settled. Even in the case of physical settlement, financial assets are not bulky and do
not need special facility for storage. Due to the bulky nature of the underlying assets, physical
settlement in commodity derivatives creates the need for warehousing. Similarly, the concept
of varying quality of asset does not really exist as far as financial underlying are concerned.

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However in the case of commodities, the quality of the asset underlying a contract can vary
largely. This becomes an important issue to be managed. We have a brief look at these issues.

Physical settlement

Physical settlement involves the physical delivery of the underlying commodity, typically at
an accredited warehouse. The seller intending to make delivery would have to take the
commodities to the designated warehouse and the buyer intending to take delivery would
have to go to the designated warehouse and pick up the commodity. This may sound simple,
but the physical settlement of commodities is a complex process. The issues faced in physical
settlement are enormous. There are limits on storage facilities in different states. There are
restrictions on interstate movement of commodities. Besides state level Octroi and duties
have an impact on the cost of movement of goods across locations. The process of taking
physical delivery in commodities is quite different from the process of taking physical
delivery in financial assets.
We take a general overview at the process flow of physical settlement of commodities. Later
on we will look into details of how physical settlement happens on the NCDEX.

Delivery notice period

Unlike in the case of equity futures, typically a seller of commodity futures has the option to
give notice of delivery. This option is given during a period identified as `delivery notice
period'.
Such contracts are then assigned to a buyer, in a manner similar to the assignments to a seller
in an options market. However what is interesting and different from a typical options
exercise is that in the commodities market, both positions can still be closed out before expiry
of the contract. The intention of this notice is to allow verification of delivery and to give
adequate notice to the buyer of a possible requirement to take delivery. These are required by
virtue of the fact that the actual physical settlement of commodities requires preparation from
both delivering and receiving members.
Typically, in all commodity exchanges, delivery notice is required to be supported by a
warehouse receipt. The warehouse receipt is the proof for the quantity and quality of

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commodities being delivered. Some exchanges have certified laboratories for verifying the
quality of goods. In these exchanges the seller has to produce a verification report from these
laboratories along with delivery notice. Some exchanges like LIFFE, accept warehouse
receipts as quality verification documents while others like BMF-Brazil have independent
grading and classification agency to verify the quality.
In the case of BMF-Brazil a seller typically has to submit the following documents:
 A declaration verifying that the asset is free of any and all charges, including fiscal
debts related to the stored goods.
 A provisional delivery order of the good to BM&F (Brazil), issued by the warehouse.
 A warehouse certificate showing that storage and regular insurance have been paid.

Assignment

Whenever delivery notices are given by the seller, the clearing house of the exchange
identifies the buyer to whom this notice may be assigned. Exchanges follow different
practices for the assignment process. One approach is to display the delivery notice and allow
buyers wishing to take delivery to bid for taking delivery. Among the international
exchanges, BMF, CBOT and CME display delivery notices. Alternatively, the clearing
houses may assign deliveries to buyers on some basis. The Indian commodities exchanges
have alsoadopted this method.
Any seller/ buyer who has given intention to deliver/ been assigned a delivery has an option
square off positions till the market close of the day of delivery notice. After the close of
trading, exchanges assign the delivery intentions to open long positions. Assignment is done
typically either on random basis or first-in-first out basis. In some exchanges, the buyer has
the option to give his preference for delivery location.
The clearing house decides on the daily delivery order rate at which delivery will be settled.
Delivery rate depends on the spot rate of the underlying adjusted for discount/ premium
quality and freight costs. The discount/ premium for quality and freight costs are published
the clearing house before introduction of the contract. The most active spot market is
normally taken as the benchmark for deciding spot prices. Alternatively, the delivery rate is
determined based on the previous day closing rate for the contract or the closing rate for the
day.

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Delivery

After the assignment process, clearing house/ exchange issues a delivery order to the buyer.
The exchange also informs the respective warehouse about the identity of the buyer. The
buyer required to deposit a certain percentage of the contract amount with the clearing house
as margin against the warehouse receipt. The period available for the buyer to take physical
delivery is stipulated by the exchange. Buyer or his authorised representative in the presence
of seller or his representative takes the physical stocks against the delivery order. Proof of
physical delivery having been effected forwarded by the seller to the clearing house and the
invoice amount is credited to the seller's account.

In India if a seller does not give notice of delivery then at the expiry of the contract the
positions are cash settled by price difference exactly as in cash settled equity futures
contracts.

Warehousing

One of the main differences between financial and commodity derivatives are the need
warehousing. In case of most exchange-traded financial derivatives, all the positions are cash
settled. Cash settlement involves paying up the difference in prices between the time the
contract was entered into and the time the contract was closed. For instance, if a trader buys
futures on a stock at Rs.100 and on the day of expiration, the futures on that stock close
Rs.120, does not really have to buy the underlying stock. All he does is take the difference of
Rs.20 cash. Similarly the person who sold this futures contract at Rs.100, does not have to
deliver the underlying stock. All he has to do is pay up the loss of Rs.20 in cash.
In case of commodity derivatives however, there is a possibility of physical settlement.
Which means that if the seller chooses to hand over the commodity instead of the difference
in cash, the buyer must take physical delivery of the underlying asset. This requires the
exchange to make an arrangement with warehouses to handle the settlements. The efficacy of
the commodities settlements depends on the warehousing system available. Most

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international commodity exchanges used certified warehouses (CWH) for the purpose of
handling physical settlements.

Such CWH are required to provide storage facilities for participants in the commodities
markets and to certify the quantity and quality of the underlying commodity. The advantage
of this system is that a warehouse receipt becomes good collateral, not just for settlement of
exchange trades but also for other purposes too. In India, the warehousing system is not as
efficient as it is in some of the other developed markets. Central and state government
controlled warehouses are the major providers of agri-produce storage facilities. Apart from
these, there are a few private warehousing being maintained. However there is no clear
regulatory oversight of warehousing services.

Quality of underlying assets

A derivatives contract is written on a given underlying. Variance in quality is not an issue in

case of financial derivatives as the physical attribute is missing. When the underlying asset is
a commodity, the quality of the underlying asset is of prime importance. There may be quite
some variation in the quality of what is available in the marketplace. When the asset is
specified, it is therefore important that the exchange stipulate the grade or grades of the
commodity that are acceptable. Commodity derivatives demand good standards and quality
assurance/ certification procedures. A good grading system allows commodities to be traded
by specification.
Currently there are various agencies that are responsible for specifying grades for
commodities. For example, the Bureau of Indian Standards (BIS) under Ministry of
Consumer Affairs specifies standards for processed agricultural commodities whereas
AGMARK under the department of rural development under Ministry of Agriculture is
responsible for promulgating standards for basic agricultural commodities. Apart from these,
there are other agencies like EIA, which specify standards for export oriented commodities.

1.2 Commodities traded

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In all there are around 40 forty commodities traded in the different commodity markets.
These commodities are basically divided in four main types, namely:

 Agricultural commodities which consist of all agricultural products like cotton, wheat,
jowar, coffee, guar gum, soyabean, seas am, mustard oil, etc
 Precious metals which include gold and silver
 Base metals include other metals like tin copper, magnesium
 Energy includes commodities like crude oil, brent crude oil, furnace oil.

All these commodities have different set of features different characteristics, different dealing
methods, and different margins. Due to these differences these commodities require different
contracts which some extra rules relating to delivery, trading, quality specifications,
warehousing requirements, settlement procedure, etc.

Commodity Markets

Precious Metals Others Metals

Agriculture Energy

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1,3 Evolution of the commodity market in World

Early forward contracts in the US addressed merchants' concerns about ensuring that there
were buyers and sellers for commodities. However “credit risk” remained a serious problem.
To deal with this problem, a group of Chicago businessmen formed the Chicago Board of
Trade (CBOT) in 1848. The primary intention of the CBOT was to provide a centralised
location known in advance for buyers and sellers to negotiate forward contracts. In 1865, the
CBOT went one step further and listed the first
“Exchange traded” derivatives contract in the US, these contracts were called “futures
contracts”. In 1919, Chicago Butter and Egg Board, a spin-off of CBOT, was reorganised to
allow futures trading. Its name was changed to Chicago Mercantile Exchange (CME). The
CBOT and the CME remain the two largest organised futures exchanges, indeed the two
largest ” financial” exchanges of any kind in the world today.
The first stock index futures contract was traded at Kansas City Board of Trade. Currently
the most popular stock index futures contract in the world is based on S&P 500 index, traded
on Chicago Mercantile Exchange. During the mid eighties, financial futures became the most
active derivative instruments generating volumes many times more than the commodity
futures. Index futures, futures on T-bills and Euro-Dollar futures are the three most popular
futures contracts traded today. Other popular international exchanges that trade derivatives
are LIFFE in England, DTB in Germany, SGX in Singapore, TIFFE in Japan, MATIF in
France, Eurex etc. Some of the oldest and most famous stock exchanges in the world are as
follows:-

COUNTRY EXCHANGE
Chicago Board of Trade (CBOT)
United States of America
Chicago Mercantile Exchange
New York Cotton Exchange
New York Mercantile Exchange
New York Board of Trade
The Winnipeg Commodity Exchange
Canada The Winnipeg Commodity Exchange
Brazil Brazilian Futures Exchange Commodities

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and Futures Exchange

Australia Sydney Futures Exchange Ltd.

