“A STUDY ON FUTURE OF COMMODITY MARKET IN INDIA”

A PROJECT SUBMITTED TO

UNIVERSITY OF MUMBAI FOR PARTIAL COMPLETION OF DEGREE OF

MASTER IN COMMERCE

SEMESTER-IV

UNDER THE FACULTY OF COMMERCE

BY

RUSHIKESH BHAGAT

ROLL NO -2021501

UNDER THE GUIDANCE OF PROF.

DARSHAN PAGDHARE

LALA LAJPATRAI COLLEGE OF COMMERCE AND ECONOMICS

APRIL 2022

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 CERTIFICATE

This is to certify that Mr. RUSHIKESH BHAGAT has worked and duly completed the
project work for the degree of Master in Commerce under the faculty of commerce and his
project is entitled, “A STUDY ON FUTURE OF COMMODITY MARKET IN INDIA”
under my supervision.

I further certify that the entire work has been done by student under my guidance.
It is his own work and facts reported are his personal findings and investigations.
This Project is Original to the Best of our Knowledge and has been accepted for the
Assessment.

Name and signature of

Co-ordinator

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 DELCLARATION BY LEARNER

I, the undersigned Mr. RUSHIKESH BHAGAT hereby declare that the work embodied in this
project work titled “A STUDY ON FUTURE OF COMMODITY MARKET IN INDIA”,
forms my own contribution to the research work carried out under the guidance of Prof. Darshan
Pagdhare is a result of my own research work and has not been previously submitted to any other
University of any other degree/diploma to this or any other University.

Wherever reference has been made to previous works of others, it has been clearly indicated
as such and included in the bibliography.

I, hereby further declare that all the information of this document has been obtained and
presented in accordance with academic and ethical conduct.

Name and Signature of Student

(Mr. Rushikesh Bhagat)

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 CERTIFICATE EXAMINER

I hereby certify that the work which is been presented in M.Com Part-II Sem-III project report
entitled “A STUDY ON FUTURE OF COMMODITY MARKET IN INDIA” in partial
fulfillment of the requirements for the award of the Master in Commerce submitted to the Lala Lajpat
Rai College of Commerce and Economics, Mahalaxmi, Mumbai-400034 is an authentic record of my
own work carried out under supervision of Prof. Darshan Pagdhare. The matter presented in this
Project Report has not been submitted by me for the award of any other degree elsewhere.

Co-ordinator Principal

Internal Examiner External Examiner

College Stamp

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 ACKNOWLEDGEMENT

I would like to acknowledge the following as being idealist channels and fresh dimensions in
completion of this project.

I take this opportunity to thank the University of Mumbai for giving me chance to do this
project.

I would also like to thank my college Principal Neelam Arora and Vice Principal Dr. Arun
Poojari for giving me this opportunity to showcase my hard work. I take this opportunity to
thank our coordinator Dr. Rahul Shetty for his moral support. I take this platform to express
my profound gratitude and deep regards to my project guide Prof. Darshan Pagdhare for his
exemplary guidance, monitoring and constant encouragement throughout the course of this
thesis.

I would like to thank all my college library, my supervisors and colleagues at work who
helped me in the most important parts of my internship by answering my questions and
providing me knowledge with focus and integrity, enabling me to achieve accurate results.

Lastly, I thank almighty, my parents, brother, sister and friends for their constant
encouragement without which this assignment would not be possible.

Thanking you

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 INDEX
Sr. No. Contents
1. Introduction
2. History of Commodity
3. Indian market Evaluation and Regulation
4. Benefit of Commodity Futures Markets
5. Research Methodology
6. Objective of Study
7. History of commodity market Development in India
8. Types of Commodity
9. Importance & Significance of Commodity Market
10. Review of the Literature
11. Risk of Commodity
12. Data Analysis and Data Interpretation
13. Need for Commodity Market in India
14. Problems Faced by Commodity Market in India
15. Classification Of Commodities
16. Conclusion
17. References

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 INTRODUCTION
Commodity futures markets have a limited presence in developing countries. Historically,
governments in many of these countries have discouraged futures markets. If they were not
banned, their operations have been constricted by regulation. In the recent past, however,
countries have begun to liberalise commodity markets. And in a reversal of earlier trends, the
development of commodity futures markets is being pursued actively with support from
governments (UNCTAD, 2002). Policy makers expect social benefits in terms of price
discovery, risk management and better allocation of resources. Similarly, the World Bank has
undertaken many initiatives to explore the possibility of market-based systems of price
stabilisation (Claessens and Duncan, 1993). Yet, it is well known, that even in developed
countries, not all commodities are traded on futures markets. Indeed, only a minority of
contracts floated by commodity exchanges succeeds in attracting trading volumes to be liquid
(Brorsen and Fofana, 2001; Thompson et al. 1996). If this happens in environments with
smoothly functioning spot markets, mature legal institutions and supportive government
policy what could be the prospects of futures markets in developing countries.
The history of organised commodity derivatives in India goes back to the nineteenth century
when the Cotton Trade Association started futures trading in 1875, barely about a decade
after the commodity derivatives started in Chicago. Over time the derivatives market
developed in several other commodities in India.
Following cotton, derivatives trading started in oilseeds in Bombay (1900), raw jute and jute
goods in Calcutta (1912), wheat in Hapur (1913) and in Bullion in Bombay (1920). However,
many feared that derivatives fuelled unnecessary speculation in essential commodities, and
were detrimental to the healthy functioning of the markets for the underlying commodities,
and hence to the farmers. With a view to restricting speculative activity in cotton market, the

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Government of Bombay prohibited options business in cotton in 1939. Later in 1943, forward
trading was prohibited in oilseeds and some other commodities including foodgrains, spices,
vegetable oils, sugar and cloth. After Independence, the Parliament passed Forward Contracts
(Regulation) Act, 1952 (Government of India, 1952) which regulated forward contracts in
commodities all over India. The Act applies to goods, which are defined as any movable
property other than security, currency and auctionable claims.
The Act prohibited options trading in goods along with cash settlements of forward trades,
rendering a crushing blow to the commodity derivatives market. Under the Act, only those
associations/exchanges, which are granted recognition by the Government, are allowed to
organise forward trading in regulated commodities.
The Act envisages three-tier regulation:
(i) The Exchange which organises forward trading in commodities can
regulate trading on a day-to-day basis;
(ii) (ii) the Forward Markets Commission provides regulatory oversight under the
powers delegated to it by the Central Government, and
(iii) (iii) the Central Government - Department of Consumer Affairs, Ministry of
Consumer Affairs, Food and Public Distribution - is the ultimate regulatory
authority. “Futures trading is an agreement between a buyer and a seller obligating
the seller to deliver a specified asset of specified quality and quantity to the buyer
on a specified date at a specified place and the buyer in turn is obligated to pay to
the seller a renegotiated price in exchange of the delivery”.
A World Bank study has stated that ‘the ability of a futures exchange to function properly
depends in part upon the ability of the exchange and the regulator to ensure that the prices of
the contracts traded on the exchange reflect supply and demand”. The already shaken
commodity derivatives market got a crushing blow when in 1960s, following several years
of severe droughts that forced many farmers to default on forward contracts (and even
caused some suicides), forward trading was banned in many commodities considered
primary or essential. As a result, commodities derivative markets dismantled and went
underground where to some extent they continued as over the counter (OTC) contracts at
negligible volumes. Much later, in the 1970s and 1980s the Government relaxed forward
trading rules for some commodities, but the market could never regain the lost volumes.
The Indian economy is witnessing a mini revolution in commodity derivatives and risk
management. Commodity options trading and cash settlement of commodity futures had
been banned since 1952 and until 2002 commodity derivatives market was virtually non-
existent, except some negligible activity on an OTC basis. Now in September 2005, the
country has 3 national level electronic exchanges and 21 regional exchanges for trading
commodity derivatives. As many as eighty (80) commodities have been allowed for
derivatives trading. The value of trading has been booming and is likely to cross
Trillion mark in 2006 and, if
all goes well, seems to be set to touch $5 Trillion in a few years. This paper analyses
questions such as: how did India pull it off in such a short time since 2002? Is this progress
sustainable and what are the obstacles that need urgent attention if the market is to realise its
full potential? Why are commodity derivatives important and what could other emerging
economies learn from the Indian mistakes and experience? (Ahuja, 2006).
After the Indian economy embarked upon the process of liberalisation and globalisation in

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1990, the Government set up a Committee in 1993 to examine the role of futures trading. The
Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17
commodity groups. It also recommended strengthening of the Forward Markets Commission,
and certain amendments to Forward Contracts (Regulation) Act 1952 (Government of India,
1952), particularly allowing options trading in goods and registration of brokers with
Forward Markets Commission. The Government accepted most of these recommendations
and futures trading were permitted in all recommended commodities. Commodity futures
trading in India remained in a state of hibernation for nearly four decades, mainly due to
doubts about the benefits of derivatives. Finally a realisation that derivatives do perform a
role in risk management led the government to change its stance. The policy changes
favouring commodity derivatives were also facilitated by the enhanced role assigned to free
market forces under the new liberalisation policy of the Government. Indeed, it was a timely
decision too, since internationally the commodity cycle is on the upswing and the next
decade is being touted as the decade of commodities.
Commodity markets are places where the buyers and sellers of commodities meet at one
place. Trading in commodities is done through the exchanges at national and regional levels
through the various financial instruments including Derivatives. Commodity exchange is a
place where various commodities and derivatives are bought or sold. Indian commodity
exchanges usually trade on commodity futures. The commodity Derivative markets
witnessed a phenomenal growth since the year 2000 resulting from the liberalisation of the
commodity markets. This process was followed by setting up of the commodity exchanges
leading the Indian commodity markets to be at par with the International Commodity
markets. Currently, Indian commodity markets have an exhaustive list of commodities
available for trading.
India is among the top-5 producers of most of the commodities, in addition to being a major
consumer of bullion and energy products. Agriculture contributes about 22 per cent to the
gross domestic product (GDP) of the Indian economy. It employs around 57 per cent of the
labour force on a total of 163 million hectares of land. Agriculture sector is an important
factor in achieving a GDP growth of 8-10 per cent. All this indicates that India can be
promoted as a major center for trading of commodity derivatives. It is unfortunate that the
policies of FMC during the most of 1950s to 1980s suppressed the very markets it was
supposed to encourage and nurture to grow with times. It was a mistake other emerging
economies of the world would want to avoid. However, it is not in India alone that
derivatives were suspected of creating too much speculation that would be to the detriment of
the healthy growth of the markets and the farmers. Such suspicions might normally arise due
to a misunderstanding of the characteristics and role of derivative product. It is important to
understand why commodity derivatives are required and the role they can play in risk
management. It is common knowledge that prices of commodities, metals, shares and
currencies fluctuate over time. The possibility of adverse price changes in future creates risk
for businesses. Derivatives are used to reduce or eliminate price risk arising from unforeseen
price changes. A derivative is a financial contract whose price depends on, or is derived from,
the price of another asset. Two important derivatives are futures and options.
A market where commodities are traded is referred to as a commodity market. These
commodities include bullion (gold, silver), non-ferrous (base) metals such as copper, zinc,
nickel, lead, aluminum, tin, energy (crude oil, natural gas, etc.), agricultural commodities
such as soya oil, palm oil, coffee, pepper, cashew, etc. Existence of a vibrant, active, and
liquid commodity market is normally considered as a healthy sign of development of a
country’s economy. Growth of a transparent commodity market is a sign of development of
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an economy. It is therefore important to have active commodity markets functioning in
a country.

A Commodity futures is an agreement between two parties to buy or sell a specified and
standardized quantity of a commodity at a certain time in future at a price agreed upon at the
time of entering into the contract on the commodity futures exchange. The need for a
futures market arises mainly due to the hedging function that it can perform. Commodity
markets, like any other financial instrument, involve risk associated with frequent price
volatility.

The study of Indian derivatives markets in Money & Finance would be incomplete without
an account of the commodity derivatives market in the country. In this paper we attempt to
bring forth the nature of information flows between futures and spot prices in the market for
commodity derivatives in India, taking into consideration the history of commodity
derivatives globally, and the importance of and problems associated with commodity markets
particularly in less mature econo-mies. In our previous studies on the Indian stock and futures
markets we have seen that the characteristics exhibited by the price index/returns in these
markets are more or less in agreement with or at least lean towards what should be expected
in a mature or efficient market. Here we make an attempt to see whether price movements in
the Indian commodity derivatives market exhibit similar trends or not, particu-larly as this
market is less developed compared to the financial deriva-tives markets, being constrained by
its chequered history with many policy reversal The study of Indian derivatives markets in
Money & Financewould be incomplete without an account of the commodity derivatives
market in the country. In this paper we attempt to bring forth the nature of information flows
between futures and spot prices in the market for commodity derivatives in India, taking into
consideration the history of commodity derivatives globally, and the importance of and
problems associated with commodity markets particularly in less mature econo-mies. In our
previous studies on the Indian stock and futures markets we have seen that the characteristics
exhibited by the price index/returns in these markets are more or less in agreement with or at
least lean towards what should be expected in a mature or efficient market. Here we make an
attempt to see whether price movements in the Indian commodity derivatives market exhibit
similar trends or not, particu-larly as this market is less developed compared to the financial
deriva-tives markets, being constrained by its chequered history with many policy reversal
The study of Indian derivatives markets in Money & Financewould be incomplete without an
account of the commodity derivatives market in the country. In this paper we attempt to bring
forth the nature of information flows between futures and spot prices in the market for
commodity derivatives in India, taking into consideration the history of commodity
derivatives globally, and the importance of and problems associated with commodity markets
particularly in less mature econo-mies. In our previous studies on the Indian stock and futures
markets we have seen that the characteristics exhibited by the price index/returns in these
markets are more or less in agreement with or at least lean towards what should be expected
in a mature or efficient market. Here we make an attempt to see whether price movements in
the Indian commodity derivatives market exhibit similar trends or not, particu-larly as this
market is less developed compared to the financial deriva-tives markets, being constrained by
its chequered history with many policy reversal The study of Indian derivatives markets in
Money & Finance would be incomplete without an account of the commodity derivatives
market in the country. In this paper we attempt to bring forth the nature of information flows
between futures and spot prices in the market for commodity derivatives in India, taking into
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consideration the history of commodity derivatives globally, and the importance of and
problems associated with commodity markets particularly in less mature econo-mies. In our
previous studies on the Indian stock and futures markets we have seen that the characteristics
exhibited by the price index/returns in these markets are more or less in agreement with or at
least lean towards what should be expected in a mature or efficient market.Here we make an
attempt to see whether price movements in the Indian commodity derivatives market exhibit
similar trends or not, particu-larly as this market is less developed compared to the financial
deriva-tives markets, being constrained by its chequered history with manypolicy reversal
The study of Indian derivatives markets in Money & Finance would be incomplete without
an account of the commodity derivatives market in the country. In this paper we attempt to
bring forth the nature of information flows between futures and spot prices in the market for
commodity derivatives in India, taking into consideration the history of commodity
derivatives globally, and the importance of and problems associated with commodity markets
particularly in less mature economies. In our previous studies on the Indian stock and futures
markets we have seen that the characteristics exhibited by the price index/ returns in these
markets are more or less in agreement with or at least lean towards what should be expected
in a mature or efficient market. Here we make an attempt to see whether price movements in
the Indian commodity derivatives market exhibit similar trends or not, particularly as this
market is less developed compared to the financial derivatives markets, being constrained by
its chequered history with many policy reversals.
The two major economic functions of a commodity futures market are price risk management
and price discovery. Forward contracting in commodities is an important activity for any
economy to meet food and raw material requirements, to facilitate storage as a profitable
economic activity and also to manage supply and demand risk. Forward contracts, however,
give rise to price risk; so there arises the need of price risk management. Price risk in forward
contracts can be managed through futures contracts. A commodity futures contract is an
agreement to buy (or sell) a specified quantity of a commodity at a future date, at a price
agreed upon—the futures price—when entering into the contract. In determining the futures
price, market participants compare the current futures price to the spot price that can be
expected to prevail at the maturity of the futures contract. Inventory decisions link current
and future scarcity of the commodity and consequently provide a connection between the
current spot price and the expected future spot price. As an investment product commodity
futures are quite different from financial derivatives. They do not raise resources for firms to
invest; rather, commodity futures allow producers (both agricultural and industrial) to obtain
insurance for the future value of their outputs (or inputs). Commodity futures do not
necessarily represent direct exposures to actual commodities.
Investors in commodity futures receive compensation for bearing the risk of short-term
commodity price fluctuations. Standardised, organised and centralised futures exchanges
guarantee that risks are borne by a vast number of investors (including speculators) in return
for a premium. The diversity of requirements and opinions of the market participants leads to
efficient price discovery in the market. The inherent difficulty with commodities, and hence
commodity futures, is that within the asset class they display many differences. Some
commodities are storable and some are perishable; some are input goods and some are
intermediate goods, and within the same commodity group there may be vast differences in
quality.
These features make the development of commodity markets that much more difficult and
command more resources for infrastructure as compared to financial markets. It is well

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known that though India is considered a pioneer in some forms of derivatives in
commodities, the history of formal commodity derivatives trading is rather chequered. In
recent times there has been an enormous amount of interest generated in commodities trading
in India along with the massive growth in stock market trading volumes. This is indeed a
welcome sign as it is historically proven that inclusion of commodity exposures can reduce
the overall volatility (risk) of a portfolio of investments, while significantly improving the
return potential of the portfolio. Thus simultaneous growth of financial and physical
derivatives trading could help to widen and deepen both markets as investors have more
choice and they may benefit from a portfolio strategy involving both underlyings. In India
government policy regarding the agricultural commodity futures market keeps fluctuating
according to the needs of public (food) policy and the observed inflation trends at any point
of time.
This is understandably not unique to India but is true of global commodity markets
particularly in developing countries. However, despite temporary reversals, the policy thrust
in India now is on using the commodity derivatives market to integrate the vast numbers of
poor agriculturists into the mainstream financial markets. The debate on how soon and how
well the developments in the market for commodity futures in India would actually serve
the cause of poor and marginal farmers/producers remains wide open.
But there is no doubt that efficient commodity derivatives markets have immense potential
for contributing to price stability and economic development. The main purpose of the
present study would be to look into some characteristics of the Indian commodity futures
market in order to judge whether prices indicate efficient functioning of the market or
otherwise.

Two of India’s national level electronics exchanges, the

Multi Commodity Exchange of India Ltd. (MCX) and the
National Commodity and Derivatives Exchange Ltd. (NCDEX), have been tracking
multicommodity indices for spot and futures prices, constituting prices of a basket of
commodities from various sectors. We make use of these index values to comment on the
efficiency in price formation in the electronically traded commodity derivatives market. We
try to empirically answer some questions related to the Indian market:
1. What is the nature of information flows between the spot and futures market for
commodities? Is price formation in one market aided by the other or are prices formed in
isolation in the two markets?
2. How far are the Indian Spot and Futures indices (/prices) integrated in the commodity
market? Do they exhibit same features of integration and fairly efficient information
flows as found in the relatively liberalised and better-developed stock market? Is there
any difference between the multi-commodity and the agricultural indices in this respect?
3. How far are the Indian Spot and Futures indices (/prices) integrated with world indices?
4. What is the relationship between the Indian equity futures index and the multi-commodity
index? More specifically, do the two show low/negative correlation such that there are
benefits of portfolio diversification available to investors in both asset classes? The rest of
this paper is structured as follows: Section II discusses the case for commodity
derivatives as an instrument to bring about price stability in commodity markets as made
out by
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 international developmental agencies like the World Bank and UNCTAD. Section III
briefly touches upon the evolution of the market in India and the existent regulations. The
section also presents some charts to depict the growth of the market.
Section IV first discusses how price trends in the market can indicate the presence of
inefficiencies in the market. The second part of this section presents our sample data followed
by an outline of the methodology followed. The major findings from our analysis of price
trends are listed in the last part of this section. Section V concludes this study with a
discussion on policy indications from this as well as a few other studies on developing
commodity derivative markets.

History of Commodity
1848 marked the era of organized trading of commodities in Chicago. This arose with the
need of guaranteed supply of seasonal agricultural crops.

