QUOTE OF THE WEEK:

The ability to deal with people is as purchasable a commodity as sugar or coffee and I will pay more for that ability than for any other under the sun – John Rockefeller

YOUR FINANCE DEMYSTIFIED:

Commodities are actual, tangible products or goods which can be physically stored. Gold, cosmetics, books etc. are some of the examples for commodities. Investing in them with a commodity trading company is called commodity trading. Many investors make quick money from it by putting in any minimal capital they wish to invest.

However, during times of economic uncertainties, investors tend to pull out their funds from traditional risky commodities and flock towards safer ones such as gold and bonds and treasuries. Gold is considered as a safe haven investment and is also a hedge against inflation, i.e. its value rises with an increase in inflation.

Many factors influence commodity trading such as weather conditions, demand and supply fundamentals, geo-political concerns and the global economic environment.  Commodity prices also affect companies that have a direct interest in them such as metal producers, oil refiners, miners, garment manufacturers etc. Most companies use a particular commodity as a raw material which makes them very sensitive to commodity market movements.

The most recent example can be seen with crude oil, a commodity with robust global demand to meet countries’ energy demands. The recent geo-political tensions between Iran, a major oil exporter, and some western countries saw several supply disruptions of the commodity which shot up its price.

1. Risk involvement

Some experts suggest that commodity trading is not for regular investors. It is risky to some extent but if you are careful and can control your greed, it can be safe enough and can work for you like any other investment option. You need to determine your risk appetite and not directly aim for high returns in order to lower the risk.

2. The Process

In commodity trading, you do not actually own any commodity. The process is to bet on the future price of a particular product depending on global and domestic demand-supply situation, weather, output etc. If you think that price of a product will rise in future, you can buy it now and sell when the price is high. When you think the price is going to go down then you may sell it. You would find buyers and sellers operating in the market any time. Non-fulfillment of the obligation results in the delivery of the commodity. While this is the process for futures trading, there is also spot market trading in the commodities market. Spot market trading involves farmers, traders etc. and results in the immediate delivery of goods in case of sales and purchases.

3. Types of players in this market

All those involved in a total commodity circle are called Commercials. This includes the basic producer, the developer and the merchants.

When a group of people put together their investments to increase the chance of good returns and cut back possible losses, they are called Large Speculators.

The most common players are Small Speculators. They are the individuals who invest through a broker or have their own commodity account. 

4. Starting commodity trading

The first thing that you need for commodity trading is the knowledge of facts that affect commodities. All commodities have different reasons for their rise and fall. For e.g., a crop which requires more rain will see its price rise in case of a drought as its output may be affected adversely, thereby making its supply and availability scarce. But a crop which needs less rain will see its prices fall as the climate would favour its output, thus increasing its supply and availability. You also need to be aware of the techniques of investing in this sector to get the best results. You need to ensure that you have a clear idea of a commodity and then sell or buy according to the expected market price and situation.  You can invest through a commodity brokerage or operate a personal commodity trading account.

To offset the risks arising out of fluctuations in company prices, companies adopt the practice of commodity hedging.

For instance, if a garment manufacturer expects the prices of cotton to increase in the next two months, he will buy a position in the futures market at the prevailing price to offset the likely price increase. Similarly, if the prices are likely to fall, he will sell the position in the futures market at the prevailing prices against the physical goods he holds.

Hedging of Price Risk in Commodities

A PICTURE SPEAKS A THOUSAND WORDS...

DID YOU KNOW?

Weather directly affects all commodities and now investors can purchase derivatives on weather by purchasing contracts.

IN THE NEWS THIS WEEK:

Breathing life into the financial markets of the country, the Reserve Bank of India surprised all by its higher than expected 50 basis points cut in key lending rates to spur demand and thereby growth. Would this translate to cheaper homes, cheaper cars and a revival in demand that has been suppressed for a while now? We will have to wait and watch.

RBI cuts repo rate by 50 bps; CRR left unchanged

Also read…

What is CRR, repo and reverse repo rate?   

ABOUT FLAME

FLAME (Financial Literacy Agenda for Mass Empowerment) is an IIFL initiative to promote financial literacy amongst the masses in order to make them an integral part of India's spectacular growth story.

In an era of accelerating GDP and rising per capita growth, financial literacy has become more critical than ever before such that we all reap the tangible benefits of the nation's economic prosperity. Financial inclusion has been quite high on the governmental agenda, given its emphasis on widening the Banking & Financial services network across the country. IIFL's FLAME initiative stands committed to complement this effort by helping common people gain financial growth and security though better awareness and education on the variety of financial products while avoiding the lure of and loss from unrealistic claims made by unscrupulous agents and ponzi schemes.

Our objective is to light a FLAME, as the name suggests, which will set ablaze a chain of FLAMEs across the country. The new-found light of knowledge will undoubtedly dispel the dark clouds of financial illiteracy and ensure the bright sunshine of financial growth and prosperity.

This portal is but one of the various IIFL initiatives that would be part of FLAME.