China Beijing Commodity Exchange Shanghai

Metal Exchange
Hong Kong Hong Kong Futures Exchange

Japan Tokyo International Financial Futures Exchange

Kansai Agricultural Commodities Exchange
Tokyo Grain Exchange
Malaysia Kuala Lumpur commodity Exchange
Singapore Singapore Commodity Exchange Ltd.
France Le Nouveau Marche MATIF

Russia The Russian Exchange

MICEX/ Relis Online St. Petersburg Futures Exchange
The Spanish Options Exchange
Spain Citrus Fruit and Commodity Futures Market of
Valencia
The London International Financial Futures
United Kingdom Options exchange

1.4 Evolution Commodity Market In India

The organized trading in commodity futures markets has a long history in India. In 1875, the
first commodity futures exchange was set up in Mumbai under the guidance of Bombay
Cotton Traders Association. During 1900-1920 many futures markets were set up including
raw jute futures market in Kolkata (1912) and wheat futures market in Hapur (1913). A
number of other exchanges appeared between 1920 and 1940 trading such commodities as
raw jute, jute products, pepper, turmeric, potatoes, sugar, castor seed, groundnuts, groundnut
oil, rice, wheat, etc. With the outbreak of World War II and in its aftermath trading in
forward and futures contracts as well as options was either outlawed, as part of the
Government's drive to contain inflation, or made impossible through price controls. This

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situation persisted until 1952, when the Government introduced the Forward Contracts
(Regulation) Act, which to this day controls all transferable forward contracts and futures.
Through this act Forward Market Commission (FMC) was established to oversee the working
of future exchanges in India. The Act allowed futures market trade in a number of
commodities (but excluded some which were seen as essential foods, such as sugar and food
grains). During 1960s, the government either banned or suspended futures trading in several
commodities, including cotton, raw jute, edible oilseeds and their products. Futures' trading
in pepper, turmeric, castor seed, linseed, etc. was, however still permitted. In 1977, futures'
trading in non-edible oilseeds like castor seed and linseed was forbidden. The reason for this
crackdown on futures markets was that, in Government's view, these markets helped driving
up prices for commodities, by giving free rein to speculators. The Government's policies
underwent a change in the late 1970s, when futures trade in gur and potato was allowed on
the recommendations of Khusro Committee. This committee recommended the revival of
futures trading in a wide range of commodities, but little action resulted.
As on August 2003, there are 21 commodity exchanges in operation in India dealing in
futures trading in 35 commodities (FMC website). Out of these, two exchanges viz., Indian
Pepper and Spice Trade Association (IPSTA), Cochin and the Bombay Commodity Exchange
(BCE) Ltd. have the status of international exchange and deal in international contracts
(transacting party could be a foreign national also) in pepper and castor oil respectively. The
commodities in which futures trading is done by other exchanges are: pepper, turmeric, gur,
castor seed, hessian, jute sacking, cotton, potato, castor oil, soya bean and its oil and cake,
coffee, mustard seed and its oil and oilcake, groundnut and its oil, sunflower oil,
copra/coconut and its oil and oilcake, cottonseed and its oil and oilcake, kapas, RBD
palmolein, rice bran and its oil and oilcake, sesame seed and its oil and oilcake, safflower
seed and its oil and oilcake, and sugar.

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2 Commodity Trading
Exchanges in India
2.1MCX
2.2NCDEX
2.3NMCE

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Ministry of
Consumer affairs

Forward Market
Commission

Commodity
Exchanges

National Level Regional Level

Stock Exchange Stock Exchange

20 Regional
NCDEX MCX NMCE Exchanges

Forward Market Commission

In India commodity markets are governed by Forward Market Commission The

Forward Contract (Regulation) Act was enacted in 1952. this act passed in the parliament
to regulate the futures markets and avoid the exploitation of farmers by middlemen and cruel
landlords. In 1966, in the aftermath of a severe drought and escalating food prices, forward
trading was banned in most commodities to make it easier for the government to impose price
controls. A long settled over the commodity markets.

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That was unfortunate. Futures and forward contracts allow market participants to
transfer risks from those wary of it to those who are hungry for it. Those most vulnerable to
risk-the farming community-have suffered over the subsequent decades. Not only was the
economics of the ban suspect, but also turned a blind eye to a natural dispensation among
Indians to trade in commodities. Forward trading in commodities is mentioned in Kautilya’s
Arthashastra. The Bombay Cotton Trade Association set up a futures market for cotton in
1875, a mere decade after the Chicago Board of Trade opened for business. Subsequently,
India developed vibrant forward markets in a host of commodities.

In November 2003, Mukesh Ambani, was speaking at the inauguration of MCX, a

spanking new national, multi- commodity exchange. The government has decided to clear the
way for forward trading in commodities once again. Mukesh says that MCX and the other
exchanges are sitting on a market worth $ 600 billion a year (or Rs 30 lakh crore).

Currently, the annual value of all commodity futures traded in India is $ 135 billion,
far less than the potential 4600 billion. What is significant, however, is the speed at which
the gap is being narrowed. “Volumes in commodity futures have perked up from Rs 20,000
crore- 30,000 crore per annum before the liberalization of futures trading, to around Rs 5.71
lakhs crore per annum today. The natural instinctive genius of the Indian trader has come into
play”, says S. Sundereshan, Chairman, FMC (forward market commission), which regulates
commodity futures market in India

Commodities’ trading is now one of the latest trend in the town. Volumes grew by
over 900 % between financial years 2002-03 and 2004-05. “The growth of the commodities
business has been beyond what was originally projected. With new commodity contracts
getting launched sequentially, the average daily futures volumes could scale upwards of Rs
140,000 crore”, says Vineet Bhatnagar, country manager of Refco (India), one of the largest
non- bank futures players globally. With national level exchange of India (MCX) and the
National commodities Derivatives Exchange (NCDEX) yet to complete two years of full-
fledged commercial operations, the growth in commodity futures trading is almost as
spectacular as India’s success in business process outsourcing.

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Commodity Exchanges

In India there are about 25 commodity exchanges, these include exchanges at national level
and regional level commodity exchanges. Of all these exchanges there are only three national
level commodity exchanges. And these are National Commodity And Derivatives Exchange
(NCDEX), Multi Commodity Exchange (MCX), National Commodity Exchange (NMCE).
But among these NCDEX and MCX are quite functional in the country. The basic difference
between the national level and regional level exchanges is their area of their operations and
the technology used by the exchanges.

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2.1Multi Commodity Exchange of India Limited (MCX):

MCX an independent multi commodity exchange has permanent recognition from

Government of India for facilitating online trading, clearing and settlement operations for
commodity futures markets across the country. It was inaugurated in November 2003 by
Mr. Mukesh Ambani. It is headquartered in Mumbai. The key shareholders of MCX are
Financial Technologies (India) Ltd., State Bank of India, NABARD, NSE, HDFC Bank,
State Bank of Indore, State Bank of Hyderabad, State Bank of Saurashtra, SBI Life
Insurance Co. Ltd., Union Bank of India, Bank of India, Bank of Baroda, Canara Bank,
Corporation Bank.

MCX offers futures trading in the following commodity categories: Agri

Commodities, Bullion, Metals- Ferrous & Non-ferrous, Pulses, Oils & Oilseeds, Energy,
Plantations, Spices and other soft commodities.

Today MCX is offering spectacular growth opportunities and advantages to a large

cross section of the participants including Producers / Processors, Traders, Corporate,
Regional Trading Centers, Importers, Exporters, Cooperatives, and Industry Associations.