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Rice tickets: Rice was stored in warehouses for future use. Warehouse holders sold receipts
against the stored rice to raise cash. These tickets were treated as commercial currency until
rules came into existence.
Chicago in United States had become a chief commercial hub in 19th century.
Wheat producers from Mid-west sold their produce to dealers & distributors.
Producers were at the mercy of dealers due to the unavailability of storage facilities, absence
of uniform weighing & grading mechanisms. The farmers and dealers met in a common
place for transacting wheat for cash.
“Futures trading” came into existence when sellers & buyers started making commitments to
exchange the produce for cash in future.
The producer would agree to sell his produce to the buyer at a future delivery date at an
agreed upon price. This kind of agreement was beneficial to both producer and the dealer.
The dealer could sell his contract to someone else in case he is not interested in taking
delivery of the produce. In the same way, if the producer does not want to deliver his
produce to dealer, he can pass on the same to someone else.
The price movement in the wheat market would determine the price of such contract.
Certain modifications were made in the contracts to protect the traders from unexpected price
movements and unfavorable climatic factors. This promoted trader’s entry in futures market
which would speculate on price movements in market to earn profit.
Chicago Board of Trade (CBOT) was established in 1848 to regulate and supervise the
contracts. In 1870 and 1880s the New York Coffee, Cotton and Produce Exchanges were
born. Any commodity could be traded if there were buyers and sellers.

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In order to bring a proper system of storage, pricing, and transfer of agricultural products in
New York, a group of Manhattan dairy merchants got together in 1872.
A merger of four small exchanges was formed in 1993, during the Great Depression – the
National Metal Exchange, the Rubber Exchange of New York, the National Raw Silk
Exchange, and the New York Hide Exchange.
The largest commodity exchange in USA is Chicago Board of Trade, The Chicago
Mercantile Exchange, the New York Mercantile Exchange, the New York Commodity
Exchange and New York Coffee, sugar and cocoa Exchange. Worldwide there are major
futures trading exchanges in over twenty countries including Canada, England, India, France,
Singapore, Japan, Australia and New Zealand.

In India
Cotton Trade Association started futures trading in 1875 in India. Datives market developed
in several commodities in India. Following Cotton, derivatives trading started in oilseed in
Bombay (1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur (1913) and
Bullion in Bombay (1920).
The parliament passed the Forward Contracts (Regulation) Act, 1952, which regulated
contracts in Commodities all over the India. The act prohibited options trading in Goods
along with cash settlement of forward trades.
Under the act only those associations/exchanges, which are granted reorganization from the
Government, are allowed to organize forward trading in regulated commodities.

The Act Considered Three Tire Regulations:

(i) Exchange which organizes forward trading in commodities can regulate trading
on dayto-day basis.
(ii) Forward Markets Commission provides regulatory oversight under the powers
delegated to it by the central Government.
(iii) The Central Government- Department of Consumer Affairs, Ministry of Consumer
Affairs, Food and Public Distribution- is the ultimate regulatory authority.
The Government set up a committee (1993) to examine the role of futures trading after
Liberalization and Globalization in 1990.
The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17
commodity groups. It also recommended strengthening Forward Markets Commission, and
certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing
option trading in goods and registration of brokers with Forward Markets Commission.
The Government accepted most of these recommendations and futures’ trading was permitted
in all recommended commodities.
Commodity exchanges are purely speculative today. A price transparency is maintained as
they reach to the producers, end-users, and even the retail investors.
By Exchange rules and by law, no one can bid under a higher bid, and no one can offer to sell
higher than someone else’s lower offer. That keeps the market as efficient as possible. The
commodities future market in India has experienced an unexpected boom in terms of modern
exchanges since 2002.
In 2006, the number of commodities allowed for derivatives trading as well as the value of
futures trading in commodities crossed $ 1 trillion mark.
Since 1952 till 2002 commodity datives market was virtually non- existent, except some
negligible activities on OTC basis.

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In India, there are 25 recognized future exchanges, of which there are three national
level multi-commodity exchanges.
Government of India has allowed forward transactions in commodities through Online
Commodity Exchanges, a modification of traditional business known as Adhat and Vayda
Vyapar to facilitate better risk coverage and delivery of commodities.

The three exchanges are:

National Commodity & Derivatives Exchange Limited (NCDEX) Mumbai,
Multi Commodity Exchange of India Limited (MCX) Mumbai and
National Multi-Commodity Exchange of India Limited (NMCEIL) Ahmedabad. There are
other regional commodity exchanges situated in different parts of India.

Price volatility is perhaps the most pressing issue facing producers of primary commodities.
The low prices for basic commodities limit the income farmers(/small producers) can receive
for their products and the high volatility of these prices makes it very difficult for them to
optimise the use of their income (Morgan, 2000).4 While these producers are not exclusively
located in LDCs, the impact of volatility on producers there is much greater than it is for
those in developed market economies.5 Policies designed to counter the effects of the
inherent instability of commodity markets have taken various forms since the 1930s but in
general it is possible to say that they all shared a common feature of being based on
intervention. In essence, buffer stock schemes were heavily promoted especially through the
establishment of the International Commodity Agreements (ICAs) (for a more detailed
review of the earlier history of these and other policies, see GordonAshworth, 1984).
However, two main problems arose within this system. First, the difficulty in setting the price
range and updating it over time in response to changes in either costs or consumer tastes.
Second, finding sufficient funds to keep prices within the specified range, a problem that was
especially acute if there was a run of years of high production with low prices and stocks
needed to be held over a long period. Concerns about commodity price fluctuations also led
to pervasive commodity policy interventions by national governments. The goal has been
either to replace the price discovery by markets with a planned and regulated system of
prices or to insulate producers and consumers from market price fluctuations through price
controls or subsidies. Many countries have unilaterally pursued price stabilisation,
particularly in agriculture. These have typically taken the form of institutional arrangements
for price stabilisation programmes, including physical buffer stock schemes, stabilisation
funds, variable tariff schemes, and marketing boards. Commodity futures markets thus have a
limited presence in developing countries where commodity markets fall short of the ideal.
Historically, governments in many of these countries have discouraged futures markets; if
they were not banned, their operations were constricted by regulation. The main concern
being that speculative activity in futures markets could reinforce price instability and
volatility in essential commodities and lead to further problems of food security.
Government interventions to artificially stabilise prices, on the other hand, pre-empted the
development of a market-based price risk management system. In the recent past, however,
countries have begun to liberalise commodity markets and in a reversal of earlier trends, the
development of commodity futures markets is being pursued actively with support from
governments. The World Bank initiative to devise market-based approaches for dealing with
commodity price risk has provided a fresh impetus for research in the area of commodity
futures markets as a policy option.6 The World Bank (1999) notes: “...marketbased
management instruments,
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despite several limitations, offer a promising alternative to traditional stabilisation
schemes…”. The argument is that the use of price risk management instruments allows
governments to disengage from costly, distortionary, and counterproductive policies. At the
national level, many countries have unilaterally abandoned marketing boards that were once
common for coffee, cocoa, and other import crops—as well as long-standing food marketing
agencies.7 Others have done so under budget pressure or as part of reforms supported by the
World Bank and other institutions.8 Coinciding with policy developments favouring
commodity derivatives trading, a revolution in information technology spurred the growth of
risk management centres, especially in areas where market fragmentation impeded efficient
pricing. UNCTAD (2002) notes that well-organised commodity exchanges form natural
reference points for physical trade, and help the price discovery process. If a commodity
exchange manages to link different warehouses in the country, this allows trade to take place
more efficiently. Historically, most commodity exchanges developed as physical transaction
hubs where producers delivered and sold their crops to buyers with storage facilities. Because
producers had little choice but to accept the spot offer price, most exchanges were buyers
markets. Market fragmentation—i.e., poor price correlation among the regional exchanges—
also characterised the exchange network. Electronic transaction models and instant price
dissemination systems have transformed these traditional market arrangements. The new
electronic exchanges broadcast multiple prices from various spot and forward markets giving
producers a range of seasonal and geographic options for storing or marketing their crops. By
disseminating a spectrum of instantly observable or transparent prices, these exchanges have
conferred pricing power to the producer and aided institutional development, e.g., grading
and warehouse receipt systems, supply chain integration and farm credit facilitation (FAO,
2007).
A commodity futures contract is a tradable standardised contract, the terms of which are set
in advance by the commodity exchange. A futures market facilitates offsetting trades without
exchanging physical goods until the expiry of a contract. As a result, the futures market
attracts hedgers for risk management, and encourages participation of traders (speculators and
arbitrageurs) who possess market information and price judgement. While hedgers have
longterm perspective of the market, the traders or arbitrageurs prefer an immediate view of
the market and these diverging views lead to price discovery for the commodity concerned.
Insurance offers coverage of the risks of physical commodity losses due to fire, pilferage,
transport mishaps, etc.; it does not cover similarly the risks of value losses resulting from
adverse price variations, which occur with a much higher probability. Hedging is the practice
of offsetting the price risk inherent in any cash market position by taking an equal but
opposite position in the futures market. This technique is very useful in the case of any
longterm requirements for which the prices have to be firmed so as to quote a sale/purchase
price, but the hedger wants to avoid buying the physical commodity immediately to prevent
blocking of funds and incurring large holding costs. A Simple Hypothetical Illustration: A
wheat miller enters into a contract to sell flour to a bread manufacturer four months from
now. The price is agreed upon today though the flour would only be delivered after four
months. A rise in the price of wheat during the course of the next four months would result in
losses on the contract to the miller. To safeguard against the risk of increasing prices of
wheat, the miller buys wheat futures contracts that call for the delivery of wheat in four
months time. After the expiry of four months, as feared by the miller, the price of wheat may
have risen. The miller then purchases the wheat in the spot market at a higher price.
However, since he has hedged in the futures market, he can now sell his contract in the
futures market at a gain since there is an increase in the futures price as well. Hedging thus

22 | Page
offsets losses from purchase of wheat at a higher cost through sale of the futures contract
thereby protecting the profit on the sale of the flour. The tendency of the difference between
spot and futures prices to decline continuously, so as to become zero on maturity, is referred
to as Convergence. Convergence occurs at the expiration of the futures contract because any
difference between the cash and futures prices would then quickly be negated by
arbitrageurs. There are two types of futures contracts, those that provide for physical delivery
of a particular commodity or item and those which call for a cash settlement. Delivery on
futures contracts is the exception rather than the rule; however, a delivery provision offers
buyers and sellers the opportunity to take or make delivery of the physical commodity if they
so choose. More importantly, however, the fact that buyers and sellers can take or make
delivery helps to assure that futures prices will accurately reflect the cash market value of the
commodity at the time the contract expires. Futures prices evolve from the interaction of bids
and offers emanating from all over the country. The bid and offer prices are based on the
expectations of prices on the maturity date. Two methods generally used for predicting
futures prices are fundamental analysis and technical analysis. The fundamental analysis is
concerned with basic supply and demand information, such as, production and consumption,
import and export patterns, weather conditions, and relevant policies of the government like
taxation. Technical analysis includes analysis of movement of prices in the past. Many
participants use fundamental analysis to determine the direction of the market, and technical
analysis to time their entry and exist. Settlement price is the price at which all the trades
outstanding are settled, i.e., profits or losses, if any, are paid. The method of fixing settlement
price is prescribed in the bye-laws of the exchanges; normally it is a weighted average of the
prices of transactions both in the spot and futures market during the period specified. An
important part of understanding futures and cash price dynamics is being able to explain and
anticipate cash/futures basis movement. Basis is normally calculated as cash price minus the
futures price. A positive basis indicates a futures discount (Backwardation) and a negative
number, a futures premium (Contango). When the prices of spot, or contracts maturing
earlier, are higher than a particular futures contract, it is said to be trading at Backwardation.
It is usual for a contract maturing in the peak season to be in backwardation during the lean
period. Contango means a situation where futures contract prices are higher than the spot
price and the futures contracts maturing earlier. It arises normally when the contract matures
during the same crop season. In a well-integrated market, Contango is equal to the cost of
carry, viz. interest rate on investment, loss on account of loss of weight or deterioration in
quality, etc. As basis volatility (risk) increases the effectiveness of the hedge decreases.

The primary benefit of futures markets is to allow for anticipatory hedging in a free-market
price regime. Hedging is the practice of offsetting the price risk inherent in any cash market
position by taking an equal but opposite position in the futures market. Hedging involves
buying or selling of a standardised futures contract against the corresponding sale or
purchase respectively of the equivalent physical commodity. By taking a position in the
futures markets that is opposite to that held in the spot market, the producer can potentially
offset losses in the latter with gains in the former. Futures markets thus offer a mechanism
for dealing with price risk. Secondly, because futures markets offer a range of contracts for
each commodity, there is a great deal of flexibility in pricing for the individual trader, as
compared with a fixed policy rate regime.
Futures markets also play a role in inventory management. The basis or price spread, which is
the price difference between futures contracts of different maturities, signals the availability
of stocks to the market. In essence, the basis is a measure of storage and interest costs that

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must be borne by a spot market trader in holding stocks now, for sale at some point in the
future. Clearly, as the basis gets larger, the incentive to store increases; as a result, the level
of inventories held in the spot market will be determined by the basis. This ensures an
efficient process of private storage and in turn leads to a smoother pattern of prices in the spot
market and hence can, potentially, reduce price volatility. Futures markets can also provide
price support for credit needs to small producers. In fact, better access to credit has been
driving demand for commodity price hedging in the developed market economies. The
collateral value of inventory is substantially enhanced if it is hedged, enabling firms
(/farmers) to borrow a larger proportion of inventory value on more attractive terms. There
are other wider benefits to the economy of a more efficient allocation of resources that could
arise from establishing or using futures markets. Entities in commodity-dependent countries
have little or no access to price risk management instruments, particularly for agricultural
products, mostly due to policy barriers. Even though many of these countries are major
producers of primary products, and some are also major consumers, their participation in
commodity futures markets is minor. Uncertainty, especially long-term, has a negative impact
on productivity and therefore reduces growth. When a commodity is produced and then sold
on a spot market, there is considerable risk that in the time between a production decision
being taken and the output being sold, prices could have moved against the trader. This spot
price risk creates problems for producers who do not know what their income levels will be
and this hinders their planning process. An efficient futures market provides reasonably
accurate indications of the future spot price and thus helps in production planning.10 In the
financial markets commodity futures can be seen as an additional risk management tool since,
as an asset class, commodity futures have been seen to exhibit negative correlation with stock
futures and bonds and positive correlation with inflation (Gorton and Rouwenhorst, 2005).
Hence it provides a degree of stability under volatile market conditions. This in turn
generates a wide investor base for commodity futures as an asset, as it extends the investor
base beyond only those who have exposures in the physical commodity market. There are
obvious limitations to the benefits from commodity futures. Futures provide protection
against price risk, and price risk instruments address only a portion of the underlying problem
of income protection. For example, in the case of metals or energy commodities, where
shocks typically originate on the demand side through the industrial business cycle,
production can be planned and from the producer’s point of view volatile prices explain most
revenue volatility. However, agricultural commodities, especially field crops, are also subject
to variable weather and pest conditions and the actual income protection gained from hedging
may vary largely. Nevertheless, price insurance would, in most cases, contribute significantly
to income stability as hedging delivers a substantial reduction in uncertainty over the time
horizon it covers.

The Indian Market Evolution and Regulations

In India local markets for futures on agricultural commodities have been recorded to be
around from the 1800s. After Independence, the Forward Contracts (Regulation) Act, 1952
(FCRA, 1952) was passed to regulate this market with Forward Markets Commission (FMC)
being set up in 1953 in Mumbai as the regulator. Commodity derivatives were banned in the
late ’60s, but were revived again in the ’80s. After the successful equity market reforms of
the ’90s, the Government of India tried to replicate similar reforms for the commodity
derivatives markets and in 1999 suggested that the Minimum Support Price (MSP) as a
pricehedging instrument could be replaced with derivatives markets. National-level
multicommodity exchanges were permitted to be set up on conditions of being backed by

24 | Page
internationally prevailing best practices of trading, clearing and settlement. The national
commodity exchanges follow electronic, transparent trading and clearing with novation,
similar to the equity market [See Box 2]. At present, 103 commodities have been approved
for trading out of which 92 commodities are actively traded. The development of the
commodity derivatives market in India like many other countries has been hindered by policy
reversals on concerns regarding its effect on prices and supplies of essential commodities.
This apart, integration of spot and futures market is cited as a critical factor for further growth
of commodity futures in India. According to Nair (2004), the major stumbling block for the
development of commodity futures markets in India is the fragmented physical/spot market
with government laws and various taxes that hinder the free movement of commodities.
Thomas (2003) in a similar critique draws attention to the prevalence of bilateral deals
in local exchanges, the lack of price transparency both in the (fragmented) futures and
spot markets for many commodities and the absence of certified warehouses.
The spot market in commodities is controlled to a large extent by the State Governments.
There are restrictions on holding of stocks, turnover, and movement of goods and there are
variations in the duties levied by the different State Governments. This fragments the
commodity spot markets and impedes the commodity futures markets from reaching the
market players outside the boundaries of the states, or zones in which the exchanges are
located. Harmony in the policies of different states is advocated for developing nationwide
commodity markets. Absence of standards and grading systems is a more difficult issue;
however, it is unlikely to be an enduring obstacle especially for widely traded commodities
such as cotton, sugar, wheat or oils. There are three tiers of regulators governing forward
trading, viz. the Central Government, Forward Markets Commission (FMC) and the
recognised Commodity Exchanges/Associations.11 The Central Government broadly
determines the policy as to commodities in which futures/forward trading is to be permitted
and the Exchange/Association through whom such trading is to be permitted. The Forward
Markets Commission performs the role of approving the rules and regulations of the
exchanges subject to which the trading is to be conducted, accords permission for
commencement of trading in different contracts, monitors market conditions continuously
and takes remedial measures whenever the trading tends to go outside the permissible limits.
The recognised exchanges/associations provide the framework of rules and regulations for
conduct of trading as well as the platform for trading, reporting and recording of contracts,
execution and settlement of contracts and a forum for exchange of documents and payments,
etc. Certain proposed amendments to the FCRA, 1952 (FMC, 2006) are expected to
strengthen the regulatory aspects and ensure orderly conditions in the commodity futures
market. So far, FMC was attached to office of the Ministry of Consumer Affairs, Food and
Public Distribution, and it did not have adequate financial and operational autonomy. An
Ordinance has been issued in January 2008, converting FMC into an independent regulatory
body. This would help to restructure and strengthen FMC on the lines of the Securities and
Exchange Board of India (SEBI), the securities market regulator, and confer upon the FMC
all the required powers for effective regulation of the commodity derivatives market. The
Bill provides for statutory provision relating to registration of members and other
intermediaries to ensure their effective monitoring by the FMC. The Bill also provides for
inserting new provisions relating to corporatisation and demutualisation of the existing
commodity exchanges and for setting up of a Clearing Corporation. The penal provisions in
the present Act are inadequate for regulating the markets effectively; hence, the proposed
amendment seeks to enhance penal provisions. The proposed amendment also seeks to
introduce options

25 | Page
26 | Page
in goods and commodity derivatives. This will provide farmers and other stakeholders with a
more flexible risk management tool.