In a significant development, National Stock Exchange of India Ltd. (NSE), country’s

largest exchange and National Bank for Agriculture and Rural Development (NABARD),
country’s premier agriculture development bank announced their strategic participation in the
equity of MCX on June 15, 2005. This new partnership of NSE and NABARD with MCX
makes MCX consortium the largest distribution network across the country.

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MCX is an ISO 9001:2000 online nationwide multi commodity exchange. It has over
900 members spread across 500 centers across the country, with more than 750 VSAT’s and
leased line connections and 5,000 and more trading terminals that provide a transparent
robust and trustworthy trading platform in more than 50 commodity futures contract with a
wide range of commodity baskets which includes metals, energy and agriculture
commodities. Exchange has pioneered major innovations in Indian commodities market,
which has become the industry benchmarks subsequently.

MCX is the only Exchange which has got three international tie-ups which is with
Tokyo Commodity Exchange (TOCOM), the 250 year old Baltic Freight Exchange, London,
Dubai Metals & Commodity Centre (DMCC) & Dubai Gold & Commodity Exchange
(DGCX), the strategic initiative of Government of Dubai. MCX has to its credit, setting up of
the National spot exchange (NSEAP), which connects all India APMC markets thereby
contributing in the implementation of Government of India’s vision to create a common
Indian market

The trading system of MCX is state-of-the-art, new generation trading platform that
permits extremely cost effective operations at much greater efficiency. The Exchange Central
System is located in Mumbai, which maintains the Central Order Book. Exchange Members
located across the country are connected to the central system through VSAT or any other
mode of communication as may be decided by the Exchange from time to time. The controls
in the system are system driven requiring minimum human intervention. The Exchange
Members places orders through the Traders Work Station (TWS) of the Member linked to the
Exchange, which matches on the Central System and sends a confirmation back to the
Member Settlement: Exchange maintains electronic interface with its Clearing Bank. All
Members of the Exchange are having their Exchange operations account with the Clearing
Bank.

All debits and credits are affected electronically through such accounts only. All
contracts on maturity are for delivery. MCX specifies tender and delivery periods. A seller or
a short open position holder in that contract may tender documents to the Exchange
expressing his intention to deliver the underlying commodity. Exchange would select from

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the long open position holder for the tendered quantity. Once the buyer is identified, seller
has to initiate the process of giving delivery and buyer has to take delivery according to the
delivery schedule prescribed by the Exchange Players involved in commodities trading like
commodity exchanges, financial institutions, and banks have a feeling that the markets are
not being fully exploited. Education and regulation are the main impediments to the growth
of commodity trading. Producers, farmers and agri-based companies should enter into formal
contracts to hedge against losses. The use of commodity exchanges will create more trading
opportunities; result in an integrated market and better price discoveries.

MCX offers trading in various Products which include Gold, Silver, Castor Seeds,
Soy Seeds, Castor Oil, Refined Soy Oil, Soymeal, RBD Palmolein, Crude Palm Oil,
Groundnut Oil, Sesame Seed, Mustard /Rapeseed Oil, Cottonseed, Mustard Seed (Hapur),
Mustard Seed (Jaipur), Soy Seeds, Castor Oil, Refined Soy Oil, Soymeal, RBD Palmolein,
Groundnut Oil, Sesame Seed, Mustard Seed (Jaipur), Pepper, Red Chilli, Jeera, Turmeric,
Copper, Nickel, Tin, Aluminium , Chana, Rice, Wheat, Maize, Crude Oil, Rubber, Cashew,
Guar Seed, Polypropylene (PP), High Density Polyethylene (HDPE).

2.2 National Commodity and Derivatives Exchange

(NCDEX)

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NCDEX is a public limited company incorporated on April 23, 2003 under the
Companies Act, 1956. It obtained its Certificate for Commencement of Business on May 9,
2003. It has commenced its operations on December 15, 2003.

National Commodity & Derivatives Exchange Limited (NCDEX) is a

professionally managed online multi commodity exchange promoted by ICICI Bank
Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank for
Agriculture and Rural Development (NABARD) and National Stock Exchange of India
Limited (NSE). Punjab National Bank (PNB), CRISIL Limited (formerly the Credit
Rating Information Services of India Limited), Indian Farmers Fertiliser Cooperative
Limited (IFFCO) and Canara Bank by subscribing to the equity shares have joined the
initial promoters as shareholders of the Exchange. NCDEX is the only commodity
exchange in the country promoted by national level institutions. This unique parentage
enables it to offer a bouquet of benefits, which are currently in short supply in the
commodity markets. The institutional promoters of NCDEX are prominent players in
their respective fields and bring with them institutional building experience, trust,
nationwide reach, technology and risk management skills.

NCDEX is regulated by Forward Market Commission in respect of futures

trading in commodities. Besides, NCDEX is subjected to various laws of the land like the
Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and

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various other legislations, which impinge on its working.

NCDEX is located in Mumbai and offers facilities to its members in more

than 390 centres throughout India. The reach will gradually be expanded to more centres.
NCDEX is a nation-level, technology driven de-mutualized on-line commodity
exchange with an independent Board of Directors and professionals not having any vested
interest in commodity markets. It is committed to provide a world-class commodity
exchange platform for market participants to trade in a wide spectrum of commodity
derivatives driven by best global practices, professionalism and transparency.

NCDEX currently facilitates trading of thirty six commodities - Cashew, Castor Seed,
Chana, Chilli, Coffee, Cotton, Cotton Seed Oilcake, Crude Palm Oil, Expeller Mustard
Oil, Gold, Guar gum, Guar Seeds, Gur, Jeera, Jute sacking bags, Mild Steel
Ingot, Mulberry Green Cocoons, Pepper, Rapeseed Mustard Seed ,Raw Jute, RBD
Palmolein, Refined Soy Oil, Rice, Rubber, Sesame Seeds, Silk, Silver, Soy Bean, Sugar,
Tur, Turmeric, Urad, Wheat, Yellow Peas, Yellow Red Maize & Yellow Soybean Meal.
At subsequent phases trading in more commodities would be facilitated.

2.3 National Multi Commodity Exchange (NMCE)

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 NMCE is the first to get the ‘National’ status and be fully operational
 Demutualised Corporate Structure leading to a reliable, effective, impartial and rule-
based management by professionals having no trade interest.
 Convergence of all the offers and bids emanating from all over the country in a Single
Electronic Order Book of the Exchange ensuring equal access to all intermediaries.
 Participation of diverse interests like Importers, Exporters, Growers, Brokers, Traders,
etc., using an electronic trading system providing a fair, efficient and transparent
commodities market.
 Fair Trading Practice ensured through inbuilt checks and balances in the System.
 Use of LEMDA based margining at 99.9% VAR (Value at Risk) system for the initial
margin.
 Warehouse Receipt System based Delivery of Underlying Commodities meeting the current
international standards; its endeavor is to fulfill its mission in letter and spirit.
 First to establish a Trade Guarantee Fund, thereby offering guaranteed clearing and
book entry settlements by assuming counter-party risks.
 Real Time Price & Trade Data Dissemination

 NMCE Market Surveillance Program

 NMCE would bring about the convergence of large-scale processors, traders, and
farmers along with banks. NMCE would provide a common ground for fixation of
future prices of a number of commodities enabling efficient price discovery/forecast.
In addition, hedging using different and diverse commodities would also be possible
with help of NMCE. In short, NMCE is leading transition of highly fragmented,
controlled and restricted commodity economy to globally integrated, efficient
and competitive environment in the 21st Century.

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3 Trading and Settlement

Procedure At Commodity
Market
3.1Trading Procedure
3.2Clearing and Settlement
Procedure

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3.1 TRADING PROCEDURE

The various aspects in trading are as follows:

a) Placing the order

b) Methods of trading
c) Kinds of orders
d) Kinds of margins
e) Pricing of futures
f) Closing out the positions

a) Placing the order

In futures market an order should contain specifications such as buy or sell, the number of
contracts, the month of contract, type and quality of the commodity, the exchange, the price
specifications and the period of validity. Usually, orders are placed by telephone, with
brokers representing users and producers. If an order is executed the client receives a
confirmation. The Investor who agrees to buy assumes a long futures position and the
investor who agrees to sell assumes a short futures position.

b) Methods of Trading
The trading in future exchanges is carried out through two methods. They are

i. Open outcry
ii. Electronic trading

i. Open Outcry
Open outcry trading is a face to face and highly activated form of trading used on the floors
of the exchanges. In open outcry system the futures contracts are traded in pits. A pit is a
raised platform in octagonal shape with descending steps on the inside that permit buyers and
sellers to see each other. Normally only one type of contract is traded in each pit like a
Eurodollar pit, Live Cattle pit, etc.