At present 22 Exchanges are recognised/registered for forward/futures trading in

commodities. Most of the commodity exchanges in India are single commodity platforms
and cater mainly to the regional requirements. However, four national-level multi-commodity
exchanges have been set up in the country to overcome the problem of fragmentation. These
exchanges are: 1. National Multi Commodity Exchange of India (NMCE) 2. National Board
of Trade (NBOT) 3. Multi Commodity Exchange of India (MCX) 4. National Commodity &
Derivatives Exchange of India (NCDEX) NMCE, the first state-of-the-art demutualised
multi-commodity exchange, commenced futures trading in 24 commodities on November 26,
2002 on a national scale and the basket of commodities has grown substantially since then to
include cash crops, food grains, plantations, spices, oil seeds, and metals & bullion, among
others. National Board of Trade (NBOT) was incorporated on July 30, 1999 to offer a
transparent and efficient trading platform to various market intermediaries in the commodity
futures trade. Futures trading primarily in soy and some other edible oils is carried out here.
MCX is India’s largest independent and demutualised multi-commodity exchange. It was
inaugurated on November 10, 2003 and has permanent recognition from the Government of
India for facilitating online trading, clearing and settlement operations for commodities
futures markets across the country. By 2006, MCX featured amongst the world’s top three
bullion exchanges and top four energy exchanges. MCX is now the world’s 8th largest
commodity exchange, and accounts for 75 per cent of the market share in India. It has strong
partnerships with banks, financial institutions, warehousing companies and other stakeholders
of the marketplace. MCX has various strategic Memoranda of Understanding/Licensing
Agreements with global exchanges like The Tokyo Commodity Exchange (TOCOM), New
York Mercantile Exchange (NYMEX), London Metal Exchange (LME), Dubai Multi
Commodities Centre (DMCC), and New York Board of Trade (NYBOT). With NYSE Euro
Next, the parent body of NYSE picking up 5 per cent stake in the exchange the total foreign
holding in MCX would be about 32 per cent. Commodity categories traded here cover: Agri
Commodities, Bullion, Metals—Ferrous & Non-ferrous, Pulses, Oils & Oilseeds, Energy,
Plantations, and Spices and other soft commodities. MCX maintains an insured Settlement
Guarantee Fund of about Rs. 100 crore. NCDEX is a nation-level, technology driven
demutualised online commodity exchange with an independent Board of Directors and
professional management. It commenced operations on December 15, 2003. The four
institutional promoters of NCDEX are prominent players in their respective fields and
contribute significantly to its technological and risk management skills. NCDEX has tied up
with NCCL for clearing all trades on the exchange. NCDEX also maintains and manages a
settlement guarantee fund in order to deal with defaults. NCDEX prescribes the accreditation
norms, comprising financial and technical parameters, which would have to be met by the
warehouses. NCDEX takes an assayer’s certificate for confirming compliance with technical
norms by the warehouses. The exchange specifies, in its contract description, the particular
grade/variety of a commodity that is being offered for trade. A range is specified for all the
properties and only those grades/varieties that fall within the range is accepted for delivery.
In case the commodities fall within the range, but differ from the benchmark specifications,
the exchange also specifies a premium/rebate. The exchanges follow best international risk
management practices and provide a financially secure environment by putting in place a
suitable risk management mechanism (system of upfront margining based on the Value at
Risk margining system, daily mark to market and special intra-day clearing and settlement in

27 | Page
the event of high volatility in prices). The performance of the contracts registered by the
exchange are guaranteed either by the exchange or its clearing house. Clearing Houses put in
place a sound risk-management system to be able to discharge their role as a counter-party to
all participants. Clearing Houses interpose between buyers and sellers as a legal counterparty,
i.e., the clearing house becomes the buyer to every seller and vice versa (novation). Novation
thus obviates the need for ascertaining the credit-worthiness of each counter-party and the
only credit risk that the participants face is the risk of clearing house committing a default.
The exchanges also maintain their own Trade/Settlement Guarantee Fund, which can be used
in case of any default. Some exchanges have also prescribed certain minimum capital
adequacy norms.

Criteria for a Commodity Quality for Futures.

• The basic criteria to be fulfilled: – The product should be in a raw, basic and
unprocessed state. – The product needs to be fairly standardized ensuring a fair
representation of the commodity in future trading and also adequate liquidity for the CMs
being traded. – Price of the product represents the fundamental forces of demand supply. –
Presence of many competing sellers of the product to ensure widespread trading activity in
the physical commodity market. – The product should have adequate life.

• The Kabra committee appointed by the Government in June 1993, discusses the basic
criteria to be suitable for futures trading : – The commodity must be homogeneous or be
possible to specify a standard grade and to measure deviations from that grade. – Commodity
should have suitable demand supply conditions. – Prices should be volatile to necessitate
hedging. – The commodity should be free from substantial control from Givornment
regulations imposing restrictions on supply, distribution and prices of the commodity. –
Commodity should be storable.

Benefits of Commodity Futures Markets

The primary objectives of any futures exchange are authentic price discovery and an efficient
price risk management. The beneficiaries include those who trade in the commodities being
offered in the exchange as well as those who have nothing to do with futures trading. It is
because of price discovery and risk management through the existence of futures exchanges
that a lot of businesses and services are able to function smoothly.

Price Discovery:-Based on inputs regarding specific market information, the demand and
supply equilibrium, weather forecasts, expert views and comments, inflation rates,

Government policies, market dynamics, hopes and fears, buyers and sellers conduct trading
at futures exchanges. This transforms in to continuous price discovery mechanism. The
execution of trade between buyers and sellers leads to assessment of fair value of a particular
commodity that is immediately disseminated on the trading terminal.

• Price Risk Management: - Hedging is the most common method of price risk
management. It is strategy of offering price risk that is inherent in spot market by
taking an equal but opposite position in the futures market. Futures markets are used as
a mode by hedgers to protect their business from adverse price change. This could dent
the profitability of their business. Hedging benefits who are involved in trading of

28 | Page
 commodities like farmers, processors, merchandisers, manufacturers, exporters,
importers etc.
• Import- Export competitiveness: - The exporters can hedge their price risk and
improve their competitiveness by making use of futures market. A majority of
traders which are involved in physical trade internationally intend to buy forwards.
The purchases made from the physical market might expose them to the risk of price
risk resulting to losses.

The existence of futures market would allow the exporters to hedge their proposed
purchase by temporarily substituting for actual purchase till the time is ripe to buy in
physical market. In the absence of futures market it will be meticulous, time consuming
and costly physical transactions.

• Predictable Pricing: - The demand for certain commodities is highly price elastic. The
manufacturers have to ensure that the prices should be stable in order to protect their
market share with the free entry of imports. Futures contracts will enable predictability
in domestic prices. The manufacturers can, as a result, smooth out the influence of
changes in their input prices very easily. With no futures market, the manufacturer can
be caught between severe short-term price movements of oils and necessity to maintain
price stability, which could only be possible through sufficient financial reserves that
could otherwise be utilized for making other profitable investments.
• Benefits for farmers/Agriculturalists: - Price instability has a direct bearing on
farmers in the absence of futures market. There would be no need to have large reserves
to cover against unfavorable price fluctuations. This would reduce the risk premiums
associated with the marketing or processing margins enabling more returns on
produce. Storing more and being more active in the markets. The price information
accessible to the farmers determines the extent to which traders/processors increase
price to them. Since one of the objectives of futures exchange is to make available these
prices as far as possible, it is very likely to benefit the farmers. Also, due to the time lag
between planning and production, the marketdetermined price information
disseminated by futures exchanges would be crucial for their production decisions.
• Credit accessibility: - The absence of proper risk management tools would attract the
marketing and processing of commodities to high-risk exposure making it risky
business activity to fund. Even a small movement in prices can eat up a huge proportion
of capital owned by traders, at times making it virtually impossible to payback the loan.
There is a high degree of reluctance among banks to fund commodity traders, especially
those who do not manage price risks. If in case they do, the interest rate is likely to be
high and terms and conditions very stringent. This possesses a huge obstacle in the
smooth functioning and competition of commodities market. Hedging, which is
possible through futures markets, would cut down the discount rate in commodity
lending.

• Improved product quality: - The existence of warehouses for facilitating delivery with
grading facilities along with other related benefits provides a very strong reason to
upgrade and enhance the quality of the commodity to grade that is acceptable by the
exchange. It ensures uniform standardization of commodity trade, including the terms of
quality standard: the quality certificates that are issued by the exchange-certified
warehouses have the potential to become the norm for physical trade.

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• Commodities as an asset class for diversification of portfolio risk: Commodities
have historically an inverse correlation of daily returns as compared to equities. The
skewness of daily returns favors commodities, thereby indicating that in a given time
period commodities have a greater probability of providing positive returns as compared
to equities. Another aspect to be noted is that the “sharpe ratio” of a portfolio consisting
of different asset classes is higher in the case of a portfolio consisting of commodities as
well as equities. Thus, an Investor can effectively minimize the portfolio risk arising
due to price fluctuations in other asset classes by including commodities in the
portfolio.

• Commodity derivatives markets are extremely transparent : in the sense that the
manipulation of prices of a commodity is extremely difficult due to globalisation of
economies, thereby providing for prices benchmarked across different countries and
continents. For example, gold, silver, crude oil, natural gas, etc. are international
commodities, whose prices in India are indicative of the global situation.

• An option for high net worth investors: With the rapid spread of derivatives trading
in commodities, the commodities route too has become an option for high net worth
and savvy investors to consider in their overall asset allocation.

• Useful to the producer: Commodity trade is useful to the producer because he can get
an idea of the price likely to prevail on a future date and therefore can decide between
various competing commodities, the best that suits him.

Useful for the consumer: Commodity trade is useful for the consumer because he
gets an idea of the price at which the commodity would be available at a future point
of time. He can do proper costing/financial planning and also cover his purchases by
making forward contracts. Predictable pricing and transparency is an added advantage.
Risks associated with Commodities Markets No risk can be eliminated, but the same
can be transferred to someone who can handle it better or to someone who has the
appetite for risk. Commodity enterprises primarily face the following classes of risks,
namely: the price risk, the quantity risk, the yield/output risk and the political risk.
Talking about the nationwide commodity exchanges, the risk of the counter party
(trading member, client, vendors etc) not fulfilling his obligations on due date or at any
time thereafter is the most common risk.
This risk is mitigated by collection of the following margins: - •
Initial Margins
• Exposure margins
• Market to market of positions on a daily basis
• Position Limits and Intra day price limits
• Surveillance

Commodity price risks include: -

• Increase in purchase cost vis-a-vis commitment on sales price
• Change in value of inventory

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• Counter party risk translating into commodity price risk

Current Scenario of Indian Commodity Market

The growth paradigm of India’s commodity markets is best reflected by the figures
from the regulator’s official website, which indicated that the total value of trade on
the commodity futures market in the financial year 2008/09 was Rs. 52.49 lakh crore
(over US$1 trillion) as against Rs. 40.66 lakh crore in the preceding year, registering
a growth of 29.09%, even under challenging economic conditions globally. The main
drivers of this impressive growth in commodity futures were the national commodity
exchanges. MCX, NCDEX and NMCE along with two regional exchanges – NBOT
Indore and ACE, Ahmedabad – contributed to
99.61% of the total value of commodities traded during 2008/09. So far, this year’s
volumes have seen a significant jump over the last year in agro-commodities, as well as
international commodities like gold, silver, crude oil and copper. More than 100
commodities are today available for trading in the commodity futures market and more
than 50 of them are actively traded. These include bullion, metals, agricultural
commodities and energy products. Most importantly, an archaic market has suddenly
turned into an organised, service-oriented set-up with shooting volumes. The
unqualified success of the futures market has ensured the next step, i.e., the launch of
electronic spot markets for agro-products. Being in a time-zone that falls in the gap left
by the major commodity exchanges in the US, Europe and Japan has also worked in
India’s favour because commodity business by its very nature is a 24/7 business.
Innovation coupled with modern and successful financial market environment has
ensured the beginning of a success story in commodities which will eventually
see India becoming a price-setter in major commodities on the strength of its large
production and consumption.

Benefits of Commodity Futures

• Benefits to Investors, Producers, Consumers, Manufactures

• Price risk management Price discovery.
• High Financial Leverage.

Commodities as an asset class for diversification of portfolio risk. Commodity derivatives

are extremely transparent. An option for high net worth investors. Useful to the producer.
Useful for the consumer. Useful to exporters. Improved product quality.
Credit accessibility Benefits to the Indian Economy : – Business generation.
Employment opportunities. – With India importing bulk of raw material, there is a scope
for minimizing prize risk for International commodities for the Indian Economy as a
whole.

Evolution of Commodity Future Markets in India

History of futures trading in commodities in India dates back to may centuries.
Organized futures market in India emerged in 1875 when Bombay Cotton Trade
Association was established. Future trading in oilseeds started in 1900 when Gujarati
Vyapari Mandali
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32 | Page
(today’s National Multi Commodity exchange, Ahmedabad) was established. The
Calcutta Hessian Exchange Ltd. Was set up in 1912 for Forward Trading in raw jute and
jute goods. For wheat, future markets were in existence at several centers at Punjab and
UP. The most notable was Chamber of Commerce at Hapur 1993. Others were located at
Amritsar, Moga, Ludhiana, Jalandhar, Fazilka, Dhuri, Barnala and Bhatinda in Punjab
and Barirlly in UP. In 1919, then Govt. of Bombay passed the Contract Control Act ad
set up the Cotton Contracts Board.

Evolution of Commodity Future Markets in India

The future trading in gold began in Mumbai in 1920 and similar ones came up at Rajkot,
Jaipur, Jamnagar, Kanpur, Delhi and Calcutta. The organized futures trading in raw jute
commenced in 1927 with the establishment of the East India Jute Association Ltd. India
has a lot of turbulence in the commodity future markets and the cotton market option was
banned in 1939 September to curb speculation in cotton market options. In mid 1940 s,
trading in futures and forwards became difficult as a result of price controls by the
government. Similarly, oilseeds forward contract was banned continuing with the
banning of forward trading in food grains, spices, vegetable oilsm sugar and cloth. These
orders were retained with modifications made in Essential Supplies Temporary Powers
Act, 1946. Evolution of Commodity Future Markets in India

In 1945, The Calcutta Hessian Exchange Limited and East India association Ltd were
amalgamated to form East India Jute Hessian Limited. With a view to do away with all
the loopholes, the Bombay Forward Contract Control Act, 1947 was rolled out. After
Independence, the Constitution of India brought the subject of “Stock Exchanges and
future markets” in the Union. This accelerated the formation of the 1952 December
Forwards Contracts Act, the committee being headed by Prof. Shroff and select
committees of two successive Parliaments. Forward Contracts Rules were notified by
the Central Government in July 1954.

The Act divides the commodities into 3 categories: – The commodities in which future
trading can be organized.
The commodities in which future trading in prohibited.
If it’s a free commodity, it is necessary to obtain the Certificate of Registration from the
Forward Markets Commission.
Evolution of Commodity Future Markets in India
In late 1960 s, the Government of India suspended forward and futures trading in many
commodities to avoid speculation. However, MSP came in. In 1980, Khusro Committee
recommended re-introduction of futures trading in most of the major commodities. In

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 1996, the World Bank in association with UNCTAD conducted stody on Indian
Commodity markets.
Commodity Derivatives Markets Structure of India Ministry of Consumer Affairs,
Food and Public Distribution Forward Market Commission National Electronic
Exchange Multi Commodity Exchange of India Ltd. National CM & Derivatives
Exchange Ltd. (NCDEX)- Mumbai National Multi CM Exchange of India Ltd.
(NMCE)- Ahmadabad Indian CM Exchange Ltd. (ICEX) - Gurgaon Regional
Exchange National Board of Trade (NBOT) Other Regional Exchanges.

RESEARCH METHODOLOGY

The systematic review of literature revealed that the majority of studies covered the
feasibility of futures trading, institutional and policy level constraints, strengthening of
regulations, liberalizing the exchanges, institutional building, need for new instruments in the
market and International market linkages. In the aftermath of reintroduction, most of the
studies conducted by many researchers focused on impact of futures on volatility, risk
management, price discovery, hedging, and market efficiency, relation between return and
trading volume, lead-lag relationship between trading activity and cash price volatility before
and after introduction of futures market, but no study was found with regard to assessing the
growth, development and future prospects on long term performance of the market. Hence,
the present paper is undertaken as a modest attempt to dwell on such untapped aspects.

Objective of the Study

The main objective of the study is to analyze the growth, trends and prospects of commodity
derivative market in India and test the significance in performance of the market.

1) To study the history and evolution of Indian Commodity Market.

2) To study the different forms of investing in Indian commodity markets.

3) To study the different segments of Indian Commodity Markets.

4) To analyze the regulatory framework of commodity market in India.

5) To study the challenges as faced by commodity market in India.

The present study is conducted on commodity markets in India. The study is descriptive in
nature. The literature and data are mainly based on a secondary source which has been
collected from commodity market and their various publications, text book related topics,
magazines, reputed journals, newspapers, and various internet sources like
www.mcxindia.com, www.ncdexindia.com, www.nmceindia.com, www.fmce.gov.in and
other publications. The various reports and records issues as maintained by Government of
India (GOI) are also used in this study. This study is based on historical background of
commodity markets in India & its policies and designed to gather descriptive
information’s. There is no tool applied to values and volume fluctuations of the commodity
market.

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HISTORY OF COMMODITY MARKET DEVELOPMENT IN INDIA:

The turnover of the commodity market in our country has grown potentially in a short span of
time. This market favours more of speculators. The future market leaves a lot to be desired as
an effective instrument of risk management and price discovery for the benefit of the
growers, traders, processors and other stakeholders. Further the policymakers have looked
over the consideration involving the discipline of checks and balances. The opening up of the
commodity future market in India was an important initiative taken with an aim to improve
domestic market efficiency. It further aids the price discovery process and provides a
platform for price risk management in commodities. In September 2013, the regulatory body
FMC has been brought under the control of Ministry of Finance. At present 46 commodities
are traded in six National Exchanges and 11 Commodity specific exchanges. The futures
trading in agricultural products constitute the total turnover in 2013-14, with food items
contributing 55.6 per cent and non-agricultural products contributing 17.5 per cent. However,
the volume of trade has declined by 39 per cent during 2015-16, over the previous year. The
FMC has been implementing the price dissemination scheme to control the inflationary
trends and to provide the requisite prices to the farmers. The future markets help the farmers
to predict the price, as well as it helps the government to take the pre-emptive reaction when
required. Though, it has been noted that the prices has been largely influenced by the
Eurocrisis.

INITIATIVES TAKEN BY GOVERNMENT OF INDIA FOR COMMODITY

MARKETS:

The Government of India (Forwards Commission Market along with SEBI) has undertaken
various activities and assistance programmes to promote our commodities market. During the
year 2015-16 the commission conducted 872 awareness programs, out of which 535
programmes were for the benefit of the farmers and 337 programs for other stakeholders.
There were 100 capacity programmes conducted with the aim to build capacities of the
important stakeholders in the eco-system of commodity future markets and to sensitize the
policy makers about the utility of the futures markets. Out of the total 83 programs were
conducted for the general states and 17 were for the NER states. The FMC is association with
the Commodity Exchange initiated a process of dissemination of futures and spot prices of
agricultural commodity by installing Price Ticker boards at various locations. This may help
hedger group like farmers in their pre-sowing and post harvest decision making process and
hedging their price risks in the market. The officers of the Commission participated in
various international conferences and were also deputed for training/symposium organized by
international organizations/training institutes. Further the commission with the National
exchange has facilitated participation of hedgers in various exchange programs, exhibitions
and expos.

CHALLENGES TO COMMODITIES MARKET IN INDIA: Our country, being

strongly

agriculture based has to contend with the long-term decline and short term volatility of real
commodity prices on international markets. The long-term decline in real prices reflects the
tendency for productivity and production to grow at a faster rate than demand, leading to
overproduction which hampers the price provided to the farmers. Whereas the volatility reflects
the impact of exogenous factors such as weather on our production of commodities. These

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problems are exacerbated by market distortions, tariffs and subsidies in developed countries,
tariffs in developing countries and the market power in some commodity supply chains of
large transnational corporations. These distortions also limit our access to lucrative markets
and hinder attempts to secure a greater share of the final product price on the part of our
producers and exporting community. To summarize in points following are the problems as
faced by commodity markets in India:
1) Legal Challenges
2) Regulatory Challenges
3) Infrastructural Challenges
4) Awareness amongst the investors and producers 5) Other challenges regarding trading.
The Indian commodity futures landscape has been evolving and the national commodity
exchanges have made a big headway since their inception, with volumes surging with every
passing year. The turnover on the Indian commodity bourses has increased 120 times after
electronic trading was introduced in 2003, according to the Forward Markets Commission
(FMC), the commodities market regulator.

The MCX is the world's largest exchange in silver, the second largest in gold, copper and
natural gas and the third largest in crude oil futures. However, as a whole, exchange-traded
commodities account for only a fifth of the total volume of commodities traded in India.
Globally, the futures market in commodities is 30-40 times the size of the underlying
physical commodity trade. The higher the multiplier, the more thinly the commodity price
risks can spread across the market. So, it is evident that there is a large scope for increase in
the volume of commodity futures trading in India.
Lamdo Rutten, MD & CEO, MCX Part of the reason for the rising trade volumes on the
Indian commodity futures exchanges is that they provide an efficient platform for hedging
against price uncertainty and global volatility. The exchanges provide transparent price
discovery and hedging platform for trading futures contracts of different commodities. On
these exchanges, the fair value prices are determined through active participation of a large
number of stakeholders of the commodity value chain, who have access to information on the
demand and supply conditions.
In recent years, with the globalisation of the Indian economy and sensitivity of prices of
commodities to global factors, commodities have witnessed heightened price volatility.
This has exposed all stakeholders to price shocks, from primary producers, such as farmers,
to end-users, such as the manufacturing sector. For instance, in 2010, the high volatility in
international prices of most commodities was reflected in the Indian prices.

Volatility in the MCX Comdex, the benchmark index of the MCX, was 17.7 per cent in
2009 and 11.37 per cent during 2010 (January-October), while that for its Agri Index stood
at 13.35 per cent and 12.48 per cent, respectively, during the same period. This has
prompted a growing demand for hedging among commodity users. The high correlation
between domestic and international prices is reflected in the close intertwining of the
Goldman Sachs Commodity Index and the MCX Comdex during the 21-month period
between January 2009 and September 2010 (see graph).

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With heightened volatility in commodity prices and increasing execution of price risk
management through the exchange platform, the Indian commodity futures market grew by
38 per cent in 2008, 41 per cent in 2009, and by 51 per cent between January and October
2010, in comparison with the corresponding period of the previous year. The commodity
futures trading volumes, taken as a whole, have risen at a compounded annual growth rate
of
97.9 per cent between 2003-4 and 2009-10.

The MCX has developed different contract denominations to accommodate the needs of
varied market participants, ranging from all types of traders such as hedgers (jewellers,
importers, retailers, and others from the physical market), and speculators, to investors (HNIs
and retail) and arbitrageurs.

UNTAPPED POTENTIAL
Although India has to cover a long distance to be able to harness the potential in many
commodities, it has substantial opportunities to develop consumer demand and uncover latent
consumption. Despite having significant benefits, commodities trading has been mostly
limited to large corporates, trading houses and high net worth individuals (HNIs). The key
reason that discourages retail investors from actively participating in commodities trading is
lack of familiarity.

Moreover, the current tax regime is not favourable for investors. Finally, the institutional and
policy-level issues associated with commodity exchanges have to be addressed by the
government in coordination with the FMC. This will help take necessary measures to pave
the way for a significant expansion and further development of the commodity futures
markets.

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 REGULATED GROWTH
The FMC has initiated several measures to stimulate active trading interest in
commodities. Steps such as lifting the ban on futures trading in commodities, approving
new exchanges which offer modern infrastructure and systems, and removing legal
hurdles to attract more participants have increased the scope of commodity derivatives
trading in India. This has boosted both the spot market and the futures market in the
country. The trading volumes are increasing while the list of commodities traded on the
national commodity exchanges also continues to expand.
The FMC has continued its efforts to broadbase the market by undertaking various
regulatory measures to facilitate hedgers' participation and promote delivery in
agricultural commodities. These include introduction of Exchange of Futures for
Physicals (EFP), Alternate Futures Settlement Mechanism and introduction of an early
delivery system in select commodities. In addition, efforts have been made to develop an
aggregation model in collaboration with the commodity exchanges to promote
participation of farmers (these will become feasible once options are allowed, which
requires amendments to the Forward Contracts (Regulation) Act, 1952).
GOING FORWARD
The commodity markets are at a juncture where investment in education and research is
important to sustain their growth. The MCX has been taking various initiatives to
systematically develop markets through continuous innovation, education and research
focused on spreading awareness of the modern trading mechanisms facilitated by
commodity exchanges. The MCX, in association with the FMC, conducted 95 joint
awareness programmes during January-October 2010 for physical market participants,
especially farmers, who are the primary beneficiaries of this market, for hedging against
price risk or for future price discovery.

To widen and deepen our commodities market for the future, policymakers need
strengthen the institutional infrastructure through market-friendly policies on taxation,
enabling of institutions, such as banks and mutual funds, to participate in the commodity
futures market, and the provision to initiate trading in options and intangible
commodities. These would
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fructify as and when the Forward Contracts (Regulation) Act, 1952, under which the
commodity futures market operate, is amended by the Parliament. Besides, innovative
application of ICT, increased awareness programmes and outreach initiatives, best-in-class
technological advancements by bringing solutions that address our customers' top trading
needs, product innovation in line with the changing market dynamics and emerging
challenges, and domain knowledge would ensure that the Indian commodity futures market
scales global heights.
commodity futures offers the following benefits:

• High leverage: You can take a position in a particular commodity by paying only a
fraction of that value as margin. Moreover, the margins in the commodity futures market are
lower than equity futures and options.
• Less manipulation: Governed by international price movements, commodity markets are
less prone to rigging or price manipulation.
• Diversification: Commodity prices are prone to supply-demand dynamics, weather
conditions, geo-political tensions and natural disasters. Accordingly, commodities are an
independent asset class, and can prove to be an effective means of diversification in one’s
investment portfolio.

If you are an importer or exporter, you benefit in the following ways:

Hedge against price fluctuations: In today’s highly volatile scenario, wide fluctuations in
prices of import and export products can directly affect your bottom-line. Commodity futures
helps you to procure or sell commodities at a price decided months before the actual
transaction, thereby ironing out any price changes that happen subsequently.

If you are a producer of a commodity, futures can help you in the following ways:

• Lock-in price for your produce: If you are a farmer, there is a possibility that the price
of your produce may come down drastically at the time of harvest. By taking positions in
commodity futures, you can effectively lock-in the price at which you wish to sell your
produce at harvest time.
• Assured demand: Any glut in the physical market could mean an endless wait for a
buyer. Selling commodity futures contracts can give you assured demand at the time of
harvest.
If you are a large-scale consumer of a product, here is how this market can help you:

• Control your costs: If you are an industrialist, the raw material cost dictates the final price of
your output. Any sudden rise in the raw material cost can compel you to pass on the hike to
your customers, making your products unattractive in the market. On the other hand, if you
are unable to pass on the costs, your margins and profitability will be hit. Through
commodity futures, you can lock-in the price of your raw materials.
• Ensure continuous supply: Any shortfall in the supply of raw materials can stall your
production and make you default on your sale obligations. You can avoid this risk by buying
a commodity futures contract by which you are assured of supply of a fixed quantity of
materials at a pre-decided price at the appointed time.

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Commodity Market is about trading of precious metals, energy, oil, spices & so on. Click
here to know what is Commodity market & also read about the benefits of trading in
commodity market!
Gold and other metals can be accessed in number of ways including traditional physical
holdings, futures contracts, D-mat forms, ETFs and through correlated markets such as
mining stocks. Each mode of holdings has its own advantages and disadvantages but with so
many options available, investors of all types should be able to find a product to match their
temperament.
Trading in commodities futures has a long history. However, organized trading on an
exchange started in 1848 with the establishment of the Chicago Board of Trade (CBOT).

METAL Aluminium, Copper, Lead, Nickel, Sponge Iron, Steel Long

(Bhavnagar), Steel Long (Govindgarh), Steel Flat, Tin, Zinc

BULLION Gold, Gold HNI, Gold M, i-gold, Silver, Silver HNI, Silver M

FIBER
Cotton L Staple, Cotton M Staple, Cotton S Staple, Cotton
Yarn, Kapas

ENERGY
Brent Crude Oil, Crude Oil, Furnace Oil, Natural Gas, M. E.
Sour Crude Oil

SPICES Cardamom, Jeera, Pepper, Red Chilli, Turmeric

PLANTATIONS Arecanut, Cashew Kernel, Coffee (Robusta), Rubber

PULSES Chana, Masur, Yellow Peas

PETROCHEMICALS HDPE, Polypropylene(PP), PVC

OIL & OIL SEEDS Castor Oil, Castor Seeds, Coconut Cake, Coconut Oil, Cotton
Seed,
Crude Palm Oil, Groundnut Oil, Kapasia Khalli, Mustard Oil,
Mustard Seed (Jaipur), Mustard Seed (Sirsa), RBD Palmolein,
Refined Soy Oil, Refined Sunflower Oil, Rice Bran DOC, Rice
Bran Refined Oil, Sesame Seed, Soymeal, Soy Bean, Soy
Seeds

The first milestone in the 150 years rich history of organized trading in commodities in India
was the constitution of the Bombay Cotton Trade Association in the year 1875. India had a
vibrant futures market in commodities till it was discontinued in the mid 1960's, due to war,
natural calamities and the consequent shortages.
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Following the introduction of liberalization policy in 1991, the Government of India
appointed an expert committee on forward market under the chairmanship of Prof. K. N.
Kabra in 1993. The committee submitted its report in 1994 advocating the re-introduction of
futures and expanding its coverage to agricultural commodities. It also proposed an
expansion for the coverage of futures markets to minimize the wide fluctuations in
commodity prices and for hedging the risk arising from extreme price volatilities.

Commodities futures contracts and the exchanges they trade in are governed by the Forward
Contracts (Regulation) Act, 1952. The regulator is the Forward Markets Commission (FMC),
a division of the Ministry of Consumer Affairs, Food and Public Distribution.

In 2002, the Government of India allowed the re-introduction of commodity futures in India. .
1. National Commodity & Derivative Exchange

2. Multi Commodity Exchange

3. National Multi Commodity Exchange of India

In terms of market share, MCX is today the largest commodity futures exchange in India,
with a market share of close to 70%. NCDEX follows with a market share of around 25%,
leaving the balance 5% for NMCE.

Exchange traded commodities are; CEREALS Maize

Guargum, Guar Seed, Gurchaku, Mentha Oil, Potato (Agra),

Potato (Tarkeshwar), Sugar M-30, Sugar S-30

Benefits of commodity futures market;

1. Price Discovery: Based on inputs regarding specific market information, buyers

and sellers conduct trading at futures exchanges. This results into continuous price
discovery mechanism.

2. Hedging: It is strategy of managing price risk that is inherent in spot market by

taking an equal but opposite position in the futures market to protect their business
from adverse price change.

3. Import- Export competitiveness:

The exporters can hedge their price risk and improve their competitiveness by making use of
futures market. A majority of traders which are involved in physical trade internationally
intend to buy forwards. The existence of futures market allows the exporters to hedge their

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proposed purchase by temporarily substituting for actual purchase till the time is ripe to buy
in physical market.

4. Portfolio Diversification

Commodity offers at another investment options which is largely negatively correlated with
equity and currency and thus could offer great portfolio diversification.

Special Characteristics of the Commodities Market

In the broadest sense, the basic principles of supply and demand are what drive the
commodities markets. Changes in supply impact the demand; low supply equals higher
prices. So any major disruptions in the supply of a commodity, such as a widespread health
issue that impacts cattle, can lead to a spike in the generally stable and predictable demand
for livestock.

Global economic development and technological advances can also impact prices. For
example, the emergence of China and India as significant manufacturing players (therefore
demanding a higher volume of industrial metals) has contributed to the declining availability
of metals, such as steel, for the rest of the world.

Types of Commodities

Commodities that are traded are typically sorted into four categories broad categories: metal,
energy, livestock and meat, and agricultural.

Metals

Metals commodities include gold, silver, platinum, and copper. During periods of market
volatility or bear markets, some investors may decide to invest in precious metals–
particularly gold–because of its status as a reliable, dependable metal with real, conveyable
value. Investors may also decide to invest in precious metals as a hedge against periods of
high inflation or currency devaluation.

Energy commodities include crude oil, heating oil, natural gas, and gasoline. Global
economic developments and reduced oil outputs from established oil wells around the world
have historically led to rising oil prices, as demand for energy-related products has gone up at
the same time that oil supplies have dwindled.
Energy

Investors who are interested in entering the commodities market in the energy sector should
also be aware of how economic downturns, any shifts in production enforced by the

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Organization of the Petroleum Exporting Countries (OPEC), and new technological advances
in alternative energy sources (wind power, solar energy, biofuel, etc.) that aim to replace
crude oil as a primary source of energy, can all have a huge impact on the market prices for
commodities in the energy sector.

Livestock and meat commodities include lean hogs, pork bellies, live cattle, and feeder cattle.

Agriculture

Agricultural commodities include corn, soybeans, wheat, rice, cocoa, coffee, cotton, and
sugar. In the agricultural sector, grains can be very volatile during the summer months or
during any period of weather-related transitions. For investors interested in the
agricultural sector, population growth–combined with limited agricultural supply–can
provide opportunities for profiting from rising agricultural commodity prices.

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Using Futures to Invest in Commodities

One way to invest in commodities is through a futures contract. A futures contract is a legal
agreement to buy or sell a particular commodity asset at a predetermined price at a
specified time in the future. The buyer of a futures contract is taking on the obligation to
buy and receive the underlying commodity when the futures contract expires.

The seller of the futures contract is taking on the obligation to provide and deliver the
underlying commodity at the contract's expiration date. Futures contracts are available for
every category of commodity. Typically, there are two types of investors that participate
in the futures markets for commodities: commercial or institutional users of the
commodities and speculative investors.

Manufacturers and service providers use futures contracts as part of their budgeting process
to normalize expenses and reduce cash flow-related headaches. Manufacturers and service
providers that rely on commodities for their production process may take a position in the
commodities markets as a way of reducing their risk of financial loss due to a change in
price.

The airline sector is an example of a large industry that must secure massive amounts of fuel
at stable prices for planning purposes. Because of this need, airline companies engage in
hedging with futures contracts. Future contracts allow airline companies to purchase fuel at
fixed rates for a specified period of time. This way, they can avoid any volatility in the
market for crude oil and gasoline.

Farming cooperatives also utilize futures contracts. Without the ability to hedge with futures
contracts, any volatility in the commodities market has the potential to bankrupt businesses

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that require a relative level of predictability in the prices of goods in order to manage their
operating expenses.

Speculative investors also participate in the futures markets for commodities. Speculators are
sophisticated investors or traders who purchase assets for short periods of time and employ
certain strategies as a way of profiting from changes in the asset's price. Speculative investors
hope to profit from changes in the price of the futures contract. Because they do not rely on
the actual goods they are speculating on in order to maintain their business operations (like an
airline company actually relies on fuel), speculators typically close out their positions before
the futures contract is due. As a result, they may never take actual delivery of the commodity
itself.

If you do not have a broker that also trades futures contracts, you may be required to open a
new brokerage account. Investors are also typically required to fill out a form that
acknowledges that they understand the risks associated with futures trading. Futures contracts
will require a different minimum deposit depending on the broker, and the value of your
account will increase or decrease with the value of the contract. If the value of the contract
decreases, you may be subject to a margin call and required to deposit more money into your
account in order to keep the position open. Due to the high level of leverage, small price
movements in commodities can result in either large returns or large losses; a futures account
can be wiped out or doubled in a matter of minutes.

There are many advantages of futures contracts as one method of participating in the
commodities market. Analysis can be easier because it's a pure play on the underlying
commodity. There's also the potential for huge profits, and if you are able to open a
minimum-deposit account, you can control full-size contracts (that otherwise may be difficult
to afford). Finally, it easy to take long or short positions on futures contracts.

Livestock and Meat

Because the markets can be very volatile, direct investment in commodity futures contracts
can be very risky, especially for inexperienced investors. The downside of there being a
huge

potential for profit is that losses also have the potential to be magnified; if a trade goes
against you, you could lose your initial deposit (and more) before you have time to close
your position.

Most futures contracts offer the possibility of purchasing options. Futures options can be a
lower-risk way to enter the futures markets. One way of thinking about buying options is
that it is similar to putting a deposit on something instead of purchasing it outright. With an
option, you have the right–but not the obligation–to follow through on the transaction when
the contract expires. Therefore, if the price of the futures contract doesn't move in the
direction you anticipated, you have limited your loss to the cost of the option you purchased.

Using Stocks to Invest in Commodities

Many investors who are interested in entering the market for a particular commodity will
invest in stocks of companies that are related to a commodity in some way. For example,
investors interested in the oil industry can invest in oil drilling companies, refineries, tanker
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companies, or diversified oil companies. For those interested in the gold sector, some options
are purchasing stocks of mining companies, smelters, refineries, or any firm that deals with
bullion.

Stocks are typically thought to be less prone to volatile price swings than futures contracts.
Stocks can be easier to buy, hold, trade, and track. Plus, it is possible to narrow investments
to a particular sector. Of course, investors need to do some research to help ensure that a
particular company is both a good investment and commodity play.

Investors can also purchase options on stocks. Similar to options on futures contracts, options
on stocks require a smaller investment than buying stocks directly. So, while your risk when
investing in a stock option may be limited to the cost of the option, the price movement of a
commodity may not directly mirror the price movement of the stock of a company with a
related investment.

An advantage of investing in stocks in order to enter the commodities market is that trading is
easier because most investors already have a brokerage account. Public information about a
company's financial situation is readily available for investors to access, and stocks are often
highly liquid.

There are some relative disadvantages to investing in stocks as a way of gaining access to the
commodities market. Stocks are never a pure play on commodity prices. In addition, the price
of a stock may be influenced by company-related factors that have nothing to do with the
value of the related commodity that the investor is trying to track.

Using ETFs and Notes to Invest in Commodities

Exchange traded funds (ETFs) and exchange-traded notes (ETNs) are an additional option for
investors who are interested in entering the commodities market. ETFs and ETNs trade like
stocks and allow investors to potentially profit from fluctuations in commodity prices without
investing directly in futures contracts.

Commodity ETFs usually track the price of a particular commodity–or group of commodities
that comprise an index–by using futures contracts. Sometimes investors will back the ETF
with the actual commodity held in storage. ETNs are unsecured debt securities designed to
mimic the price fluctuation of a particular commodity or commodity index. ETNs are backed
by the issuer.

ETFs and ETNs allow investors to participate in the price fluctuation of a commodity or
basket of commodities, but they typically do not require a special brokerage account.
There are also no management or redemption fees with ET trade like stocks. However, not
all commodities have ETFs or ETNs that are associated with them.

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Softs ETNS

NIB BAL CAFE

BAL: iPath Bloomberg Cotton Sub Index Total Return ETN; CAFE: iPath Pure Beta
Coffee ETN; NIB: path Bloomberg Cocoa Sub Index Total Return ETN

Another downside for investors is that a big move in the price of the commodity may
not be reflected point-for-point by the underlying ETF or ETN. In addition, ETNs
specifically have credit risk associated with them since they are backed by the issuer.

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CORN: Terbium Corn Fund; SOYB: Terbium Soybean Fund; WEAT: Terbium Wheat Fund
Grains ETFs
WEAT CORN SOYB

Using Mutual and Index Funds to Invest in Commodities

While you cannot use mutual funds to invest directly in commodities, mutual funds can be
invested in stocks of companies involved in commodity-related industries, such as energy,
agriculture, or mining. Like the stocks they invest in, the shares of the mutual fund may be
impacted by factors other than the fluctuating prices of the commodity, including general
stock market fluctuations and company-specific factors.
However, there are a small number of commodity index mutual funds that invest in futures
contracts and commodity-linked derivative investments, and therefore provide investors with
more direct exposure to commodity prices.
By investing in mutual funds, investors get the benefit of professional money management,
added diversification, and liquidity. Unfortunately, sometimes management fees are high, and
some of the funds may have sale charges.
Using Commodity Pools and Managed Futures to Invest in Commodities
A commodity pool operator (CPO) is a person (or limited partnership) that gathers money
from investors and then combines it into one pool in order to invest that money in futures
contracts and options. CPOs distribute periodic account statements, as well as annual
financial reports. They are also required to keep strict records of all investors, transactions,
and any additional pools they may be operating.1
CPOs will usually employ a commodity trading advisor (CTA) to advise them on trading
decisions for the pool. CTAs must be registered with the Commodity Futures Trading
Commission (CFTC) and are usually required to get a background check before they can
provide investment advice.23

Investors may decide to participate in a CPO because they have the added benefit of receiving
professional advice from a CTA. In addition, a pooled structure provides more money and
more opportunities for the manager to invest. If investors choose a closed fund, all investors
will be required to contribute the same amount of money.
The Bottom Line
Both novice and experienced traders have a variety of different options for investing in
financial instruments that give them access to the commodity markets. While commodity
futures contracts provide the most direct way to participate in the price movements of the
industry, there are additional types of investments with less risk that also provide
sufficient opportunities for commodities exposure.
In the most basic sense, commodities are known to be risky investment propositions because
they can be affected by uncertainties that are difficult, if not impossible, to predict, such as
unusual weather patterns, epidemics, and disasters both natural and human-made.