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The trading process consists of an auction in which all bids ad offers on each of the contracts
are made known to the public and everyone can see the market's best price. To place an order
under this method, the customer calls a broker, who time-stamps the order and prepares an
office order ticket. The broker then sends the order to a booth on the exchange floor called
broker's floor booth. There, a floor order ticket is prepared, and a clerk hand delivers the
order to the floor trader for execution. In some cases, the floor clerk may use hand signals to
convey the order to floor traders. Large orders typically go directly from the customer to the
broker's floor booth. The floor trader, standing in a central location i.e. trading pit, negotiates
a price by shouting out the order to other floor traders, who bid on the order using hand
signals. Once filled, the order is recorded manually on the order parties in the trade. At the
end of each, the clearing house settles trades by ensuring that no discrepancy exists in the
matched-trade information.

ii. Electronic Trading

Electronic trading systems have become increasingly popular in the past decade. The driving
factor for the rise in the popularity of these systems is their potential to improve efficiency
and lower the cost of transactions. In addition, electronic trading systems make exchanges
available to remote investors in real time, which is an important benefit in the present
situation of increased trading from remote locations.

Electronic trading is an automated trade execution system with three key components.

1. Computer terminals, where customer orders are keyed in the and trade confirmations are
received.
2. A host computer that processes trade.
3. A network that links the terminals to the host computer.

Customers may enter orders directly into the terminal or phone in the order to a broker. With
electronic order matching systems, the host computer matches bids with offers according to

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 COMMODITY MARKET

certain rules that determine an order's priority. Priority rules on most systems include price
and time of entry. In some cases, priority rules may also include order size, type of order and
identity of the customer who placed the order.

In the simplest case, matching occurs when a trader places a buy order at a price equal to
higher than the price of an existing sell order for the same contract. The host computer
automatically executes the order, so that trades are matched immediately. Trades are then
cleared immediately, as long as the host computer is lined to the clearing house.

After hours Electronic trading System

After-hours electronic trading first began in 1992 at CME (Chicago Mercantile Exchange).
This was introduced to meet the needs of an increasingly integrated global economy and to
have an access to the currency price protection around the clock. Electronic trading system is
used in the open outcry exchanges after the day trading is over.

c) Kinds of orders
The orders (under an open outcry / electronic system) can be placed in different ways,
including:

Market Order
This is the most common type of order. No specific price is mentioned. Only the position to
be taken-long/short is stated. When this kind of order is placed, it gets executed irrespective
of the current market price of that particular asset.

Market on open
The order will be executed on the market open within the opening range. This trade is used
to enter a new trade, or exit an open trade.

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 COMMODITY MARKET

Market on Close
The order will be executed on the market close. The fill price will be within the closing
range, which may, in some markets, be substantially different from the settlement price. This
trade is also used to enter a new trade, or exit an open trade.

Limit Order
An order to buy or sell a stated amount of a commodity at a specified price, or at a better
price, if obtainable at the time of execution. The disadvantage is that the order may not get
filled at all if the price for that day does not reach the specified price.

Stop-Loss Order
A stop-loss order is an order, placed with the broker, to buy or sell a particular futures
contract at the market price if and when the price reaches a specified level. Futures traders
often use stop orders in an effort to limit the amount they might lose if the futures price
moves against their position. Stop orders are not executed until the price reaches the
specified point. When the price reaches that point the stop order becomes a market order.
Most of the time, stop orders are used to exit a trade. But, stop orders can be executed for
buying/selling positions too. A "buy" stop order is initiated when one wants to buy a contract
or go long and a "sell" stop order when one wants to sell or go short. The order gets filled at
the suggested stop order price or at a better price.

Example: A trader wants to purchase a crude oil futures contract at Rs.750 per barrel. He
wishes to limit his loss to Rs.50 a barrel. A stop order would then be placed to sell an
offsetting contract if the price falls to Rs.700 per barrel. When the market touches this price,
stop order gets executed and the trader would exit the market.

Day order
Day orders are good for only one day, the day the order is placed.
Example: A trader wants to go long on September 1, 2003 in Refined Palm Oil in a
commodity exchange. A day order is placed at Rs. 340/10 kg. If the market does not reach
this price the order does not get filled even if the market touches Rs.341 and closes. In other

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 COMMODITY MARKET

words, day order is for a specific price and if the order does not get filled that day, one has to
place the order again the next day.

Good Till Cancelled (GTC) Order

It is an open order to buy or sell that remains active until the order gets filled in the market, or
is cancelled by the person who placed the order.
Example: A trader wants to go long on Refined Palm oil when the market touches Rs.400/10
kg. The order exists until it is filled up, even if it takes months for it to happen. The order is
always open until the order is cancelled or the contract expires.

Fill or Kill order

This order is a limit order that is sent to the pit to be executed immediately and if the order is
unable to be filed immediately, it gets cancelled.

All or None order

All or None order (AON) is a limit order, which is to be executed in its entirety, or not at all.
Unlike a fill-or-kill order, an all-or-none order is not cancelled if it is not executed as soon as
it is represented in the exchange. An all-or-none order position can be closed out with
another AON order.

Spread Order
A simple spread order involves two positions, one long and one short. They are taken in the
same commodity with different months (calendar spread) or in closely related commodities.
Prices of the two futures contract therefore tend to go up and down together, and gains on one
side of the spread are offset by losses on the other. The spreaders goal is to profit from a
change in the difference between the two futures prices.

The trader is virtually unconcerned whether the entire price structure moves up or down, just
so long as the futures contract he bought goes up more (or down less) than the futures
contract he sold.

OCO Order

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 COMMODITY MARKET

It is called One cancels the Other (OCO) order. The order placed so as to take advantage of
price movement, which consists of both a Stop and a Limit price. Once one level is reached,
one half of the order will be executed (either Stop or Limit) and the remaining order
cancelled (either Limit or Stop). This type of order would close the position if the market
moved to either the stop rate or the limit rate, thereby closing the trade and at the same time,
cancelling the other entry order.

Example: A trader has a buy position at Rs.14, 000/tonne on Soybean. He wishes to have
both stop and limit orders in order to fill the order in a particular price range. A stop order is
placed at Rs. 14,100/tonne and a limit order at Rs.13, 900/tonne. If the market trades as Rs.
13,900/tonne, the limit order gets filled and the stop order immediately gets cancelled. The
trader exists the market at Rs.13, 900/tonne.

d) Kinds of Margin
Margin is the deposit money that needs to be paid to buy or sell each contract. The margin
required for a futures contract is better described as performance bond or good faith money.
The margin levels are set by the exchanges based on volatility (market conditions) and can be
changed at any time. The margin requirements for most futures contracts range from 2% to
15% of the value of the contract.
The different types of margins in futures that a trader has to maintain are as under:

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 COMMODITY MARKET

Initial Margin
The amount that must be deposited by a customer at the time of entering into a contract is
called initial margin. This margin is meant to cover the largest potential loss in one day. The
margin is a mandatory requirement for parties who are entering into the contract.

Maintenance Margin
A trader is entitled to withdraw any balance in the margin account in excess of the initial
margin. To ensure that the balance in the margin account never becomes negative, a
maintenance margin, which is somewhat lower than the initial margin, is set. If the balance
in the margin account falls below the maintenance margin, the trader receives a margin call
and is requested to deposit extra funds, to bring it to the initial margin level within a very
short period of time.

Additional Margin
In case of sudden higher than expected volatility, the exchange calls for an additional margin,
which is a preemptive move to prevent breakdown. This is imposed when the exchange fears
that the markets have become too volatile and may result in some payments crisis, etc.

Mark-to-Market Margin
At the end of each trading day, the margin account is adjusted to reflect the trader's gain or
loss. This is known as marking to market the account of each trader. All futures contracts
are settled daily reducing the credit exposure to one-day's movement. Based on the
settlement price, the value of all positions is marked-to-the-market each day after the official
close i.e. the accounts are either debited or credited based on how well the positions faired in
that day's trading session. If the account falls below the maintenance margin level the trader
needs to replenish the account by giving additional funds. On the other hands, if the position
generates a gain, the funds can be withdrawn (those funds above the required initial margin)
or can be used to fund additional trades.

e) Pricing of Futures
In futures contract the price is predetermined. The seller knows how much he is going to be
paid and the buyer knows how much he is going to pay at a future date. As futures contracts

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 COMMODITY MARKET

are standardized according to quantity, quality and location, it is price that is the only factor
on which buyers and sellers can bargain. The price in futures market is determined by a
mechanism called Price discovery.