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The Importance and Significance of Commodity Market
The growth of the commodity futures market in India has created an impact on the global
market since India is an agro-based country and for agro-based commodities, there is a huge
demand for consumption, production, and trade. In recent, decades commodity futures
markets as seen as impressive growth after the global crisis. Commodity futures market plays
an important role in deciding the price discovery and price risk management.
India is the largest consumer of commodities such as Precious metal (bullions and silver),
Metal (copper, zinc, lead, etc.) and Agricultural products (cotton, pepper, maize, wheat,
sugar, coffee, dairy products, etc.). India also dealt with the commodity spot market.
For instance, soya creates a huge market in Indore, Ahmedabad as a major market for
castor seed, for cotton, Surendranagar and Andhra Pradesh for chilli, etc. In India, the
commodity futures market is started way back and as old as the United States’ future
markets.
During the 1857 Bombay Cotton Trade Association has been set up, the Future market in
gold was inevitable and began to emerge in Mumbai 1920. In India the major three
commodity exchanges and trade happen electronically they are Multi Commodity
Exchanges (MCX), National Multi- Commodity Exchange limited (NMCE), and the
National Commodity and Derivative Exchange (NCDEX).
FMC (Forward Market Commission) in 2015 merged with SEBI and the Regulation and
Policies framework is under the control of SEBI(Security Exchange Board of
India). Commodity market in India as shown gradual evaluation of the country’s general
economic distribution and it’s a linkage with the financial sectors.
Hedging is an innovative instrument to trade in commodities and also creates a different
portfolio for the investors or traders, it also attracts the international investors because of
diversification availability that impact on the return which benefits the domestic and as well
as international investors.
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Commodity futures market booming in recent years as the financial derivatives market, since
our economy is an agro-based country there is a huge demand in domestic as well as
internationally for our agricultural commodity.
Regulatory bodies(SEBI) they are giving their topmost support to this market while framing
the policies they are stretching arms to safeguard the farmers and also the market
participants, hampering of technologies in recent decade keep the markets transparent and
trade happens in the organized form in both the markets spot and future.
Basically, it has been categorized into Pre – global crisis and Post – global crisis reason for
taking this is, in the year 2008 vital role has been played by the global crisis by crashing
world’s market and many IT companies phased the recession at the same time, Indian rupee
value got depreciated. So to analyse the price discovery process before and after the crisis is
there any improvement or change that occurred in forecasting the market price.
The result found in this paper while analysing the Pre – global crisis many authors shared
their view that the Indian commodity futures market is not mature and efficient in the price
discovery process and which impact on price risk management.
Market participant, they don’t have proper knowledge on hedging instrument, in short, they
lack in analysing the market prices few speculators play a major role in manipulating the
price and change the entire market scenario.
Trading in the commodity futures market has created chaos among the participants in
identifying spot and future markets. Key findings state that there is a domination of spot to
future markets.
On the other hand, Post – global crisis presenter’s said that there is a gradual development in
the commodity futures market.
Forecasting market price (price discovery) is mature enough which reflects in the price risk
management with the sophisticated technology future market can predict the market
movements and exchanges also closely monitored by Regulatory bodies.
Market participants have an overview or an idea about the future market at last, future market
dominate the cash market. In a nutshell after the global crisis commodity futures market are
confident inflow of information and also efficient in the price discovery process.
Commodities are an important component of having a diversified investment portfolio.
Trading in commodity futures is a fairly transparent process. The course of action leads you
to fair price discovery which is controlled by large-scale participation. Indian commodity
market trends depend on numerous factors such as demand and supply forces, government
policies, RBI policies

Review of the Literature

There are numerous studies, both theoretical and empirical, that analyse the efficiency of
futures markets in developed countries like the US and the UK. Garbade and Silber (1983)
tested the relationship between spot and futures prices for seven commodities. Their goal was
to test for efficiency in both functions of futures markets: risk management and price
discovery. They developed a partial equilibrium model to explain characteristics of price

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movements in cash and futures markets for storable commodities. Garbade and Silber argue
that the elasticity of supply for arbitrage services is constrained by both storage and
transaction costs. Thus, futures contracts will not, in general, provide perfect risk transfer
facilities over short-run horizons, though over the long run, cash and futures prices should be
integrated. While they found all markets to be integrated over a month or two, there was
considerable slippage between cash and futures markets over shorter time intervals,
especially for grains (corn, wheat and oats). Gold and silver on the contrary were highly
integrated even over one day.
They suggest that the degree of market price integration over short horizons is a function of
the elasticity of supply of arbitrage services and greater elasticity fosters more highly
correlated price changes. McKenzie and Holt (1998) tested the efficiencies of the US futures
markets for cattle, corn and soybean meal. Their results indicate that futures markets for all
these commodities are both efficient and unbiased in the long run. Kellard, et al. (1999)
examined the efficiency of several widely traded commodities in different markets, including
soybeans on the CBOT and live cattle on the Chicago Mercantile Exchange. The results show
that the long-run equilibrium condition holds, but again there was evidence of short-run
inefficiency for most of the markets studied. Alton, Anew, and Rayner (1997) re-investigated
the efficiency of UK agricultural commodity futures markets using the integration
methodology.
They found that contrary to earlier results (based on other techniques) the market is efficient
for wheat (but not efficient for some other commodities like potatoes). Zapata et al (2005)
who examine the relationship between sugar futures prices traded in New York and the world
cash prices for exported sugar, conclude that the finding of cointegration between futures and
cash prices suggests that the sugar futures contract is a useful vehicle for reducing overall
market price risk faced by cash market participants selling at the world price (i.e., not
enjoying favourable trade incentives).
The relationship between spot and futures markets in price discovery has been an important
area of research, which broadly finds that in equity markets price innovations appear first in
the futures market and are then transmitted down into the spot market (Stoll and Whaley,
1990; Chan et al., 1991). This is consistent with the argument that positions on the index
futures market enjoy greater leverage, which appeals to speculators, and this in turn adds
liquidity as well as divergent trading interests to the market. In the case of commodity
futures in the empirical literature there is a weak consensus, especially in agricultural
commodity futures.
Garbade and Silber (1983) showed with their sample of seven storable commodities that
while the futures market dominates the spot market in price discovery, there are reverse
information flows too. Their evidence suggests that the cash (spot) markets in wheat, corn,
and orange juice are satellites for their respective futures markets, with about 75 per cent of
new information incorporated first in futures prices and then flowing to cash prices. This
seems to also be the case for gold, although data limitations prevented a conclusive statement.
Price discovery for silver, oats, and copper, however, was more divided between the cash and
futures. However, the degree of integration varied over the time lag taken into consideration.
Zapata et al (2005) find uni-directional Granger causality from futures prices for world sugar
on the New York Exchange and world cash prices for sugar.
The futures market for sugar leads the cash market in price discovery and a shock in the
futures price innovation generates a quick (one month) and positive response in futures and
cash prices; but not vice versa. Silvapulle and Moosa (1999) examined the relationship
between the spot and futures prices of WTI crude oil using a sample of daily data. Linear

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causality testing revealed that futures prices lead spot prices, but nonlinear causality testing
revealed a bi-directional effect. This result suggests that both spot and futures markets react
simultaneously to new information (though the degree and speed of reaction may vary).
Asche and Guttormsen (2002) use data from the International Petroleum Exchange (IPE) on
the gas oil (termed heating oil in Europe or the US) contract, which was launched as the
IPE’s first futures contract in 1981. Their results indicate that futures prices lead spot prices,
and that futures contracts with longer time to expiration lead contracts with shorter time to
expiration. The literature on emerging commodity futures markets in developing countries is
sparse due to lack of meaningful data. Wang and Ke (2005) test the efficiency of the futures
markets for agricultural commodities in China and their results suggest a long-term
equilibrium relationship between the futures price and cash price for soybeans, and a weak
short-term efficiency of the soybean futures market. Based on a comparison of the wheat and
soy futures market, Wang and Ke (2005) conclude that participation in the world market
helps to improve the price prediction role of the futures market. Thomas and Karande (2001)
examined efficiency of the castor-seed futures markets in India. The examination included
identifying the flow of information between futures and spot prices across two different
markets, one export-oriented and another production-oriented. They find that futures
dominate spot prices, and that the export-oriented market prices dominate the
productionoriented market except in the harvest season when the relation was reversed.
Ramaswami and Singh (2006) examined the success of the soya oil futures at the National
Board of Trade (NBOT) for hedging purposes, using the principle of no-arbitrage conditions
being satisfied for efficient hedging. They find that there are very low arbitrage opportunities
in this market. Looking into the price discovery role of futures, Iyer and Mehta (2007) found
the cash market for two commodities (chana and copper) to be a pure satellite of the futures
market in the pre(contract) expiration weeks, and for four commodities (chana, copper, gold
and rubber) in the expiration weeks. Nickel was the only exception where the cash market
played a dominant role. Gold and silver, as expected, showed the highest degree of
integration between the spot and futures while nickel, rubber and chana showed very poor
integration between the markets. Thus, while most studies find evidence of information flows
between the spot and futures markets, the degree of information flows and their direction
vary significantly. The variation is mostly based on the type of commodity studied, the
market infrastructure (such as provision of efficient price dissemination) and the operation of
arbitrageurs in the futures market.

Pravakar shoo and Rajiv Kumar (2009) has evaluated that trading in commodity derivatives
on exchange platform is an instrument to achieve price discovery, better price risk
management besides helping macro economy with better resource allocation. The govt. has
proposed to impose transaction tax by 0.017% of trading volume in the 2008-2009 budgets.
He examines the efficiency and futures trading price nexus for 5 top selected commodities
namely gold, copper, petroleum crude, soya oil and chana in commodity futures market in
India. He suggests that commodity futures market is efficient for all 5 commodities. Further
he has not supported that futures market leads to higher inflation due to lack of evidence.
Bhawna et al. (2009) found the removal ban on commodities achieved the spectacular
growth, achieved its objectives price risk management and price discovery and high untapped
potential market growth in agriculture commodities. IIT Bombay (2009) conducted a research
study on behalf of Forward Market Commission (FMC) of India and found that seventy
percent of population depends on agriculture commodities, and there is a need to liberalize
the to manage the price risk through commodity futures. Sabnavis and Gurbandani (2010)

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analysed global commodity markets. These markets have proved to be efficient price
discovery mechanism in India and worldwide. Further, Gurbandani (2010) found that both
spot and future prices for selected agricultural commodities are efficient in weak form. Future
prices are independent and past prices have no role in the contribution of future price
prediction. Basu and Gavin (2010) concluded that the investors are searching for the
alternatives like high risky mortgage debt and financial derivatives market to mitigate the
risk. The study also found that there is negative correlation between equity market to
commodity futures return and it gives scope of bringing the arbitrage to exit hedging profits.
Shanmugam and Dey (2011) showed that the commodity market has performed better for all
the stakeholders. There is an urgent need for new instruments in the commodity markets. In
addition, the regulator has to develop stringent policies that can allow financial
intermediaries like institutional investors, banks and mutual funds to benefit at gross root
level. Swati and Shukla (2011) concluded there is a need to convergence of all types of
market like equity, commodity, forex and debt, which should be developed and regulated
properly to provide wide-ranging risk management solutions to Indian stakeholders. Gupta
and Ravi (2012) investigated the relationship in price discovery which proved that futures
markets are more responsive in dissemination information and price discovery to correct spot
market. Mahanta (2013) analysed price trends in the international market and concluded that
gold price movements in international market is positively correlated with Indian gold price
movements, so proper considerations to international markets should be given while
designing policies of derivatives market in India. Barua and MA hanta (2013) investigated
the high inflationary pressure due to commodity derivatives. Few futures contracts like red
gram, black gram, chickpeas, wheat, rice, potato, refined soybean oil and rubber have been
cancelled, but analysis proved that the ban on these commodity futures contract didn’t bring
price stability. Popli and Singh (2014) revealed that commodity futures market was volatile
in USA, U.K. and India. The comparison between US, U.K and Indian futures markets
reveals the policy makers have to follow the clue from U.S and U.K regulation to promote
and encourage investments in commodity derivatives market.

There is plethora of studies in the field since the existence of trading took place on
commodities at India and the world. The important studies are reviewed and presented in a
chronological order and examined the performance of trading, growth, role of price
discovery, hedging, regulation future prospects to assess the performance of Indian
commodity derivatives market specifically. Shroff (1950) referred the Government of India
draft bill on introduction of forward trading in India and recommended the introduction of
forward trading helps in hedging, price stabilization, reducing the speculation. The study
further advised to establish the trading rules and regulations, approved and managed by
Government. Kamara (1982) analysed the impact of introduction of commodity futures by
comparing the spot market volatility before and after introduction of commodity futures and
found no significant change. Kabra Committee Report (1993) advised to strengthen the
Forward Market Commission (FMC) and Forward Contract Act, 1952 by means of
improving infrastructure, telecommunication, functioning of the exchanges, adequate norms,
automation of trading in exchanges, regulation to designing and trading of futures contracts,
and establishing strong vigilance committee. UNCTAD and World Bank Joint Mission
Report (1996) highlighted the role of futures markets as market based instruments for
managing risks and suggested the strengthening of institutional capacity of the regulator and
the exchanges for efficient performance of these markets. Further noted that Government
intervention was pervasive in some sensitive major commodities like wheat, rice and sugar
and was of the view that future markets in these commodities were unlikely to be viable.

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 The National Agricultural Policy, (2000) recommended to liberalize the agriculture and
allied sector, enhance the infrastructure and information technology, the commodity
exchanges have to launch futures contract on liquid commodities in the market. Singh (2000)
analyzed efficiency of Indian commodity futures, advised optimizing the futures markets to
discover the prices and minimize risk. According to him, exchanges should be self-regulated
to curb speculation. The Government should minimize the intervention in pricing mechanism
and should initiate private participation. Sahadevan (2002) surveyed the recognized
exchanges and their organizational, trading and the regulatory set up for futures trading in
commodities and revealed that many of the commodity futures exchanges fail to provide an
efficient hedge against the risk emerging from volatile prices of many farm products in
which they carry out futures trading. Habibullah Committee (2003) advised the Government
of India that the development of commodity derivatives market must be upheld by removal
of obstruction on convergence between securities and commodity derivatives market on
account of policies relating to cash market, which will impact demand and supply forces. The
Government follows common policy applicable to all over India. It further advised on
removal of restrictions on participation of banking institutions at least for hedging purpose.
The new policy framework should permit the introduction of the commodity futures indices
contracts, spreads, weather, electricity and freight. It also recommended modifying the SEBI
regulation to permit participation of mutual funds, Foreign Institutional Investor. Chen and
Firth (2004) analyzed the relationship between return and trading volume of four commodity
futures in China, by using correlation and Granger causality test. They found no correlation
between return and volume, but signify the causality from trading volume and return, vice
versa. They, however, found a correlation between absolute return and trading volume. Bir
(2004) investigated hedging performance of agricultural commodity futures market in terms
of price discovery and risk management. The factors responsible for inefficient hedging in
commodities were found as low volume, low participation, inadequate warehouse facility
and deficient information system of commodity exchanges. Wang and Ke (2005) analysed
the efficiency of the futures market for agricultural commodities in China found that long
term equilibrium exists between futures and cash prices for Soybean. On the other hand, the
comparison of wheat and soya bean futures reveals short term efficiency of Soybean futures
market. Zapata (2005) analysed the unidirectional Granger causality from futures prices for
world sugar on the New York Exchange and world spot price of sugar and found the futures
market helps in price discovery in spot, and the flow of information is from futures to spot
market but not vice versa. Gorton and Rouwenhorst (2004, 2005) analysed the long term
characteristics of investment in collateralized commodity futures contracts by creating a
commodity futures weighted index covering period of July 1959 to December 2004. The
results showed that there was higher historical index and spot market return during the
sample period. Further the study was found that the commodity futures risk premium was
higher than debt market returns and equal to equity market return. Ahuja (2006) analyzed the
commodity derivatives market in India. And found that the commodity futures market in
India has recorded spectacular growth to reach a one trillion mark in 2006. However, several
challenges have to be overcome for further stability and persistent growth and development
of the market. Karande (2007) studied the castor seed futures traded in with Mumbai and
Ahmadabad and evaluated three features of commodity futures market in India, viz, basis
risk, price discovery and spot price volatility. The result found that the price discovery was
achieved and beneficial in spot price volatility market. Liu and Zhang (2006) analyzed the
Price discovery of Spot and Futures price in Chinese Copper, Aluminum, Rubber, Soybean
and Wheat markets and found that lead lags relationship between spot and futures market is

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quite limited. Abhijit Sen (2007) revealed that there is no significant proof for price
acceleration of agricultural commodity prices in post futures period, the period of study being
very short to discriminate enough between the futures trading and the cyclical adjustments.
Lokare (2007) revealed significant co integration between futures and spot prices of selected
commodities and had shown the slower operational efficiency. On the other hand, there was
inefficient exploitation of available information to capture in the prices of futures contract.
Ram and Ashis (2007) concluded that agricultural commodity derivatives provide an efficient
protection against the price volatility risk in terms of commodity prices, commodity
exchanges offer a broad based platform for trading of agricultural and non-agricultural
commodities over time and space so the commodity exchanges need to be developed at
national level. IIM Bangalore (2008) study found post futures period volatility increased, in
spite of negative results of futures market, suggested to integrate the geographical separated
markets, remove the incompetence is arising among the futures prices and futures spot prices,
which was due to immature nature of the market, there are many obstruction in nature of the
institutional and policy level constraints. Kedarnath and Mukharjee (2008) investigated the
impact of futures trading on agricultural commodity market and found there is no significant
change in spot prices post futures period in essential commodities, but a comparative
advantage found through causality analysis proves that bidirectional relation exists between
futures and spot market through flow of information. Bose (2008) found that information
flow between the market helps in price determination. In spite of lesser degree of association
in spot and futures indices, the agriculture commodity indices show weak performance in
price dissemination for predicting the futures prices than non-agriculture commodity futures
indices. Nath and Lingareddy (2008) concluded that futures trading in the selected
commodities escort to increase volatile in case of urad, in case of gram and wheat prices
moderately rise in post futures period not proved statistically significant. Bhawna et al.
(2009) found the removal ban on commodities achieved the spectacular growth, achieved its
objective as price risk management and price discovery and high untapped potential market
growth in agriculture commodities. IIT Bombay (2009) conducted a research study on behalf
of Forward Market Commission (FMC) of India and found that seventy percent of population
depends on agriculture commodities, and there is a need to liberalize the to manage the price
risk through commodity futures. Sabnavis and Gurbandani (2010) analyzed global
commodity markets. These markets have proved to be efficient price discovery mechanism in
India and worldwide. Further, Gurbandani (2010) found that both spot and future prices for
selected agricultural commodities are efficient in weak form. Future prices are independent
and past prices have no role in the contribution of future price prediction. Basu and Gavin
(2010) concluded that the investors are searching for the alternatives like high risky mortgage
debt and financial derivatives market to mitigate the risk. The study also found that there is
negative correlation between equity market to commodity futures return and it gives scope of
bringing the arbitrage to exit hedging profits. Shanmugam and Dey (2011) showed that the
commodity market has performed better for all the stakeholders. There is an urgent need for
new instruments in the commodity markets. In addition, the regulator has to develop stringent
policies that can allow financial intermediaries like institutional investors, banks and mutual
funds to benefit at gross root level. Swati and Shukla (2011) concluded there is a need to
convergence of all types of market like equity, commodity, forex and debt, which should be
developed and regulated properly to provide wideranging risk management solutions to
Indian stakeholders. Gupta and Ravi (2012) investigated the relationship in price discovery
which proved that futures markets are more responsive in dissemination information and
price discovery to correct spot market. Mahanta (2012) analyzed price trends in the

62 | Page
international market and concluded that gold price movements in international market is
positively correlated with Indian gold price movements, so proper considerations to
international markets should be given while designing policies of derivatives market in India.
Barua and Mahanta (2012) investigated the high inflationary pressure due to commodity
derivatives. Few futures contracts like red gram, black gram, chickpeas, wheat, rice, potato,
refined soybean oil and rubber have been canceled, but analysis proved that the ban on these
commodity futures contract didn’t bring price stability.
Popli and Singh (2012) revealed that commodity futures market was volatile in USA, U.K.
and India. The comparison between US, U.K and Indian futures markets reveals the policy
makers have to follow the clue from U.S and U.K regulation to promote and encourage
investments in commodity derivatives market. Kaur and Anjum (2013) carried out the study
on agricultural commodity futures in India and found that in spite of development of
commodity futures market, farmers could not gain leverage from the market, as there is no
integration between spot and futures market. They further found that due to lack of
infrastructure and warehousing, regional exchanges could not penetrate to rural India
The literature review focused on the price discovery of agricultural commodities during
different time horizons. And it can be categorized into Pre – global crisis and Post – global
crisis. This paper as concentrated on limited literature review and its major findings.
Pre – global crisis: Price discovery of agricultural commodity Jian Yang and David J.
Leatham (1999) The authors investigated the price discovery function of futures markets by
taking the three major exchanges in the U.S. wheat future market: The Chicago Board of
Trade, Kansas City Board of Trade, and Minneapolis Grain Exchange. The assumption of the
future market prefers more information than the spot markets to find an equilibrium price, so
it improves the price discovery function. The findings reveal the existence of one equilibrium
price across three futures markets in the long run, but no co-integration among prices in three
representative spot market. Jian Yang and David J.Leatham (2001) examined the price
discovery of future markets and the cash market the evidence emphasis that storability and
non-storability do not affect the prevailing cointegration between both the market's price.
And in the long run it allows for the compounding factors of the stochastic interest rate.
Susan Thomas, Kiran Karande (2001) authors analyzed the price discovery of India's castor
seed market. They found that three of four contracts, the futures market in Bombay
dominates the price discovery and it has been considered as the production center. Likewise
spot markets dominate the prices in the production center, however, spot and futures markets
are the first to get the information about the harvest. BK Vashist, Ashutosh Vashist (2002)
the focal point of view is to explore the determination of equilibrium price of an agricultural
future contract and its relationship with the expected spot price at maturity of the contract.