Price discovery
It is the process of arriving at a figure in which one person buys and another sells a futures
contract for a specific expiration date. In an active futures market, the process of price
discovery continues from the market's opening until its close. The prices are freely and
competitively derived. Future prices are therefore considered to be superior to the
administered prices or the prices that are determined privately. Further the low transaction
costs and frequent trading encourages wide participation in futures markets lessening the
opportunity for control by a few buyers and sellers.

In an active futures markets the free flow of information is vital. Futures exchanges act as a
focal point for the collection and dissemination of statistics on supplies, transportation,
storage, purchases, exports, imports, currency values, interest rates and other pertinent
information. Any significant change in this data is immediately reflected in the trading pits
as traders digest the new information and adjust their bids and offers accordingly. As a result
of this free flow of information, the market determines the best estimate of today and
tomorrow’s prices and it is considered to be the accurate reflection of the supply and demand
for the underlying commodity. Price discovery facilitates this free flow of information,
which is vital to the effective functioning of futures market.

Interpretation of Price charts and tables

Example: NCDEX Cotton Futures Prices on Thursday, September 4, 2005.

Contract Open High Low Settle Lifetime Lifetime Open

Month High Low Interest
Sept 262.75 263.50 261.50 262.00 270.50 238.00 33922
Dec 266.25 267.50 264.75 266.75 268.00 235.50 141307
Estimated Volume 38,000; volume Wed 38592; open interest 348967+987

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 COMMODITY MARKET

The first line of the table: Cotton 5,000 Kg; Rs per 10 Kg. This indicates that the table
applies to the NCDEX Cotton contract, the contract size is 5,000 Kg, and the prices shown in
the table are in units of Rs per Kilograms.

Opening Price : The open or opening price is the price or range of prices for the day's first
trades, registered during the period designated as the opening of the market or the opening
call.

Closing Price : The closing price is the price or range of prices at which the commodity
futures contracts are traded during the brief period designated as the market close or on the
closing call (i.e. last minute of the trading day).
Highest Price: The word high refers to the highest price at which a commodity futures
contract is traded during the day.

Lowest Price: Low refers to the lowest price at which a commodity futures contract is traded
during the day.

Settlement Price: This is abbreviated as settle in most of the pricing tables. There will be
many trades occurring in the last few minutes. Settlement price is computed from the range
of closing prices. Settlement price is important to calculate the daily gains, losses and margin
requirements. It is used by the clearing house to calculate the market value of outstanding
positions held by its members.

Change: The change refers to the change in settlement prices from the previous days close to
the current day's close.

Lifetime high and low: They refer to the highest and lowest prices recorded for each contract
from the first day it traded to the present.

Open Interest: It refers to the number of outstanding contracts for each maturity month.

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In the line at the bottom of the table, Est. vol. indicates the estimated volume of trading for
that day. Vol. Wed. indicates the trading volume for the previous day. Open interest refers
to the total open interest for all contract months combined at the end of the day's trading
session. Then the figure +987 indicates an increase of 987 contracts from the open interest of
the previous day.

Patterns of Futures Prices

As the maturity date approaches the futures prices show different patterns. Based on these
patterns the markets can be predicted.

Normal Markets: Markets where the prices increase as the time to maturity increases.
Inverted Markets:Markets where the price is a decreasing function of the time to maturity.

Convergence of futures price to spot price

As the delivery month of a future contract approaches the futures prices converges to the spot
price of the underlying asset. When the delivery period is reached the futures price equals or
is very close to the spot price. This happens because if the futures price is above the spot
price during the delivery period it gives rise to a clear arbitrage opportunity for traders. In
case of such arbitrage the trader can short his futures contract, buy the asset from the spot
market and make the delivery. This will lead to a profit equal to the difference between the
futures price and spot price. As traders start exploiting this arbitrage opportunity the
demand for the contract will increase and futures prices will fall leading to the convergence
of the future price with the spot price. If the futures price is below the spot price during the
delivery period all parties interested in buying the asset will take a long position. The trader
would buy the contract and sell the asset in the spot market making a profit equal to the
difference between the future price and the spot price. As more traders take a long position
the demand for the particular asset would increase and the futures price would rise nullifying
the arbitrage opportunity.

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f) Closing out the Positions

The futures contracts are squared-off before the delivery date. Most of the traders choose to
closeout their positions prior to the delivery period specified in the contract. Closing out
means taking opposite positions of trade from the original one.

Continuing from Example 1 : The Mumbai investor who bought the December soybean
futures on September 2, 2005 can close out the position by selling (i.e. going short) one
December futures contract on any date before the agreed upon delivery date. The Indore
investor who sold the Soybean futures can closeout by buying one December contract at any
time before the Delivery date. The investor's total gain or loss is determined by the change in
the futures prices between the date of entering in to the contract and date of closing out the
contract.

3.2CLEARING AND SETTLEMENT

INTRODUCTION

Most of the futures contracts do not lead to the actual physical delivery of the underlying
asset. The settlement is by closing out, physical delivery or cash settlement. All these
settlement functions are taken care of by an exchange-clearing house, called clearing house /
corporation, in futures transactions.

Clearing House
A clearing house is a system by which exchanges guarantee the faithful compliance of all
trade commitments undertaken on the trading floor or electronically over the electronic
trading systems. The main task of the clearing house is to keep track of all the transactions
that take place during a day so that the net position of each of its members can be calculated.
It guarantees the performance of the parties to each transaction. It is responsible for:

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 COMMODITY MARKET

 Effecting timely settlement

 Trade registration and follow up
 Control of the evolution of open interest
 Financial clearing of the payment flow
 Physical settlement (by delivery) or financial settlement (by price difference) of contracts.
 Administration of financial guarantees demanded by the participants.

Functions of the clearing house

Clearing house has a number of members, who are mostly financial institutions responsible
for the clearing and settlement of commodities traded on the exchanges. The margin
accounts for the clearing house members are adjusted for gains and losses at the end of each
day (in the same way as the individual traders keep margin accounts with the broker). In the
case of clearing house members only the original margin is required (and not maintenance
margin). Everyday the account balance for each contract must be maintained at an amount
equal to the original margin times the number of contracts outstanding. Thus depending on a
day's transactions and price movement the members either need to add funds or can withdraw
funds from their margin accounts at the end of the day. The brokers who are not the clearing
members need to maintain a margin account with the clearing house member through whom
they trade in the clearing house.

Provisions Regarding Members Of The Clearing House

REGULATION OF CLEARING HOUSE

Exchanges shall prescribe the process from time to time for the functioning and operations of
the Clearing House and to regulate the functioning and operations of the Clearing House for
the settlement of non-depository deals.

CLEARING HOUSE TO DELIVER COMMODITIES AT DISCRETION

The Clearing House is entitled at its discretion to deliver commodities, which it has received
from a member under these Regulations to another member who is entitled under these

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 COMMODITY MARKET

Regulations to receive delivery of commodities of a like kind or to instruct a member to give

direct delivery of commodities which he has to deliver.

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 COMMODITY MARKET

Processes of a clearing house

Trading Roo Price

information
Member Trading Commitments
Checking information
Report Statement
of commitments
Clearing Section-
Input Report on Margins
In-out

Computer Processing
Statement of account for
Statement of
Output daily Settlement
Margines Margin
Daily clearing account
Required -
(Mark to Market)
Margin
 Exchange Trading fee
Deposited
 Exchange Tax
Margin required  Liability Reserve
Payment
or refundable  Special Security

Margin required is to be
paid by cash or
substitutable securities.
Margin refundable is to
be returned on request
Amount to be paid
or received
To be made through
account transfer at the
contracted bank by noon
of 2 business days after
the date of the statement.

NO LIEN ON CONSTITUTUENT'S COMMODITIES

When a member is declared a defaulter neither the Exchange nor the creditor of the defaulter
shall be entitled to any lien on the commodities delivered by him to the Clearing House on
account of his Constituents.