They have categorized the study into two distinctive features:

1. To know the spot market demand and supply condition expected by the hedgers to
persuade at maturity of the contract the risk aversion is possible, the responsiveness of the
speculator will also be the same thus important determinants of the equilibrium contract
price.

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2. The second equilibrium relationship is based on the different seasonality phases of
the contract price and the expected spot price, is basically to shift in the net hedgers and
speculators as a whole this is done to shift the net hedging interest. Sunil Kumar (2004)
analyzed the price discovery in six Indian commodity exchanges for five commodities. They
have used the future market price and spot price to check the efficiency and ability of the
future market they used the Johansen cointegration technique and found at last that future
market inability in gathering and incorporating the information and also they confirmed
inefficiency of the future market. Hector Zapata, T. Randall Fortenbery Delroy Armstrong
(2005) the aim to find the future price of sugar traded in New York and world export of cash
price and result state that future price leads the cash price and this statement does not have a
piece of evidence to prove a change in the cash price change in future price because of
unidirectional causality from future to cash. To conclude that sugar future contract is useful
for market participants which reduce the overall market price risk. LIU Qing – fu, ZHANG
Jin – qin, (2006) studied the price discovery process and volatility spillovers in the Chinese
spot – future market. They found that there is a long term relationship and bidirectional
informational flow between the spot and the futures market in China, and also they told that
future market being dominated. Gaurav Raizada, Gurpreet Sahi (2006) this paper focus on
the future market efficiency and analyzing its effect on the social welfare and inflation of the
economy.
To study the efficiency of the futures market they choose wheat future market at National
Commodity & Derivatives Exchange Ltd. (NCDEX). They found that the commodity futures
market is still inefficient in the short run and also the social loss statistic indicates poor price
discovery. Bharat Ramaswami and Jatinder Bir Singh (2007) the whole idea behind this
paper is to know the relationship between the spot and futures market. And soya oil contract
in the National Board of Trade (NBOT) in India. The major focus is on soya oil import and
its impact on the hedgers and speculator, during the short run volatility to make the contract
attractive. Sushmitha Bose (2008) the study makes a comparison between the commodity
futures market and financial derivative markets and result says that future market is less
developed when compared to financial derivative and they also found with the available
notional price indices they made a conclusion multi-commodity exchange (MCX) have a
higher exposure to metals and energy products, and also they made note that future and spot
prices contribute to price discovery. The future market can float the information to predict the
spot price and thus it helps in reducing the volatility, on the other hand, Agricultural Indices
does not have clarity features. R. Salvadi Easwaran and P. Ramasundaram (2008) the authors
argue that the Indian future market fails to identify the performance of the price discovery in
which interns affect the price risk, and also they have found that price discovery does not
occur in agricultural commodity futures markets. And also he addressed the policies that
should be promoted by the Forward Market Commission (FMC) and SEBI for the purposeful
and vibrant segment for price risk management in Indian agriculture.

Post – global crisis:

Price discovery of agricultural commodity K. Elumalai, N. Rangasamy, and R.K. Sharma
(2010) the paper try to examine the relationship between the futures market and spot market
by taking pepper, guar seed, and chana from commodity futures market they found that there
is a linkage between spot and futures market. The study also broadly revealed that three
agricultural futures impacting the spot price and indicating the better hedging efficiency in

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future market exchange for the producer to hedge their price. Ashutosh Varma and C.V.R.S
Vijaya Kumar (2010) The study has done to analyse the negative covariance between the spot
price and net cost of carrying model and its effect on the maturity period, by taking wheat
and pepper contract. they concluded that maturity effect is present and it is explained through
a negative covariance between the spot price and net cost of carrying. Dr. Kedar Nath
Mukherjee (2011) this paper has been expressed the viewpoint among the development and
efficiency of the futures market and founds that comparatively is disseminating the
information of price risk management and price discovery and it helps to develop an
underlying commodity market in India. Dr. Moonies Shakeel and Shriram Purankar (2014)
this paper present a viewpoint of the long-run relationship of cash and future market by doing
various analysis they found that positive cointegration between the cash and futures market
by taking a series commodity like chana, castor seed, soya bean. It also disseminates effective
information which leads to price discovery in India. Nidhi Aggarwal, Sargam Jain, and Susan
Thomas (2014) this paper examine that the commodity future can also do the price discovery
and hedging effectively but, which is riskless effective. And discussed the viewpoint of the
hedger to improve factors that affect hedging effectiveness. In the market various policy
intervention in both the spot and futures market. K. Dhineshni and Dr. S.P. Dhandayuthapani
(2016) this paper also analyzed the comovement between the spot and futures market. The
selected commodity is pepper, jeera, chilli, coriander, and turmeric daily data has been
collected from the NCDEX. And the results reveal the long-run relation between the spot and
future market and also helps in the flow of information efficiently through which prices are
discovered. Tanushree Sharma (2016) in this paper author discussed the relationship between
the spot market and unexpected future trading and also includes the volatility whenever high
unexpected trading happens it automatically increase the spot price. And this unexpected
trade manipulates speculation and it affects the genuine hedgers. To concluded regulators
should take steps in checking speculation in future pepper trading. Dr. P. S. Velmurugan and
Mohammad Irshad V.K. (2017) examined the comovement between the future price and
underlying spot price they found that there is an interrelationship in price movements. Data
collected from the spot and future major five agricultural commodities (Castor seed, Chana,
Chilli, Jeera, and Wheat). Dr. Anil Kumar Swain and Mr. Laxmindharl Samal (2017) in this
study author's discussed price volatility were the producers of the agricultural commodity are
facing not only yield risk but, also the price risk. They also suggest that commodity
derivative instruments should achieve price risk management and helps in evaluating the
hedging effectively. They found that the minimum variance hedge ratio has been used for raw
jute contract prices and it indicates a high price future market. There is also an equal trend in
spot and futures prices. Rodrigo Lanna F. Silveira, Fabio L. Mattos, and Maria Slyvia M.
Saes (2017) the paper present that there is price volatility for coffee futures contracts which is
impacted by the coffee crop report. Findings say that coffee crop reports affect the price of
coffee seed impact is more from the world's major producers Colombia, Brazil, and Vietnam.
Debashish Maitra (2017) this study aims to know does seasonality, break, and volatility
spillover effect the commodity futures market. Results say that the seasonality and a
structural break lead to low spillover but this is a negligible concept. They also observed that
the effect of spillover from higher from the spot market to the futures market. P.K. Shau,
Soumik Dey et al. (2018) analyzing the price discovery which is the important feature to
hedge the sharp fluctuation and recent years in India exporting playing a major role there is a
huge demand for Indian spices so, the transmission of price signal between spot and futures
market is important. The key findings prove that there is a correlation between the spot price
and the futures price. On another side the author's discussed the bidirectional price movement

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in spot and futures price. Puja Sharma and Tanushree Sharma (2018) the paper state that there
is price movement interrelation between the spot and futures market prices in the long run
which indicate that future contract can be an effective hedging instrument. In this study it has
been observed that there is a short-run flow from future to spot price concerning chilli.
Sarveshwar Kumar Inani (2018) analyzing price discovery from the spot and future market
taking six commodities (castor seed, oilcake, coriander, cottonseed, sugar, and turmeric)
result reveals that these six commodities dominate the future market and four commodities
(chana, jeera, guar seed, mustard seed) are dominating the spot market. It can be
concluded that the future market is more efficient in price discovery and information flow
are been effectively utilized. Policymakers can also try future contracts on different
agricultural commodities.

A commodity futures contract is an agreement to buy or sell a predetermined amount

of a commodity at a specific price on a specific date in the future. Commodity
futures can be used to hedge or protect an investment position or to bet on the
directional move of the underlying asset.

Many investors confuse futures contracts with options contracts. With futures contracts,
the holder has an obligation to act. Unless the holder unwinds the futures contract before
expiration, they must either buy or sell the underlying asset at the stated price.

Commodity futures can be contrasted with the spot commodities market.

KEY TAKEAWAYS

• A commodity futures contract is a standardized contract that obliges the

buyer to purchase some underlying commodity (or the seller to sell it) at
a predetermined future price and date.
• Commodity futures can be used to hedge or protect a position in
commodities.
• A futures contract also allows one to speculate on the direction of
a commodity, taking either a long or short position, using leverage.

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 • The high degree of leverage used with commodity futures can amplify
gains, as well as losses.
• The IRS requires a specific form when reporting gains and losses from
commodity futures contracts: Form 6781.
How a Commodity Futures Contract Works?
Most commodity futures contracts are closed out or netted at their expiration date. The
price difference between the original trade and the closing trade is cashs-ettled.
Commodity futures are typically used to take a position in an underlying asset. Typical
assets include:

• Crude oil
• Wheat
• Corn
• Gold
• Silver
• Natural gas

Commodity futures contracts are called by the name of their expiration month, meaning
a contract ending in September is a September futures contract. Some commodities can
have a significant amount of price volatility or price fluctuations. As a result, there's the
potential for large gains but large losses as well.

Commodity futures and commodity forward contracts are functionally similar. The
major difference is that futures are traded on regulated exchanges and have standardized
contract terms. Forwards instead trade over-the-counter (OTC) and have customizable
terms.

Speculating with Commodity Futures Contracts

Commodities futures contracts can be used by speculators to make directional price bets on
the underlying asset's price. Positions can be taken in either direction, meaning investors can
go long (or buy), as well as go short (or sell) the commodity.

Commodity futures use a high degree of leverage so that the investor doesn't need to put up
the total amount of the contract. Instead, a fraction of the total trade amount must be placed

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with the broker handling the account. The amount of leverage needed can vary, given the
commodity and the broker.

As an example, let's say an initial margin amount of $3,700 allows an investor to enter into a
futures contract for 1,000 barrels of oil valued at $45,000—with oil priced at $45 per barrel.
If the price of oil is trading at $60 at the contract's expiry, the investor has a $15 gain or a
$15,000 profit. The trades would settle through the investor's brokerage account crediting the
net difference of the two contracts. Most futures contracts will be cash-settled, but some
contracts will settle with the delivery of the underlying asset to a centralized processing
warehouse.

Considering the significant amount of leverage with futures trading, a small move in the price
of a commodity could result in large gains or losses compared to the initial margin.
Speculating on futures is an advanced trading strategy and not fit for the risk tolerance of
most investors.

Risks of Commodity Speculating

Unlike options, futures are the obligation of the purchase or sale of the underlying asset. As a
result, failure to close an existing position could result in an inexperienced investor taking
delivery of a large number of unwanted commodities.

Trading in commodity futures contracts can be very risky for the inexperienced. The high
degree of leverage used with commodity futures can amplify gains, as well as losses. If a
futures contract position is losing money, the broker can initiate a margin call, which is a
demand for additional funds to shore up the account. The broker will usually have to approve
an account to trade on margins before it can enter into contracts.

Hedging with Commodity Futures Contracts

Another reason to enter the futures market is to hedge the price of a commodity.
Businesses use futures to lock in prices of the commodities they sell or use in production.

The goal of hedging is to prevent losses from potentially unfavorable price changes rather
than to speculate. Many companies that hedge use or produce the underlying asset of a
futures contract. Examples include farmers, oil producers, livestock breeders, and
manufacturers.

For example, a plastics producer could use commodity futures to lock in a price for buying
natural gas by-products needed for production at a date in the future. The price of natural
gas—like all petroleum products—can fluctuate considerably, leaving an unhedged plastics
producer at risk of cost increases in the future.

If a company locks in the price and the price increases, the manufacturer would have a profit
on the commodity hedge. The profit from the contract would offset the increased cost of
purchasing the product. Alternatively, the company could take delivery of the product at
a cheaper fixed price.

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 Risks of Commodity Hedging

Hedging a commodity can lead to a company missing out on favorable price moves
since the contract is locked in at a fixed rate regardless of where the commodity's price
trades afterward.

Also, if the company miscalculates its needs for the commodity and over-hedges, it
could lead to having to unwind the futures contract for a loss when selling it back to the
market.

Pros
• Leveraged margin accounts only require a fraction of the total contract
amount deposited initially.
• Speculators and companies can trade both sides of the market.
• Companies can hedge the price of necessary commodities, and control costs.

Cons
• The high degree of leverage can amplify losses and lead to margin calls and
significant losses.
• Hedging a commodity can lead to a company missing out on favorable price moves
since the contract is fixed.
• If a company over hedges a commodity, it can lead to losses from unwinding the
contract.

Example of Commodity Futures

Business owners can use commodity futures contracts to fix the selling prices of their
products weeks, months, or years in advance.

For example, let's say a farmer expects to produce 1,000,000 bushels of soybeans in the
next 12 months. Typically, soybean futures contracts include the quantity of 5,000
bushels. The farmer's break-even point on a bushel of soybeans is $10 per bushel,
meaning $10 is the minimum price needed to cover the costs of producing the soybeans.

The farmer sees that a one-year futures contract for soybeans is currently priced at $15
per bushel. The farmer decides to lock in the $15 selling price per bushel by selling
enough oneyear soybean contracts to cover the harvest. The farmer needs 200 futures
contracts (1,000,000 bushels needed / 5,000 bushels per contract = 200 contracts).

One year later, regardless of price, the farmer delivers the 1,000,000 bushels and
receives the locked-in price of $15 x 200 contracts x 5000 bushels, or $15,000,000 in
total income.

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 Unless soybeans were priced at $15 per bushel in the market on the expiration date, the
farmer had either gotten paid more than the prevailing market price or missed out on higher
prices. If soybeans were priced at $13 per bushel at expiry, the farmer's $15 hedge would
be
$2 per bushel higher than the market price for a gain of $2,000,000. On the other hand,
if soybeans were trading at $17 per bushel at expiry, the $15 selling price from the
contract means the farmer would have missed out on an additional $2 per bushel profit.

How to Trade Commodity Futures

These days, trading commodity futures online is a straightforward process. That said,
you should do plenty of due diligence before jumping in.

Here are a few steps to take to help you get started:

1. Choose an online commodity broker that fits your needs (Interactive Brokers
is a very popular commodity broker due to its wide selection of products,
good service, and low commissions)
2. Fill out the financial documentation required to open an account
3. Fund the account
4. Develop a trading plan that fits your personal risk and return objectives
5. Start trading

When you start out, try to use small amounts and only make one trade at a time if
possible. Don't overwhelm yourself. Overtrading can cause you to take on far more risk
than you can handle.

The Commodity Futures Trading Commission (CFTC)

Commodity futures contracts and their trading are regulated in the U.S. by the
Commodity Futures Trading Commission (CFTC), a federally-mandated U.S. regulatory
agency established by the Commodity Futures Trading Commission Act of 1974.1

The CFTC regulates the commodity futures and options markets. Its goals include the
promotion of competitive and efficient futures markets and the protection of investors
against manipulation, abusive trade practices, and fraud.

Commodity Market : A Perspective

A market where commodities are traded is referred to as a commodity market.

These commodities include bullion (gold, silver), non-ferrous (base) metals such as
copper, zinc, nickel, lead, aluminum, tin, energy (crude oil, natural gas, etc.),
agricultural commodities such as soya oil, palm oil, coffee, pepper, cashew, etc.
Existence of a vibrant, active, and liquid commodity market is normally considered as
a healthy sign of development of a country’s economy. Growth of a transparent

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71 | Page
 commodity market is a sign of development of an economy. It is therefore important to
have active commodity markets functioning in a country.
Commodity Futures
A Commodity future is an agreement between two parties to buy or sell a specified
and standardized quantity of a commodity at a certain time in future at a price agreed upon at
the time of entering into the contract on the commodity futures exchange. The need for a
futures market arises mainly due to the hedging function that it can perform. Commodity
markets, like any other financial instrument, involve risk associated with frequent price
volatility.

The Need for Commodities Market in India

India is among the top-5 producers of most of the commodities, in addition to being a major
consumer of bullion and energy products, which needs use of futures and derivatives as
pricerisk management system. Fundamentally price you pay for goods and services depend
greatly on how well business handle risk. By using effectively futures and derivatives,
businesses can minimize risks, thus lowering cost of doing business. Commodity players use
it as a hedge mechanism as well as a means of making money. For an agricultural country
like India, with plethora of mandis, trading in over 100 crops, the issues in price
dissemination, standards, certification and warehousing are bound to occur. Commodity
Market will serve as a suitable alternative to tackle all these problems efficiently.

Commodities Market in India -- Evolution and Regulation

India has a long history of futures trading in commodities. In India, trading in

commodity futures has been in existence from the nineteenth century with organised trading
in cotton, through the establishment of Bombay Cotton Trade Association Ltd. in 1875. Over
a period of time, other commodities were permitted to be traded in futures exchanges. Spot
trading in India occurs mostly in regional mandis and unorganised markets, which are
fragmented and isolated.
Over time the derivatives market developed in several other commodities in India.
Following cotton, derivatives trading started in oilseeds in Bombay (1900), raw jute and jute
goods in Calcutta (1912), wheat in Hapur (1913) and in Bullion in Bombay (1920). However,
many feared that derivatives fuelled unnecessary speculation in essential commodities, and
were detrimental to the healthy functioning of the markets for the underlying commodities,
and hence to the farmers. With a view to restricting speculative activity in cotton market, the
Government of Bombay prohibited options business in cotton in 1939. Later in 1943, forward
trading was prohibited in oilseeds and some other commodities including food-grains, spices,
vegetable oils, sugar and cloth.

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 After Independence, the Parliament passed Forward Contracts (Regulation) Act,
1952 which regulated forward contracts in commodities all over India. The Act applies to
goods, which are defined as any movable property other than security, currency and
actionable claims. The Act prohibited options trading in goods along with cash settlements of
forward trades, rendering a crushing blow to
the commodity derivatives market. Under the Act, only those associations/exchanges, which
are granted recognition by the Government, are allowed to organize forward trading in
regulated commodities. The Act envisages three-tier regulation: (i) The Exchange which
organizes forward trading in commodities can regulate trading on a day-to-day basis; (ii) the
Forward Markets Commission provides regulatory oversight under the powers delegated to it
by the central Government, and (iii) the Central Government - Department of Consumer
Affairs, Ministry of Consumer Affairs, Food and Public Distribution - is the ultimate
regulatory authority.
The era of widespread shortages in many essential commodities resulting in
inflationary pressures and the tilt towards socialist policy, in which the role of market forces
for resource allocation got diminished, saw the decline of this market since the mid-1960s.
This coupled with the regulatory constraints in 1960s, resulted in virtual dismantling of the
commodities future markets.
Liberalization of Indian economy since 1991 recognised the role of market and
private initiative for the development of the economy. The much maligned market
instruments such as the futures trading were also given due recognition. Forward trading was
permitted in cotton and jute goods in 1998, followed by some oilseeds and their derivatives,
such as groundnut, mustard seed, sesame, cottonseed etc. in 1999.
The year 2003 marked the real turning point in the policy framework for commodity
market when the government issued notifications for withdrawing all prohibitions and
opening up forward trading in all the commodities. This period also witnessed other reforms,
such as, amendments to the Essential Commodities Act, Securities (Contract) Rules, which
have reduced bottlenecks in the development and growth of commodity markets. Of the
country's total GDP, commodities related (and dependent) industries constitute about roughly
50-60 %, which itself cannot be ignored. Responding positively to the favourable policy
changes, several Nation-wide Multi-Commodity Exchanges have been set up since 2002,
using modern practices such as electronic trading and clearing. The Forward Markets
Commission is the regulatory authority of the Commodity Futures Market in India. The
Commodity Futures Market comprises three National Commodity Exchanges and nineteen
Regional Commodity Exchanges. The National exchanges operating in the Indian
Commodity futures market are Multi Commodity Exchange of India (MCX), National
Commodity and Derivative Exchange of India (NCDEX) and National Multi Commodity
Exchange of India (NMCE).
MCX is an independent and de-mutualised 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. NCDEX is a nation
level, technology driven de-mutualized on-line commodity exchange. 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.