CLEARING CODE AND FORMS

A member shall be allotted a Clearing Code, which must appear on all forms used by the
member connected with the operation of the Clearing House. The Clearing Forms and
Formats to be used by the members shall be prescribed by the Clearing House.
SIGNING OF CLEARING FORMS
The member or his Clearing Assistant shall sign all Clearing Forms

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 COMMODITY MARKET

SPECIMEN SIGNATURES
A member shall file with the Clearing House specimens of his own signature and of the
signatures of his Clearing Assistants. The member and his Authorised Representative in the
presence of an officer of the Exchange or of the Clearing House shall sign the specimen
signatures card.

CLEARANCE BY MEMBERS ONLY

Clearing members including professional Clearing Members only shall be entitled to clear
and settle contracts through the Clearing House.

CHARGES FOR CLEARING

The Exchange shall from time to time prescribe the scale of clearing charges for the clearance
and settlement of transactions through the Clearing House.

CLEARING HOUSE BILLS

The Clearing House shall periodically render bills for the charges, fees, fines and other dues
payable by members to the Exchange which would also include the charges for the use of the
property as well as the charges, fines and other dues payable on account of the business
cleared and settled through the Clearing House and debit the amount payable by members to
their accounts. All such bills shall be paid within a week of the date on which they are
rendered.

LIABILITY OF THE CLEARING HOUSE

The only obligation of the Clearing House shall be to facilitate the delivery and payment in
respect of commodities, transfer deed and any other documents between members.

SETTLEMENT METHODS
A contract can be settled in three ways:
 By physical delivery of the underlying asset.
 Closing out by offsetting positions.

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 COMMODITY MARKET

 Cash settlement.

Closing Out
Most of the contracts are settled by closing out. In closing out, the opposite transaction is
effected to close out the original futures position. A buy contract is closed out by a sale and
sale contract is closed out by a buy.

Cash Settlement
When a contract is settled in cash it is marked to the market at the end of the last trading day
and all positions are declared closed. The settlement price on the last trading day is set equal
to the closing spot price of the underlying asset ensuring the convergence of future prices and
the spot prices.

Commodity Physical settlement schedule for

pay in/payout’s
Soyabean T+7
Refined soyabean oil T+7
Rapeseed mustard seed T+7
Rapeseed mustard seed oil T+7
RBD Palmolein T+7
Crude palm oil T+7
Medium staple cotton T+10
Long staple cotton T+10
Gold T+2
Silver T+4

T’ is the date of expiry of the contract.

Cash settlement on T+1 for all contracts.

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 COMMODITY MARKET

Process of Dematerlization:-

Dematerlization refers to issues of an electronic credit, instead of vault/ warehouse

receipt, to the depositor against the deposit of commodity. Any person (a consultant) seeking
to dematerialize a commodity has to open an account with an approved depository
participant.

In case of agri commodities the constituent delivers the commodity to the exchange-
approved warehouses. The commodity brought by the constituent is checked to the quality by
the exchange-approved assayers before the deposit of the same is accepted by the warehouse.
If the quality of the commodity is a per the norms defined and notified by the exchange from
time to time, the warehouse accepts the commodity and sends conformation in the requisite
form to the R&T agent who upon verification, confirms the deposit of such commodity to the
depository for giving credit to the demat account of the said constituent.

In case of precious metals, the commodity must be accompanied with the assayers’
certificate. The vault accepts the precious metal, after verifying the contents of assayers’
certificate with the precious metal being deposited. On acceptance, the vault issues an
acknowledgement to the constituent and sends confirmation in the requisite format to the
R&T agent who upon verification, confirms the deposit of such precious metal to the
depository for giving credit to the demat account of the said constituent.

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 COMMODITY MARKET

Seller client
of member Submits commodities &
Demat Request Form

Warehouse
Sends data to NSDL via
R & T Agent

R & T Agent
Accepts Goods

NSDL

Process of re-materialization:-

Re-materialization refers to issue of physical delivery against the credit in the demat account
of the constituent. The constituent seeking to rematerialize his commodity holding has to
make a request to his DP then routes his request through the depository system to the R& T
agent issues the authorization addressed to the vault/warehouse to release physical delivery to
the constituent.

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 COMMODITY MARKET

4.Commodity
Analysis
4.1Gold
4.2Guar Seed

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 COMMODITY MARKET

Study on some commodities that are traded in the commodity markets. Commodities selected
are which are traded widely in the market. So commodities like gold and guar are selected.
This analysis contains brief description if product, factors affecting its supply and demand,

4.1 Gold

For centuries, gold has meant wealth, prestige, and power, and its rarity and natural beauty
have made it precious to men and women alike. Owning gold has long been a safeguard
against disaster. Many times when paper money has failed, men have turned to gold as the
one true source of monetary wealth. Today is no different. While there have been fluctuations
in every market and decided downturns in some, the expectation is that gold will hold its
own. There is a limited amount of gold in the world, so investing in gold is still a good way to
plan for the future. Gold is homogeneous, indestructible and fungible. These attributes set
gold apart from other commodities and financial assets and tend to make its returns
insensitive to business cycle fiuctuations. Gold is still bought (and sold) by different people
for a wide variety of reasons ñ as a use in jewellery, for industrial applications, as an
investment and so on.

Traditionally South Africa has been the largest producers of gold in the world accounting for
almost 80% of all non communist output in 1970. Although it retained its position as the
single largest gold producing country, its share had fallen to around 17% by 1999 because of
high costs of mining and reduced resources. In contrast other countries like US, Australia,
Canada and China have increased their output exponentially with output from developing
countries like Peru and other Latin American countries also increasing impressively.

Global and domestic Demand-Supply

The demand for gold may be categorized under two heads consumption demand and
investment demand. Consumption of gold differs according to type, namely industrial

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 COMMODITY MARKET

applications and jewellery. The special feature of gold used in industrial and dental
applications is that some of it cannot be salvaged and thus is truly consumed. This is unlike
consumption in the form of jewellery, which remains as stock and can reappear at future time
in market in another form.
Consumer demand accounts for almost 90% of total gold demand and the demand for jewelry
forms 89% of consumer demand.

1996 1997 1998 1999 2000

--------------------------------------------------------------------------------------------
India 506.98 736.84 814.91 838.86 855.34
USA 331.56 362.04 428.29 459.71 387.55
China 374.48 406.83 314.45 343.38 329.38
SE Asia 329.69 204.04 51.63 265.62 267.18
Saudi 184.75 199.06 208.39 199.37 221.14
Turkey 153.03 201.86 172.00 139.03 207.15

World Markets

Today's gold market is a round-the-world, round-the-clock business, played out largely on

dealers' trading screens. The core of the business, however, remains in the key markets of
London, as the great clearing house, New York as the home of futures trading, Zurich as a
physical turntable, Istanbul, Dubai, Singapore and Hong Kong as doorways to important
consuming regions and Tokyo where the Commodity Exchange (TOCOM) sets the mood of
Japan. Even Paris still has a small market, a reminder of the days when the French were great
hoarders, while Mumbai has increasing importance under India's liberalised gold regime that
permits official imports through local markets.

Domestic Scenario
India is the world's largest consumer of gold. According to Gold Field Minerals Service, in
2001 it absorbed around 700 tons from the world market, compared to just 320 tons in 1994;
that is without taking into account the recycling of scrap from the immense stock of close to
10,000 tons built up on the sub-continent in the last few hundred years, or gold imported for
jewellery manufacture and re-export.

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 COMMODITY MARKET

During 1990-95, India’s share in global gold demand is placed at about 402 tons (16.4 per
cent) a year, including imports into India. This should be viewed against its share of 0.6 per
cent in world trade. On the other hand, India exported about 23 tons in 1995 accounting for a
negligible part of world trade.

Gold is valued in India as a savings and investment vehicle and is the second preferred
investment behind bank deposits. India is the world’s largest consumer of gold in jewellery
(much of which is purchased as investment). However, gold has to compete with the stock
market, investment in internet industries, and a wide range of consumer goods. In the rural
areas 22 carat jewellery remains the basic investment.

Jewellery

India is the world's foremost gold jewellery fabricator and consumer with fabricator and
consumption annually of over 600 tons according to GFMS. Measures of consumption and
fabrication are made more difficult because Indian jewellery often involves the re-making by
goldsmiths of old family ornaments into lighter or fashionable designs and the amount of
gold thus recycled is impossible to gauge. Estimates for this recycled jewellery vary between
80 tons and 300 tons a year. GFMS estimates are that official gold bullion imports in 2001
were 654 tons.

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 COMMODITY MARKET

Factors affecting the price of Gold

Uncontrolled and uncertain supply

Besides new mining supply, the available supply of gold in the market is made up of three
major ‘above-ground sources’. In recent years, the growth in gold supply has come from
these ‘aboveground’ sources.
 Reclaimed scrap, or gold reclaimed from jewelry and other industries such as
electronics
and dentistry;
 Official, or central-bank, sales
 Gold loans made to the market from official gold reserves for borrowing and lending
purposes.

The supply from these sources is not determined easily, so it is not possible to estimaye the
total supply.

Fluctuating and uncertain demand

The deregulation of the Indian gold market during the 1990s brought about a dramatic
change. Jewellery demand increased from 208 tons in 1991 to peak at 658 tons in 1998, while
demand for investment bars grew from 10 tons in 1991 to 116 tons in 1998, and registered 85
tons in 2002. India in 2001 it absorbed around 700 tons from the world market compared to
just 320 tons in 1994; that is without taking into account the recycling of scrap.
In India the rural population accounts for approximately 70% of national gold demand. Thus
India’s annual gold consumption is dictated both by the monsoon, with its effect on the
harvest, and the marriage season. Between 1998-2001 annual Indian demand for gold in
jewellery exceeded 600 tons, however in 2002, due to rising and volatile prices and a poor
monsoon season, this dropped back to 490 tons.

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 COMMODITY MARKET

The major factors influencing demand for gold in India are,

 Generation of large market surplus in rural areas as a result of all round increase in
agricultural production
 Unaccounted income/wealth generated mainly in the service sector
 Domestic gold prices relative to those of ordinary shares and international gold prices

Wide and unforeseen price variation

Economic forces that determine the price of gold are different from, and in many cases
opposed to, the forces that influence most financial assets.

Econometric studies indicate that the price of gold is determined by two sets of factors:
‘supply’ and ‘macro-economic factors’.

Supply and the gold price are inversely related. In the case of ‘macro-economic factors’, the
U.S. dollar tends to be inversely related to gold, while inflation and gold tend to move in
tandem with each other. Also, high low-interest rates are generally a positive factor for gold.
Overall, the impact of all of these determinants on the gold price is judged to be neutral-to-
positive at this time. Also there is low to negative correlation between returns on gold and
those on stock markets

An Article from ‘The Hindu’

Demand for gold set to remain strong

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 COMMODITY MARKET

World price likely to reach $500 an ounce by the end of 2005.

Oil-dollar-gold price link broken Alternative for speculative investors Nine-

month sale in India exceeds that of whole of 2004.

MUMBAI 7th November, 2005 :World Gold Council (WGC) data reveal that in the first nine
months of 2005, Indian demand was up at 645 tonnes (470 tonnes) and Indians bought 642
tonnes of the metal more than the whole of last year. Besides, it is expected that with the
festive and wedding seasons in full swing, the full year figure could well break the previous
record of 795 tonnes in 1998. According to the WGC, following the astonishing growth
witnessed in the first half of 2005, when total consumer demand rose 55 per cent.

With the U.S. dollar at a two-year high and oil prices having peaked, the alternative to
investors seems to have been gold. Madhusudan Daga, Bullion Analyst and Consultant,
Goldfield Mineral Services, attributed the spectacular rise to open speculative positions in
the U.S. "This time the link between gold, oil and the U.S. dollar seems to have been broken.
While gold has traditionally had a direct link with oil prices and an inverse one with the U.S.
dollar, this time, gold has moved up in consonance with falling oil and rising dollar."

In India, investment demand in the first nine months of 2005 was up 50 per cent at 105 tonnes
(71 tonnes) and in the July-September period, it was up 56 per cent. Globally, the price
moved up to $488 per ounce from $458 per ounce in July. Mr. Daga was confident that
prices would cross the $500 per ounce mark by the year-end.

Sanjeev Agarwal, Managing Director, Indian Subcontinent, World Gold Council, "Gold has
been on the up because over the last few years, with the U.S. dollar weakness and the huge
deficit in the U.S., the investors have been looking at other options like housing, hedge funds
and gold. Also, oil prices have moved up in last six months. So gold has been seen as a means
of diversification of portfolio."

"The underlying prospects for gold in India remain very good. The economy continues to
perform." according to the WGC.
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Trading system NCDEX's Trading System

Monday to Friday
Trading Hours - 10.00 a.m. to 4.00 p.m. & 5.00 p.m. to 11.00
Trading Hours p.m.
Closing session – 11.15 p.m. to 11.30 p.m. or as may be decided
and notified by the Exchange from time to time
Unit of trading 1 kg
Delivery unit 1 kg
Quotation/Base Value Rs per 10 Grams of Gold with 999.9 fineness
Tick size Re 1 or as may be notified by the Exchange from time to time
Limit 10%. Limits will not apply if the limit is reached during
Price band
final 30 minutes of trading
Not less than 995 fineness bearing a serial number and
identifying stamp of a refiner approved by NCDEX. List of
Quality specification
approved refiners will be available with the Exchange and also
on its web site: www.ncdex.com
Quantity Variation None
3 concurrent month contracts or as may be notified by the
No. of active contracts
Exchange from time to time
Mumbai as also other centers as may be notified by the
Delivery center
Exchange from time to time
The first 3 contracts will be launched on March 31, 2004.
Subsequently, trading in any contract month will open on the
Opening Date
21st day of the month or as may be decided by the Exchange
from time to time.
20th day of the delivery month, if 20th happens to be a holiday
Due date
then previous working day
Position limits Member-wise: Max (Rs 200 Crores, 15% of open interest)

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Client-wise: Max (Rs 100 Crores, 10% of open interest)

The price adjustment will be given for the fineness below 999.9.
Premium/Discounting The settlement price for less than 999.9 fineness will be
calculated as: (actual fineness / 999.9) Settlement Price

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4.2Guar Seed

Introduction:-

Guar, or cluster bean, (Cyamopsis tetragonoloba (L.) Taub) is a drought-tolerant

annual legume crop. Guar is being grown in India since ancient time and the Tender Green
Guar is an important source of nutrition to animals and humans and is consumed as a
vegetable and cattle feed The Guar legume plant is an agricultural product grown in arid
zones of west and North West India and parts of Pakistan.

India accounts for 80% of the total guar produced in the world and 70% is cultivated
in Rajasthan. Apart from Rajasthan, it is being grown mainly in Gujarat, Haryana and Punjab.
It is also grown in some parts of Uttar Pradesh and Madhya Pradesh.

Global Scenario:-

Pakistan, Sudan and parts of USA are the other major Guar growing countries. 75% of
the Guar Gums or their derivatives produced in India are exported mainly to USA and
European countries. The value added derivatives of Guar Powder are used by the various
industries in India as well as abroad.

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Geographic/Agronomic suitability:

Guar grows best in sandy soils and it needs moderate, intermittent rainfall with lots of
sunshine. Too much precipitation can cause the plants to become leafier, thereby reducing the
number of pods and/or the number of seeds per pod which affects the size and yield of the
seeds. Guar is a rain fed monsoon crop, which requires 8-15 inch of rain in 3-4 spell and is
generally sown after the monsoon rainfall in the second half of July to early August and is
harvested in October - November. Guar requires 2 rainfalls before sowing, one when the crop
buds, and one rainfall when the crop comes up well and the blossoming starts.

The Guar has the properties to regenerate soil nitrogen and the endosperm of guar
seed is an important hydrocolloid widely used across a broad spectrum of industries.
Rajasthan accounts for 70% of the Guar Seed cultivation.

Pricing Pattern:-

Guar seed has shelf life of more than 3 years without losing out on any of its
properties or qualities. It requires the barest minimum maintenance and handling
environment. The price range of Guar seed ranges from Rs 850/- per qtl to Rs 6500/- qtl.

The Value Chain:-

Farmer

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Agent (mandi) stockist

Broker

Split Processing Units

Broker

Powder Processing Units

Industrial use (local/export)

Consumer

Various Industrial applications of Guar Powder:-

 Food, pet-food, nutritional products and pharmaceuticals.

 Personal care products.
 Household products.
 Paints.
 Textiles and carpets.
 Mining and flocculation.
 Oils, gas and other deep well operations.
 Paper.