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 The recent policy changes and upbeat sentiments about the economy, particularly
agriculture, have created lot of interest and euphoria about the commodity markets. Even
though a large number of the traditional exchanges are showing flat volume, this has not
weakened excitement among new participants. Many of these exchanges have been permitted
with a view to extend the culture and tradition of forward trading to new areas and
commodities and also to introduce new technology and practices.
The current mind-set of the people in India is that the commodity exchanges are
speculative (due to non-delivery) and are not meant for actual users. One major reason being
that, the awareness is lacking amongst the actual users. In India, interest rate risks, exchange
rate risks are actively managed, but the same does not hold true for the commodity risks.
Some additional impediments are centered around the safety, transparency and taxation
issues.

Benefits of Commodity Futures Markets

The primary objectives of any futures exchange are authentic price discovery and an efficient
price risk management. The beneficiaries include those who trade in the commodities being
offered inthe exchange as well as those who have nothing to do with futures trading. It is
because of price discovery and risk management through the existence of futures exchanges
that a lot of businesses and services are able to function smoothly.

• Price Discovery: -Based on inputs regarding specific market information, the

demand and supply equilibrium, weather forecasts, expert views and comments, inflation
rates, Government policies, market dynamics, hopes and fears, buyers and sellers conduct
trading at futures exchanges. This transforms in to continuous price discovery mechanism.
The execution of trade between buyers and sellers leads to assessment of fair value of a
particular commodity that is immediately disseminated on the trading terminal.
• Price Risk Management: - Hedging is the most common method of price risk
management. It is strategy of offering price risk that is inherent in spot market by taking
an equal but opposite position in the futures market. Futures markets are used as a mode by
hedgers to protect their business from adverse price change. This could dent the profitability
of their business. Hedging benefits who are involved in trading of commodities like
farmers, processors, merchandisers, manufacturers, exporters, importers etc.
• Import- Export competitiveness: - The exporters can hedge their price risk and
improve their competitiveness by making use of futures market. A majority of traders
which are involved in physical trade internationally intend to buy forwards. The purchases
made from the physical market might expose them to the risk of price risk resulting to
losses. The existence of futures market would allow the exporters to hedge their proposed
purchase by temporarily substituting for actual purchase till the time is ripe to buy in
physical market. In the absence of futures market, it will be meticulous, time consuming
and costly physical transactions.

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• Predictable Pricing: - The demand for certain commodities is highly price elastic.
The manufacturers have to ensure that the prices should be stable in order to protect their
market share with the free entry of imports. Futures contracts will enable predictability in
domestic prices. The manufacturers can, as a result, smooth out the influence of changes in
their input prices very easily. With no futures market, the manufacturer can be caught
between severe short-term price movements of oils and necessity to maintain price
stability, which could only be possible through sufficient financial reserves that could
otherwise be utilized for making other profitable investments.
• Benefits for farmers/Agriculturalists: - Price instability has a direct bearing on
farmers in the absence of futures market. There would be no need to have large reserves to
cover against unfavourable price fluctuations. This would reduce the risk premiums
associated with the marketing or processing margins enabling more returns on produce.
Storing more and being more active in the markets. The price information accessible to the
farmers determines the extent to which traders/processors increase price to them. Since one
of the objectives of futures exchanges to make available these prices as far as possible, it is
very likely to benefit the farmers. Also, due to the time lag between planning and production,
the market-determined price information disseminated by futures exchanges would be
crucial for their production decisions.
• Credit accessibility: - The absence of proper risk management tools would attract
the marketing and processing of commodities to high-risk exposure making it risky business
activity to fund. Even a small movement in prices can eat up a huge proportion of capital
owned by traders, at times making it virtually impossible to pay back the loan. There is a
high degree of reluctance among banks to fund commodity traders, especially those who do
not manage price risks. If in case they do, the interest rate is likely to be high and terms and
conditions very stringent. This possesses a huge obstacle in the smooth functioning and
competition of commodities market. Hedging, which is possible through futures markets,
would cut down the discount rate in commodity lending.
• Improved product quality: - The existence of warehouses for facilitating delivery
with grading facilities along with other related benefits provides a very strong reason to
upgrade and enhance the quality of the commodity to grade that is acceptable by the
exchange. It ensures uniform standardization of commodity trade, including the terms of
quality standard: the quality certificates that are issued by the exchangecertified warehouses
have the potential to become the norm for physical trade.
• Commodities as an asset class for diversification of portfolio risk: Commodities
have historically an inverse correlation of daily returns as compared to equities. The
skewness of daily returns favours commodities, thereby indicating that in a given time
period commodities have a greater probability of providing positive returns as compared to
equities. Another aspect to be noted is that the “Sharpe ratio” of a portfolio consisting of
different asset classes is higher in the case of a portfolio consisting of commodities as well
as equities. Thus, an Investor can effectively minimize the portfolio risk arising due to price
fluctuations in other asset classes by including commodities in the portfolio.
• Commodity derivatives markets are extremely transparent in the sense that the
manipulation of prices of a commodity is extremely difficult due to globalisation of
economies, thereby providing for prices benchmarked across different countries and

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continents. For example, gold, silver, crude oil, natural gas, etc. are international
commodities, whose prices in India are indicative of the global situation.
• An option for high net worth investors : With the rapid spread of derivatives
trading in commodities, the commodities route too has become an option for high net
worth and savvy investors to consider in their overall asset allocation.
• Useful to the producer: Commodity trade is useful to the producer because he
can get an idea ofthe price likely to prevail on a future date and therefore can decide
between various competing commodities, the best that suits him.
• Useful for the consumer: Commodity trade is useful for the consumer because he
gets an idea of the price at which the commodity would be available at a future point of
time. He can do proper costing/financial planning and also cover his purchases by making
forward contracts. Predictable pricing and transparency is an added advantage.

Risks associated with Commodities Markets

No risk can be eliminated, but the same can be transferred to someone who can
handle it betteror to someone who has the appetite for risk. Commodity enterprises primarily
face the following classes of risks, namely: the price risk, the quantity risk, the yield/output
risk and the political risk. Talking about the nationwide commodity exchanges, the risk of the
counter party (trading member, client, vendors etc) not fulfilling his obligations on due date
or at any time thereafter is the most common risk.
This risk is mitigated by collection of the following margins: -
● Initial Margins
• Exposure margins
• Market to market of positions on a daily basis
• Position Limits and Intraday price limits
• Surveillance
Commodity price risks include: -
• Increase in purchase cost vis-a-vis commitment on sales price
• Change in value of inventory
• Counter party risk translating into commodity price risk Current Scenario of Indian
Commodity Market

The growth paradigm of India’s commodity markets is best reflected by the figures
from the regulator’s official website, which indicated that the total value of trade on the
commodity futures market in the financial year 2008/09 was Rs. 52.49 lakh crore (over
US$1 trillion) as against Rs. 40.66 lakh crore in the preceding year, registering a growth of
29.09%, even under challenging economic conditions globally. The main drivers of this
impressive growth in commodity futures were the national commodity exchanges. MCX,

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 NCDEX and NMCE along with two regional exchanges – NBOT Indore and ACE,
Ahmedabad – contributed to 99.61% of the total value of commodities traded during
2008/09.

So far, this year’s volumes have seen a significant jump over the last year in agro
commodities, as well as international commodities like gold, silver, crude oil and copper.
More than 100 commodities are today available for trading in the commodity futures market
and more than 50 of them are actively traded. These include bullion, metals, agricultural
commodities and energy products. Most importantly, an archaic market has suddenly turned
into an organised, service-oriented set-up with shooting volumes.
The unqualified success of the futures market has ensured the next step, i.e., the launch
of electronic spot markets for agro-products. Being in a time-zone that falls in the gap left by
the major commodity exchanges in the US, Europe and Japan has also worked in India’s
favour because commodity business by its very nature is a 24/7 business. Innovation coupled
with modern and successful financial market environment has ensured the beginning of a
success story in commodities which will eventually see India becoming a price-setter in
major commodities on the strength of its large production and consumption.
Performance Analysis of Indian Commodity Market
Commodity group-wise value of trading since 2004-05 is given in Figure 1.
Figure 1

The year 2003 is a watershed in the history of commodity futures market. The last group of
54 prohibited commodities was opened up for forward trading. Prohibition on forward
trading was completely withdrawn, including in sensitive commodities such as wheat, rice,
sugar and pulses. These markets notched up phenomenal growth in terms of number of
products on offer, participants, spatial distribution and volume of trade.

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 Starting with trade in 7 commodities till 1999, the volume of trade has increased
exponentially since 2003- 04 to reach Rs. 36.77 lakh crore in 2006-07. Almost all of this
(97.2%) of this is now accounted for by the three national exchanges. The other 21
Exchanges have a miniscule share in the total volume. There are more then 3000 members
registered with the exchanges. More than 20,000 terminals spread over more than 800
towns/cities of the country provide access to trading platforms.
Although agricultural commodities led the initial spurt, and constituted the largest
proportion of the total value of trade till 2005-06 (55.32%), this place was taken over by
bullion and metals in 2006-07. The growth in 2006-07 was almost wholly (88.7%) accounted
for by bullion and metals, with agricultural commodities contributing a small fraction
(10.7%). This was partly due to the stringent regulations, like margins and open interest
limits, imposed on agriculture commodities and the dampening of sentiments due to
suspension of trade in few commodities. Futures market growth in 2006-07 appears to have
bypassed agriculture commodities.
Moreover, there has been a very significant decline in volume of futures trade in
agriculture commodities during the year 2007-08, by 28.5%. The overwhelming bulk of this
decline is accounted for by Chana, Maize, Mentha Oil, Guar seed, Potato, Guar Gum, Chillies
and Cardamom. Trade in these eight commodities, which accounted for 57.9% of total
futures trade in agricultural commodities in 2006-07, declined by over 66.4% during 2007-08
compared to previous year. The decline in these eight commodities exceeded the decline of
futures trading volumes in all agricultural commodities taken together.
Four commodities (wheat, rice, urad and tur) were de-listed for futures trading towards the
end of financial year 2006-07. This de-listing has been held responsible in many circles for
the recent general downturn in futures trading in agricultural commodities. But these four
delisted commodities together accounted for only 6.65% of the total value of futures trading
in all agricultural commodities in 2006-07. Thus, although this may have affected market
sentiments adversely, the delisting did not have any major direct contribution to the decline
in trading observed during 2007-08. The combined share of other food grains (i.e. wheat,
rice, maize and tur) peaked at 5.0% in 2005-06 and of sugar at only 2.2%.
Figure 2

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 Figure 2 gives overall information of commodity market during year 2008-09 and 2009-10.
Here, for instance, during the year 2008-09 and 2009-10 from April to mid of May, the
market was moving almost parallel; with fall of 2% during commence of July, and 8% peak
in commence of September in 2009. Again in December 2009 there is a peak of 30% in the
commodity market. This is mainly because in this tenure, gold was at its top in the
commodity market. And the prices of gold touched pinnacle of 10 years of market.
Figure 3

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 Figure 4
Future Trading in Agricultural Commodity

Figure 4 is specific for agricultural commodity market. It shows market trend for the years
2008-09 and 2009-10. In 2008-09 due to inflation in the world economy the market go to the
bottom of 12000 crore. And it has started gradually growing up till January and again it falls
down and goes up in March. If trends of April 2009 -10 is observed, in the mid of April there
is a peak and commodity market reach to 50,000 crores. Here market went up because of
summer harvest. Again at commence of August it is peaked up and cross the line of 60,000
crores. Then it goes down due to draught condition. Again in the months of November,
December 2009 it went to peak and crossed the line of 70,000 crores which was the highest
of 2 years, which was due to better harvest of winter crops.

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*DATA ANALYSIS AND INTERPRETATION:

It is observed that out of total response 64.4% respondents are female and 34.6% of the respondents are male.

It is observed that 92.3 % of respondents age is 20 to 35 years and 7.7 % respondents age is 35

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3

It is observed that 57.7% of respondents are graduated, 26.9% are post graduate and 15.4% of respondents are under
graduation.

It is observed that 73.4% of respondents income is less than Rs 25,000 and 11.5% are Rs 25,000 to Rs50,000 and 7.7%
respondents income is Rs 75,000 to R 5
5

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5

It is observed that 84.6% of respondents profession is private employee, 7.7% are students and 3.85% are government
employee, 3.85% are entrepreneur.

It is observed that 57.7 % of respondents are trading part time and 42.3% are trading full time.

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7

It is observed that 88.5 % of respondents are investing for higher rate of return and 11.5% are investing for no
requirement of physical work.

It is observed that 80.8% of the respondents are investing on their own risk and 19.2% are investing with the advice of
their friends.

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9

It is observed that 80.8% of respondents are prefer to invest in a plantation and 7.7 are in oil.

10

It is observed that 88.5% of respondents are somewhat aware about important news and 7.7% are aware.

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11

It is observed that 76.9 % of respondents are aware of charges levied by brokerage firms and 15.4% are may be and
7.7% are not aware.

12

88.55 of respondents are investing less than 1 year 7.5 are 1-2 year .

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13

53.8% are investing Rs10,000-Rs15,000 and 30.8% are investing less than Rs5,000 and 11.5% are Rs5,000-Rs10,000.

14

It is observed that 65.4% of respondents are investing for 10%-20% rate of return and 23.1% are for less than 10% and
11.5% are more than 20%.

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15

It is observed that 84.6% of respondent are very much satisfied and 15.4% are neutral .

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Problems faced by Commodities Markets in India
Institutional issues have resulted in very few deliveries so far. Currently, there are
a lot of hassles such as octroi duty and logistics. If there is a broker in Mumbai and a broker
in Kolkata; transportation costs, octroi duty, logistical problems prevent trading to take place.
Exchanges are used only to hedge price risk on spot transactions carried out in the local
markets. Also multiple restrictions exist on inter-state movement and warehousing of
commodities.
Future Prospects
With the gradual withdrawal of the Government from various sectors in the post
liberalization era, the need has been left that various operators in the commodities market be
provided with a mechanism to hedge and transfer their risk. India’s obligation under WTO to
open agricultural sector to world trade require future trade in a wide variety of primary
commodities and their product to enable market functionaries to cope with the price volatility
prevailing in the world markets.

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Following are some of applications, which can utilize the power of the commodity
market and create a win-win situation for all the involved parties: -

❖ Regulatory approval/permission to FIIs to trading in the commodity market.

❖ Active Involvement of mutual fund industry of India. Permission to Banks for
acting as Aggregators and traders.
❖ Active involvement of small Regional stock exchanges. Newer Avenues for
trading in Foreign Derivatives Exchanges.
❖ Convergence of variance market.
❖ Amendment of the commodities Act and Implementers of VAT.
❖ Introduction of option contract

Futures Vs. Commodities

Commodities and futures often go hand in hand, although the terms represent different
concepts. Commodities are things you can buy or sell -- physical goods such as oil, grain
or metals. Futures are contracts to buy and sell things in the future. They come together in
commodity futures -- contracts that arrange trades in commodities.
Commodities
A commodity is any good -- often a raw material -- that is uniform enough that the source
of the good doesn't really matter. Gold makes an excellent introductory example: An
ounce of gold mined in South Africa has the same properties as an ounce mined in Russia
or the Rocky Mountains. If you need an ounce of gold, an ounce from any of those places
will do. They're interchangeable, and that's what makes gold a commodity.
Crude oil is a commodity, as are corn, wheat, zinc, copper, pork bellies and feeder cattle.
With some commodities, such as petroleum or agricultural products, small differences
in quality might exist from one source to the next, but they're not enough to establish
one source as preferable to others.
Futures
While a commodity is a good that gets traded, a futures contract is a mechanism for
carrying out such trades. Futures are agreements to buy or sell a quantity of something
at a set price on a specific date in the future. That "something" can be commodities,
shares of stock, bonds, currencies -- just about anything of value. Unlike an option,
which merely gives the holder an opportunity to buy or sell something, a futures
contract is an obligation. If you hold a futures contract to buy, say, 100,000 bushels of
corn, you're on the hook to buy the corn -- unless you sell the contract to someone else.
Commodity Trading
Commodities exchanges exist to facilitate trades in futures on high-demand commodities.
The Chicago Board of Trade, the New York Mercantile Exchange and the London Metal
Exchange are among the most famous of the dozens of major exchanges around the
world. Producers and end users of commodities use these markets to lock in prices.
However, the vast majority of trades involving commodities don't actually lead to
delivery. When a trader takes out a futures contract to purchase 100,000 bushels of corn

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at a given price, that trader usually doesn't expect (or want) to wind up with 100,000
bushels of corn. Rather, the trader is either speculating or hedging.

Speculation and Hedging

A speculator buys commodity futures in an attempt to profit from the changing value of
the underlying commodity, which will affect the value of the contract. The hedger, on
the other hand, tries to limit exposure to risk. Say a trader has a position that will lose
money if the price of corn rises. By taking out futures contracts that will increase in
value if corn prices rise, the trader can counterbalance, or hedge, that risk.

The growth of the commodity futures market in India has created an impact on the
global market, since India is an agro-based country and for agro-based commodities
there is a huge demand for consumption, production, and trade. In recent, decades
commodity futures markets as seen as impressive growth after the global crisis.
Commodity futures market plays an important role in deciding the price discovery
and price risk management. India is the largest consumer of commodities such as
Precious
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metal (bullions and silver), Metal (copper, zinc, lead, etc.) and Agricultural products
(cotton, pepper, maize, wheat, sugar, coffee, dairy products, etc). India also dealt
with the commodity spot market. For instance, soya creates a huge market in Indore,
Ahmedabad as a major market for castor seed, for cotton
Surendranagar and Andhra Pradesh for chilli, etc. In India, the commodity futures
market is started way back and as old as the United States' future markets. During the
1857 Bombay Cotton Trade Association as been set up, the Future market in gold was
inevitable and began to emerge in Mumbai 1920. In India the major three commodity
exchanges and trade happen electronically they are Multi Commodity Exchanges
(MCX), National Multi- Commodity
Exchange limited (NMCE), and the National Commodity and Derivative Exchange
(NCDEX). FMC (Forward Market Commission) in 2015 merged with SEBI and the
Regulation and Policies framework is under the control of SEBI(Security Exchange
Board of India). Commodity market in India as shown gradual evaluation of the
country's general
economic distribution and it's a linkage with the financial sectors. Hedging is an
innovative instrument to trade in commodities and also creates a different portfolio for the
investors or traders, it also attracts the international investors because of diversification
availability that impact on the return which benefits the domestic and as well as
international investors. The word commodity can be coined as unvarying products bought
or sold in the organized platform (exchange platform) exchange happens through
currency or barter system. In future trading there are more than 80 commodities are
allowed to trade. The background of the commodity futures market in India as been
started way back 19th century, during the British convention. The first structure form of
the commodity market in India executed at Bombay Cotton
Association Ltd, in the year 1875 by the cotton exchange Ltd. In 1900, future trading
in oilseeds took place at
Gujarati Vyapari Mandali, traded with groundnut, castor seeds, and cotton. In Hapur
1913, future trading in wheat has been established. Future trading in jute and raw jute
goods was set up in 1919, the Calcutta Hessian Exchange was established, and in later
period merged with East India Jute in the year 1927 known as East India and Hessian
Ltd. During the 20th century, Mumbai became the art of state to trade in bullions which
were set up in 1920, mid of the post-independence period, Commodity trading came
with various regulatory policies and decision is taken from the authority bodies. In
1952, based on the expert advice FC Forward Contract (Regulation) Act was framed as
a commodity market regulator in India. The Forward Market Commission (FMC) was
set up in 1953. Due to speculation in India future trading has been banned, the
government felt that inflation reiterating. Regulatory bodies are given certain guidelines
to trade in an organized form, so bilateral agreement comes into a picture as Future
Trading contract, TSD (Transferable Specific Delivery Contract) and NTSD (Non –
Transferable Specific Delivery Contract) and this can also be termed as a derivative
contract whose value has been derived from the underlying contract.
Indian Economy and Role of Agricultural Commodity Commodities are being the
backbone of many developed countries in means of production and consumption of

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goods exporting and importing goods and also it gives employment opportunity by this
it directly or indirectly benefits the countries economy. Since India is an agro-based
country, the economy is dependent on the agricultural products is also given a major
contributor to GDP (Gross Domestic Product) as 15.4% (2017) share to our economy
and GVA(Gross Value Added) as contributed 15.87% (2019) with the combination of
Agricultural and allied sector share respectively it is according to the Ministry of
statistics and program implementation(2018 – 2019). Commodity exchanges also
contributed to the growth and development of an Indian economy as a whole. The
government of India is promoting the commodity exchange and commodity trade in
India and restructuring the future market and giving permission to trade in options and
accepting the participation from the Bank, Mutual funds, and other financial institutions.
The three exchanges are:
National Commodity & Derivatives Exchange Limited (NCDEX) Mumbai,
Multi Commodity Exchange of India Limited (MCX) Mumbai and
National Multi-Commodity Exchange of India Limited (NMCEIL) Ahmedabad. There
are other regional commodity exchanges situated in different parts of India.
Price volatility is perhaps the most pressing issue facing producers of primary
commodities. The low prices for basic commodities limit the income farmers(/small
producers) can receive for their products and the hi gh volatility of these prices makes it
very difficult for them to optimise the use of their income (Morgan, 2000).4 While these
producers are not exclusively located in LDCs, the impact of volatility on producers there
is much greater than it is for those in developed market economies.5 Policies designed to
counter the effects of the inherent instability of commodity markets have taken various
forms since the 1930s but in general it is possible to say that they all shared acommon
feature of being based on intervention. In essence, buffer stock schemes were heavily
promoted especially through the establishment of the International Commodity
Agreements (ICAs) (for a more detailed review of the earlier history of these and other
policies, see GordonAshworth, 1984). However, two main problems arose within this
system. First, the difficulty in setting the price range and updating it over time in response
to changes in either costs or consumer tastes. Second, finding sufficient funds to keep
prices within the specified range, a problem that was especially acute if there was a run of
years of high production with low prices and stocks needed to be held over a long period.
Concerns about commodity price fluctuations also led to pervasive commodity policy
interventions by national governments. The goal has been either to replace the price
discovery by markets with a planned and regulated system of prices or to insulate
producers and consumers from market price fluctuations through price controls or
subsidies. Many countries have unilaterally pursued price stabilisation, particularly in
agriculture. These have typically taken the form of institutional arrangements for price
stabilisation programmes, including physical buffer stock schemes, stabilisation funds,
variable tariff schemes, and marketing boards. Commodity futures markets thus have a
limited presence in developing countries where commodity markets fall short of the ideal.
Historically, governments in many of these countries have discouraged futures markets; if
they were not banned, their operations were constricted by regulation. The main concern
being that speculative activity in futures markets could reinforce price instability and
volatility in essential commodities and lead to further problems of food security.