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5 Impediments in development of
commodity exchanges

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Agricultural commodity Futures exchanges in India are still not developed as compared to
other countries. The dominant political ideology during early years after independence dealt a
severe blow to development of futures exchanges in India. It is only after the onset of
liberalization during 1990s that attitude towards futures trading has changed and its potential
benefits are now being acknowledged in the policy circles. However, there are still a number
of impediments in their growth many of which are on account of regulatory provisions while
others relate to the practices of trade prevalent in these exchanges. As a result of these
impediments membership of commodity exchanges and volume of futures transactions have
remained low.
The membership of a majority of agricultural commodity exchanges have either remained
stagnant or declined during last few years. Small and stagnant number of members proves
that the business of trading in futures is not considered attractive. Examples of a few
exchanges will illustrate this point. The number of active members in Kochin pepper
exchange declined from 55 in 1999 to 33 in 2001. In castor oil exchange at Mumbai it
declined from 8 to 5, in Potato exchange at Hapur, it declined from 36 to 21 and in Cotton
exchange it declined from 15 to 7 during the same period. In most of the agricultural
commodity exchanges, less than 10 per cent of the registered members are actually actively
trading.
These are definite pointers to deep malaise afflicting the futures trading business in India.
Similarly, the volume of transactions in agricultural commodity exchanges have been very
low except in pepper exchange at Cochin, Gur exchange at Hapur, Castor seed exchange at
Ahmedabad, Gur exchanges at Bhatinda and Muzaffarnagar, Soya exchange at Indore and
Jute exchange at Kolkata where the annual transaction exceeded Rs. 2000 Crores during
2000-01. The average volume of transaction of other exchanges was less than Rs. 100 Crores
during 2000-01. Some of the reasons for low membership and low volume of transactions in
agricultural commodity exchanges are discussed below:

o Most of the exchanges still follow open outcry system. This stystem is not considered
to be efficient and transparent. The chances of manipulations are quite high in open
outcry system. This is the reason why the Forward Market Commission has been
emphasizing on the need for automation and has made it mandatory to have on-line

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trading system for all the commodity exchanges that are set up newly. There is a
global trend towards electronic trading; even the exchanges that have a legacy of open
outcry (and the concomitant problem of floor brokers keen on defending their turf) are
now moving towards electronic trading.

o Most of the agricultural commodity exchanges in India are beset with the problem of
poor infrastructure. They even lack basic infrastructure like modern trading ring,
warehousing facilities. independent clearing house

o Under the existing system, users of exchange, i.e. traders, hedgers, speculators, etc
need to register their full details with Forward Market Commission. This is not in tune
with foreign exchanges norms. This adds unrequired regulatory costs. This becomes a
significant issue in India where there is large expandable economy.

o Due to history of ban on futures trading a “Havala” or unorganized marketwas built

and they continue to exist now. A large portion of future is diverted to this market.
Due to there long existence they have built up good reputation in terms of liquidity
and integrity some of these markets trade as much as 20-30%higher than registered
markets.

o There is widespread lack of awareness the role and technique of trading among the
potential beneficiaries. Only traditional players who have been participating in such
trading either in formal markets or gray markets. This acts as a barrier to the growth
of futures trading in India.

o Currently, Indian tax law does not permit losses on a futures transaction to be treated
as a business expense to be offset against, say, a profit on the underlying physical
trade (unless there is a definite underlying contract).

o A major flaw in Indian commodities futures market is the practice of having an

exclusive futures exchange for each commodity. This has happened due to historical
reasons. Futures exchanges got set up in specific regions in which there was an active
spot market for a particular agricultural commodity. As a result the volumes available

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at each exchange are so miniscule that it does not permit large investments required to
create a modem derivative exchange.

o No futures market can exist in the absence of variability in the prices. Through a host
of diverse measures such as price controls, price support operations, procurement and
distribution schemes, buffer stock operations, restriction on storage and movement,
etc. the government has tried to virtually eliminate price risks. There are also
commodity based specialized government agencies like NAFED, Cotton Corporation
of India, Jute Corporation of India, etc. which control supplies of some farm products.
In the presence of these restrictions the futures markets can't be expected to develop
and play any meaningful role in price discovery of agricultural commodities.

Recommendations

 Electronic/Modern Technique
Markets in are traditional type, so there are huge amount of manipulations in it. So it’s
necessary for the governing body to use modern technique for trading in futures to avoid such
manipulations and provide its members with fair trading.

 Create Awareness among Farmers

In India many farmers, traders are not aware about the existence of commodity markets.
Inspite of efforts taken by the government to create awareness it is still not enough to attract
farmers and traders towards the commodity and regulated markets. This is due to lack of
educational facilities to farmers.

 Permitting FII and mutual-fund participation:-

Currently, regulations do not permit FIIs and mutual funds to participate in

commodity trading in India. Removal of these restrictions is likely to provide further depth to

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the commodity markets as FIIs are likely to trade actively across various commodity markets
and asset classes globally to take advantage of arbitrage opportunities.

 Increasing corporate and retail participation:-

Commodity trading in India is still at a nascent stage, with the majority of volume
attributable to traders, industry associations and speculators. Corporate and retail
participation is negligible. However, I believe this will change once the contracts mature and
there is sufficient liquidity. Up to now only a few companies have used commodity
exchanges to hedge on a trial basis. Their full entry will boost liquidity and trading volume.

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Create Infrastructure

Commodity markets lack proper infrastructural facilities which are necessary for conducting
trading smoothly. So it is necessary to have good infrastructural facilities to improve
commodity markets. It should have proper ordering, filling , processing, storage, dispatching
facilities.

 Contract of Smaller Value

Exchanges should come with concept like contract of smaller value. A contract of smaller
would be able to attract the small investors to play in the markets. This could enable to
abolish the monopoly of few existing members. This can also help these exchanges to
increase the number of their members.

 Introduction of options
Transaction volume will rise further if the regulator opens up the commodity
exchanges for commodity option trading. Currently, only trading in commodity futures is
permissible. Globally, trading volume from options is 20-30 % of the futures volume,
implying that India exchanges could get a further 20-30 % boost in commodity trading
volume.

 Warehousing Facility
All the exchanges have their warehouses at a particular place i.e. the place where it is traded
in huge numbers or place where it is produced. So it is necessary for the exchanges to locate
heir warehouses at various places as it is possible to deliver and collect the goods. This could
help in increasing percentage of delivery.

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Compulsory Delivery
Exchanges can also try with compulsory delivery contracts. This contract can be helpful
basically for farmers through which they can sell off their produce at reasonable prices.

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Conclusion
In spite of the best efforts of the government and the banks, the credit off take for agricultural
sector is not increasing to the desired extent. For this to happen, deepening of agricultural
credit market is necessary. If farmers have access to market-based price insurance through
futures markets, they will be able to benefit from higher income by commercial farming and
the potential profitability of specialization. The higher investment required for commercial
and hi-tech farming will boost the demand for farm credit. The policy environment governing
the Indian agricultural sector is rapidly evolving. Several measures have been adopted which
suggest that international price and competition is likely to intensify in agriculture sector in
near future. In order to enable the Indian farmers to meet these challenges comprehensively,
the policy environment will have to be suitably changed. The market forces will have to be
given a much greater freedom to discover prices. It is in this context that futures markets
assume a very important role in facilitating discovery of prices and devising new and
effective risk management tools for the benefit of farming economy. The opening of futures
trading in several commodities, after an almost 40-year gap, is a welcome step. Futures
trading is employed in all major global commodities markets as an effective hedge against
fluctuating prices. However, in India a great deal of groundwork, such as strengthening
Forward Market Commission, amending Forward Contract Act, 1952 and modifying
Essential Commodities Act, Minimum Support Price Mechanism, etc., needs to be done if the
futures markets are to efficiently carry out their function as a mechanism of price discovery
and risk management. There is a need to put in place a strong, but not excessive, regulatory
regime that will ensure transparency and efficient trading and encourage development of
futures trade. Efficient futures markets will stabilize the incomes of the farmers and provide
an incentive to go for capital-intensive cash crops. This, in turn, will increase the demand for
agricultural credit. Higher and stable income of the farmers will help in emergence of a
sustainable credit market in rural areas with high demand for credit coupled with high
percentage of repayment of loans.

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Bibliography

Books/ magazine: - NCFM Form National Stock Exchange.

Bank Quest

Websites: - www.mcxindia.com
www.ncdex.com
www.ficci.com
www.iibf.org
www.motilaloswal.com

Newspapers: - Hindustan Times

The Economic Times

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