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Government interventions to artificially stabilise prices, on the other hand, pre-empted the
development of a market-based price risk management system. In the recent past,
however, countries have begun to liberalise commodity markets and in a reversal of
earlier trends, the development of commodity futures markets is being pursued actively
with support from governments. The World Bank initiative to devise market-based
approaches for dealing with commodity price risk has provided a fresh impetus for
research in the area of commodity futures markets as a policy option.6 The World Bank
(1999) notes: “...market based management instruments, despite several limitations, offer
a promising alternative to traditional stabilisation schemes…”. The argument is that the
use of price risk management instruments allows governments to disengage from costly,
distortionary, and counterproductive policies. At the national level, many countries have
unilaterally abandoned marketing boards that were once common for coffee, cocoa, and
other import crops—as well as long-standing food marketing agencies.7 Others have
done so under budget pressure or as part of reforms supported by the World Bank and
other institutions.8 Coinciding with policy developments favouring commodity
derivatives trading, a revolution in information technology spurred the growth of risk
management centres, especially in areas where market fragmentation impeded efficient
pricing. UNCTAD (2002) notes that well-organised commodity exchanges form natural
reference points for physical trade, and help the price discovery process. If a commodity
exchange manages to link different warehouses in the country, this allows trade to take
place more efficiently. Historically, most commodity exchanges developed as physical
transaction hubs where producers delivered and sold their crops to buyers with storage
facilities. Because producers had little choice but to accept the spot offer price, most
exchanges were buyer’s markets. Market fragmentation—i.e., poor price correlation
among the regional exchanges—also characterised the exchange network. Electronic
transaction models and instant price dissemination systems have transformed these
traditional market arrangements. The new electronic exchanges broadcast multiple prices
from various spot and forward markets giving producers a range of seasonal and
geographic options for storing or marketing their crops. By disseminating a spectrum of
instantly observable or transparent prices, these exchanges have conferred pricing power
to the producer and aided institutional development, e.g., grading and warehouse receipt
systems, supply chain integration and farm credit facilitation (FAO, 2007).

A commodity futures contract is a tradable standardised contract, the terms of which are
set in advance by the commodity exchange. A futures market facilitates offsetting
trades without exchanging physical goods until the expiry of a contract. As a result, the
futures market attracts hedgers for risk management, and encourages participation of
traders (speculators and arbitrageurs) who possess market information and price
judgement.
While hedgers have longterm perspective of the market, the traders or arbitrageurs
prefer an immediate view of the market and these diverging views lead to price
discovery for the commodity concerned. Insurance offers coverage of the risks of
physical commodity losses due to fire, pilferage, transport mishaps, etc.; it does not
cover similarly the risks of value losses resulting from adverse price variations, which
occur with a much higher probability. Hedging is the practice of offsetting the price risk
inherent in any cash market position by taking an equal but opposite position in the
futures market.
This technique is very useful in the case of any long-term requirements for which the
prices have to be firmed so as to quote a sale/purchase price, but the hedger wants to
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avoid buying the physical commodity immediately to prevent blocking of funds and
incurring large holding costs. A Simple Hypothetical Illustration: A wheat miller enters
into a contract to sell flour to a bread manufacturer four months from now. The price is
agreed upon today though the flour would only be delivered after four months. A rise in
the price of wheat during the course of the next four months would result in losses on
the contract to the miller. To safeguard against the risk of increasing prices of wheat,
the miller buys wheat futures contracts that call for the delivery of wheat in four
months’ time. After the expiry of four months, as feared by the miller, the price of
wheat may have risen.

The commodity market is a market where traders buy and sell commodities.
Commodities are raw materials or primary agricultural products. In other words, things
that farmers, mining companies, and oil and gas companies produce or extract.
The commodity market is similar to the equity market. However, in the equity
market, people buy and sell shares.
Goldrate.com has the following definition of commodity market:
“A market where oil, agricultural products, and oil, i.e., commodities, are bought and
sold.” There are two broad types of commodities:

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1. Agricultural goods, such as sugar, cocoa, and wheat. In other words, soft
commodities.
2. Raw materials, such as gold, silver, and oil. We call these hard commodities.

Investing in commodities is riskier than equities. It is riskier because we must store and
insure commodities. They are also at the mercy of political instability in many parts of the
world.
There are four narrow categories for trading commodities. They include:
Energy: such as natural gas, gasoline (UK: petrol), heating oil, and crude oil.
Metals: including silver, gold, platinum, nickel, zinc, and copper.
Livestock and Meat: examples include feeder cattle, live cattle, poultry, eggs, pork
bellies, and lean hogs.
Agricultural Foodstuffs: including sugar, cotton, coffee, cocoa, rice, wheat, corn, and
soybeans.
We see commodities all around us. The commodity market influences the price of a
gallon of gas and the cost of a cup of coffee bought from Starbucks. In fact, it affects
the price of most of the food we consume at home.
Additionally, the commodity market determines the cost of electricity. It matters to all of
us. Put simply; it has a major bearing on our day-to-day lives.

Commodity Market
Definition:
Commodity Market implies the place where products, either produced or grown are
being traded between investors. It brings together all the participants to determine the
price, at which the commodity can be traded across the market.
To determine the price of the commodity in a commodity market auction mechanism is
used wherein sellers ask for a certain price, while buyers propose a price, then they
settle at a mutually agreeable price. Here, one thing is to be noted that sellers and buyers
interact with each other through intermediaries, also known as brokers.
In a commodity market, the risk factor is comparatively higher than the share market, as
the market is highly volatile and investors from different countries take part in the
exchange of commodities.
At present, the two main commodity exchanges that are operating in India are – Multi
Commodity Exchange popularly known as MCX, and National Commodity and
Derivatives Exchange (NCDEX). Like Share Market, Commodity Market is also
regulated by the Securities and Exchange Board of India (SEBI).
What is Commodity?

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Commodity refers to the various raw material that is used to manufacture those products
which are used by the consumers on daily basis. They are basic utility elements of a
common man. It includes those items which are movable in nature, excluding actionable
claims, money, and financial instruments.
Any tangible item of certain value having uniform quality and produced by a number
of producers in bulk quantity is a commodity. Hence, commodity means:

• Physical substance which is supplied across the market

• No product differentiation
• Existence of demand
• Produced and sold by different producers.
• Price is a result of demand and supply forces.
In India, commodity trading takes place through derivative contracts. Now you must be
wondering what is the derivative contract? A derivative contract is a contract between
investors, in which the value relies upon the underlying financial asset or commodity.
Forwards, futures, options, and swaps are the four most commonly used derivative
contracts. However, commodity trading is mostly done through a futures contracts.

classification of Commodities
Commodities are classified into two main categories:

• Hard Commodities: It entails natural resources which require mining and

extracting, for example, gold, oil, silver, copper, zinc, etc.
• Soft Commodities: It entails agricultural produce and livestock, for example,
wheat, cotton, pulses, coffee, sugar, soybean, etc.

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Types of Commodities Traded in Commodity Market
There are four segments in which commodities traded in the commodity market are
classified, as you can see in the figure below:

Now, let us discuss each of them:

Agricultural Commodities
It includes those items which are
perishable in nature like cotton,
cardamom, barley, wheat, sugar,
castor seeds, maize, potato, etc.
Also, it covers processed
commodities such as palm oil, soya
bean oil, mustard oil, etc.

Bullions and Gems Precious metals are included in this

category such as gold, platinum,
silver, diamond, sapphire, etc.

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 Energy Commodities It covers energy resources both in
its unprocessed and processed form
like crude oil and natural gas.

Base Metal Non-precious metals like copper,

brass, aluminium, zinc, lead, iron
and steel are covered in this
category. It includes both mined
metals and processed metals.

Commodity Ecosystem
As already said, a commodity market is a marketplace where all the participants can
meet and trade in commodities. So, here we are going to discuss who are these
participants:
• Buyers and Sellers of Commodities: The one who buys the commodity is the
buyer, while the one selling it, is the seller. While sellers represent the supply side,
buyers indicate the demand side. These are also called as investors. They play an
important role in price discovery as the price is determined by demand and supply
factors. It includes farmers, mining companies, manufacturing companies, importers,
exporters, government, etc.
• Commodity Exchange: It is the center of the entire commodity market, which
provides a commonplace to millions of buyers, sellers, and other players.
• Allied Entities: There are a number of entities apart from the commodity
exchange that facilitates its smooth functioning. It includes depositories,
clearinghouses, commodity brokers, warehouses, etc.
• Regulatory Body: Just like the share market, commodity markets are also regulated
by a government body, which ensures the protection of the interest of all the
investors. Also, it regulates the operations of different participants and keeps a
check on malpractices and frauds.
• Hedgers: Hedgers use commodity derivative instruments to protect against the
fluctuations in the prices of the underlying commodity, with the help of
derivatives.
• Speculator: Those who are not interested in ready contracts, but invests in
commodity in the hope of making a profit.
• Arbitrageurs: An arbitrageur is an investor who tries to earn profit through
inefficiencies present in the market, be it related to price, regulation, or
dividend

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CONCLUSION
Commodity futures market booming in recent years as the financial derivatives market,
since our economy is an agro-based country there is a huge demand in domestic as well
as internationally for our agricultural commodity. Regulatory bodies(SEBI) they are
giving their topmost support to this market while framing the policies they are stretching
arms to safeguard the farmers and also the market participants, hampering of
technologies in recent decade keep the markets transparent and trade happens in the
organized form in both the markets spot and future. To conclude on the literature review
basically, it has been categorized into Pre – global crisis and Post – global crisis reason
for taking this is, in the year 2008 vital role has been played by the global crisis by
crashing world's market and many IT companies phased the recession at the same time,
Indian rupee value got depreciated. So to analyze the price discovery process before and
after the crisis is there any improvement or change that occurred in forecasting the
market price. The result found in this paper while analyzing the Pre – global crisis many
authors shared their view that the Indian commodity futures market is not mature and
efficient in the price discovery process and which impact on price risk management.
Market participant, they don't have proper knowledge on hedging instrument, in short,
they lack in analyzing the market prices few speculators play a major role in
manipulating the price and change the entire market scenario. Trading in the commodity
futures market has created chaos among the participants in identifying spot and future
markets. Key findings state that there is a domination of spot to future markets. On the
other hand, Post – global crisis presenter's said that there is a gradual development in the
commodity futures market.
Forecasting market price (price discovery) is mature enough which reflects in the price
risk management with the sophisticated technology future market can predict the market
movements and exchanges also closely monitored by Regulatory bodies. Market
participants have an overview or an idea about the future market at last, future market
dominate the cash market. In a nutshell after the global crisis commodity futures mar
It is found that the Indian commodity market exists since ancestral period as compared
with world market. The organized market in the world started in mid of nineteen
centuries in US establishing CBOT in 1850, whereas in India contemporarily Bombay
Cotton Traders Association (BCTA) was established in 1875. The expansion of trading
slowly gained momentum till 1952, because of establishment of Forward Market
Commission and passing the Forward Trading Regulation Act. In 1966 due to some
obstructions in regulatory and policy issues, the ban on commodity forward trading was
continued till 2002. In this aftermath, Government formed some committees to study the
feasibility of reintroduction of forward trading as part of second generation reforms and
pressure form world economic reform regulators. Then a commodity derivative trading
was reintroduced in 2003 with three major national commodity exchanges under the
regulation of FMC. The growth of new journey moved with a remarkable attention to all
the stakeholders in the market. Within a short span, it reached the stage to compete with
global markets in certain commodities, viz, gold, silver, platinum etc. At present the
number of exchanges moved to 6 national and 15 regional exchanges with the increase
of permitted commodities from 53 to 113 for trading in the market. The performance of
the commodity market found through the volume and value of market has been growing
at average compounded growth in volume and value of futures market by 15 and 29
percent respectively. Such growth is non-linear between estimated and actual volumes
and values. On the other hand, the variance between the volume and value of the
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market follows a reciprocal trend. The trend projection of market over a period of next
ten years is linear at a growth rate of 45.65 and 58.71 percent in volume and value of
market. Hence, the performance of the market is very considerable and progressive.
Hence, the policy makers should concentrate to enhance the infrastructure facilities,
integration of regional exchanges to national exchanges and penetration of information
flow to reach the real users of the commodity derivatives market. With these changes,
the commodity derivatives market can reach a vivacious market performance in the
future provided the requisite facilities are created by the Government. India is one of the
top producers of a large number of commodities, and also has a long history of trading
in commodities and related derivatives. The commodities derivatives market has seen
ups and downs, but seem to have finally arrived now. The market has made enormous
progress in terms of technology, transparency and the trading activity. Interestingly, this
has happened only after the Government protection was removed from a number of
commodities, and market forces were allowed to play their role.
This should act as a major lesson for the policy makers in developing countries, that
pricing and price risk management should be left to the m arket forces rather than trying
to achieve these through administered price mechanisms. The management of price risk
is going to assume even greater importance in future with the promotion of free trade
and removal of trade barriers in the world. All this augurs well for the commodity
derivatives markets. As majority of Indian investors are not aware of organized
commodity market; their perception about is of risky to very risky investment. Many of
them have wrong impression about commodity market in their minds. It makes them
specious towards commodity market Concerned authorities have to take initiative to
make commodity trading process easy and simple. Along with Government efforts
NGOs should come forward to educate the people about commodity markets and to
encourage them to invest in to it. There is no doubt that in near future commodity
market will become ‘hot spot’ for Indian farmers rather than spot market. And
producers, traders as well as consumers will be benefited from it. But for this to happen
one has to take initiative to standardize and popularize the Commodity Market.
India is one of the top producers of a large number of commodities, and also has a long
history of trading in commodities and related derivatives. Despite this fact, commodity
futures markets are largely underdeveloped. The reason has something to do with the
extensive government intervention in the agriculture sector. Fact is that the production
and distribution of several agricultural commodities is still governed by the state and
futures trading have only been selectively introduced with stringent regulatory controls.
If futures market has to flourish, then market forces will have to be allowed to play
their role rather than trying to controlling the prices.
Analysing the future direction of the market requires understanding the four sets of
opposing forces that define the global commodity trade:
(1) net importing and net exporting countries, in search of economic gains;
(2) sovereign states (and state-owned enterprises) and privatesector companies vying
for competitive advantage;
(3) international cooperation and nationalism as opposing means of addressing failures
in resource markets; and

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(4) the physical and financial aspects of the modern commodity trade. These pairs of
forces form the critical context in which the competition for relevancy among
countries, companies, and consumers negotiate in the commodities marketplace for
economic and political advantage will take place. They are the critical context in
which the broad range of policy- and investment-related issues discussed in this book,
from debates over speculators in commodities markets to mitigating harmful energy
and food market volatility, will be settled.
The dive in crude oil prices in late 2014 underscores the potential for sudden reversals
that are intrinsic to commodity markets – particularly to those like oil with long project
lead-times – and their capacity for confounding even the best attempts by analysts to
predict long-term price paths. Brent crude oil, trading at roughly $60 per barrel at
yearend, appeared to many observers to be locked firmly in the $100 to $120 dollar
range, where it had traded over the preceding three years, for the foreseeable future.
And yet the suppositions that had formed the basis for such predictions – that the Saudis
would put a floor under prices no lower than $90 per barrel to protect the fiscal
feasibility of their social spending programs, that a stillrecovering developed-world
economy would sputter at prices above that range, and that an uptick in worldwide
consumption should prices fall below that threshold would cause any dip below it to be
short-lived and contain the seeds of its own undoing – now look feeble. Regardless of
where one sits with regard to if and when prices will regain lost ground, it is clear that
the relative tranquility that had marked commodities broadly since their rebound in 2009
to 2011 was a transitory state of affairs. We have not reached the end of oil market
history. Volatility and structural shifts, difficult to detect far in advance, are still ahead,
continue to define these markets.
India is one of the top producers of a large number of commodities, and also has a long
history of trading in commodities and related derivatives. The commodities derivatives
market has seen ups and downs, but seem to have finally arrived now. The market has
made enormous progress in terms of technology, transparency and the trading activity.
Interestingly, this has happened only after the Government protection was removed from
a number of commodities, and market forces were allowed to play their role. This should
act as a major lesson for the policy makers in developing countries, that pricing and
price risk management should be left to the market forces rather than trying to achieve
these through administered price mechanisms. The management of price risk is going to
assume even greater importance in future with the promotion of free trade and removal
of trade barriers in the world. All this augurs well for the commodity derivatives
markets. As majority of Indian investors are not aware of organized commodity market;
their perception about is of risky to very risky investment. Many of them have wrong
impression about commodity market in their minds. It makes them specious towards
commodity market. Concerned authorities have to take initiative to make commodity
trading process easy and simple. Along with Government efforts NGOs should come
forward to educate the people about commodity markets and to encourage them to invest
in to it. There is no doubt that in near future commodity market will become ‘hot spot’
for Indian farmers rather than spot market. And producers, traders as well as consumers
will be benefited from it. But for this to happen one has to take initiative to standardize
and popularize the Commodity Market. The study of market efficiency in commodity
futures markets is important to both the government and the producers/marketers in
India. Moreover, there are some other important issues related to market efficiency viz.

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effect of seasonality in agro-commodities, inflationary impact of commodity futures and
volatility spill over between spot and futures market. So in this paper, we have reviewed
the available literature on commodity futures market efficiency and related issues
mentioned above. The review showed that the results produced in available literature
are often conflicting: the efficiency hypothesis is supported only for certain markets and
only over some periods. Also from literature review, some areas have been identified
that need attention of researchers. These are commodity market microstructure,
macroeconomic issues in commodity futures market, inflationary impact of commodity
futures market and integration with other international markets and effect of sub-prime
crisis. This forms further scope of research in this area.

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