Commodity Market - Meaning, Types & Features | India Infoline(IIFL)

Last Updated: 10 Jan 2025

The stock market is a preferable choice for most investors. However, there is a completely different asset class that knowledgeable investors prefer to trade and earn hefty profits: commodity trading . The trading process is based on the price fluctuations of commodities such as natural gas, pulses, aluminum, etc. Investors can trade different types of commodities in the market. This blog details the definition of commodities and how you can profit from commodity trading.

What is a commodity market?

A commodity market is a place for investors to buy or sell different types of commodities and make a profit along the way. Typically, an investor places an order to buy a commodity to sell it in the future when the market price is higher than the purchase price.

Where to invest in commodities?

India has 22 commodity exchanges that were set up under the Forwards market commission. However, investors mainly prefer the following commodity exchanges for commodity trading:

1. National Commodity and Derivatives Exchange – NCDEX
2. Multi Commodity Exchange – MCX
3. National Multi Commodity Exchange – NMC
4. Ace Derivatives Exchange – ACE
5. Indian Commodity Exchange – ICEX
6. The Universal Commodity Exchange – UCX

Types of commodities

Although there are hundreds of commodities to trade at any of the exchanges; the most common types of commodities are as follows:

Commodity sectors	Constituents
Agriculture	Grains: Rice, Basmati rice, wheat, maize, jeera. Oil and oilseeds: Castor seeds, soy seeds, castor oil, refined soy oil, soy meal, crude palm oil, groundnut oil, mustard seed, cottonseed, etc. Spices: Pepper, red chili, jeera, turmeric, and cardamom. Pulses: Chana, urad, yellow peas, tur dal.
Metals and materials	Base metals: Aluminum, copper, nickel, zinc, tin. Bulk commodities: Iron ore, coking coal, bauxite, steel. Others: Soda ash, chemicals, rare earth metals.
Precious metals and materials	Gold, silver, platinum, and palladium.
Energy	Crude oil, natural gas, Brent crude, thermal coal, alternate energy.
Services	Oil services, mining services, and others.

Different ways of commodity trading

There are two major ways through which commodity traders can trade:

1. Futures Contract: A commodity futures contracts is an agreement between the buyer and the seller of the commodity. The buyers purchase a specific quantity of a commodity at a predetermined price. This contract remains until the price of the bought commodity has risen at the time of the expiry to make a profit.
2. Options Contract: An options trading contract is generally permitted in top commodities wherein the trader has the right but not a legal obligation to buy/sell the commodity at a fixed price. Such a contract helps investors to make a profit based on price fluctuations without having to buy/sell commodities.

Participants of the commodity market

Investors who trade different types of commodities in the commodity markets are mainly classified into the following two types:

• Hedgers: Hedgers are the producers, manufacturers, etc., of the commodity and generally enter into a futures contract to mitigate their risk exposure by entering into a futures contract. Simply put, hedgers ensure that they will get a pre-determined price for their commodities in the future and would not incur a loss if the prices go down at the time of selling.
• Speculators: Speculators are actual traders that try to predict the future price of commodities based on various factors and monitor their prices regularly. If these speculators think that the price of a particular commodity will go up, they buy the commodity contract and sell it for a profit.

Features of the commodity market

• Inverse Relation: The commodity market has an inverse relationship with the equities and bonds market. As the commodity prices rise, the prices of equities and bonds are more likely to fall.
• Demand and supply: Market demand for commodities and their current supply heavily influences the prices of different types of commodities. A rising demand with limited supply can increase the prices, while a limited demand with higher supply can result in reduced commodity prices.
• Diversification: Due to its inverse relation to other asset classes, commodities are featured products that ensure immense portfolio diversification. By commodity trading, investors can ensure a healthy portfolio even if other asset classes are consolidating or going through a correction.
• Inflation Hedge: Commodities trading provides a great way to glide through rising inflation as the prices of top commodities such as gold, silver, crude oil, etc., tend to rise over time. It allows investors to multiply their wealth by ensuring the long-term multiplication of their corpus.
• Margin Trading: Brokers, such as IIFL, that are included in commodities trading offer lower margins relative to stock and bonds, allowing both hedgers and speculators to profit more from the price fluctuations.

How Are Prices Determined in Commodities Exchange?

The commodities exchange’s prices are determined by several methods that guarantee efficiency, liquidity, and transparency. The following describes how commodities market pricing operates:

1.Demand and Supply

Prices in the commodities market are determined by the fundamental law of supply and demand. Prices decrease when a commodity’s supply exceeds its demand. On the other hand, prices increase when demand outpaces supply. Supply and demand can be impacted by changes in the weather, geopolitical events, or simply seasonal patterns.

2.Futures Contracts

Futures contracts, which are agreements to buy or sell a commodity at a predefined price at a specified period in the future, are frequently used to establish commodity prices. These contracts are exchanged on commodity markets such as the National Commodity and Derivatives Exchange (NCDEX) and the Multi Commodity Exchange (MCX). Producers and traders can influence spot prices by using futures contracts to protect themselves from price swings.

3.Speculation and Market Sentiment

A commodity’s price can be greatly impacted by investors’ opinions about its future. Price fluctuations can result from speculation, particularly in uncertain economic times. Commodity market characteristics such as electronic platforms, open outcry, and different trading techniques give market participants the chance to act on sentiment, which has a direct effect on price levels.

4.Governmental Interventions and Regulations

To maintain fair trading practices or stabilise prices, governments may step in and influence the commodities market. They might, for instance, impose tariffs or create price floors, which would affect the pricing of goods. Depending on the significance of the item and its political relevance, certain markets may have price restrictions.

5.Changes in Currency

Because commodities are traded internationally, price changes may be impacted by currency variations. For instance, holders of other currencies may see a decline in the price of commodities like gold and oil, which are normally valued in dollars, if the US dollar appreciates. The significance of the commodities market resides in the way that these swings can influence both domestic and international pricing processes.

6.World Events

The production or delivery of commodities may be disrupted by global events like wars, natural catastrophes, or political unrest, which could result in price volatility. For example, a global spike in oil prices can result from disruptions in Middle Eastern oil production.

Frequently Asked Questions

What are the three commodities in commodity trading?

As there are thousands of commodities a hedger or a speculator can trade, to make it simpler, the commodities have been divided into three categories: Agriculture, energy and metals.

What are the major commodities?

Some of the major commodities are gold, crude oil, cotton, sugar, natural gas, wheat, uranium, coffee and corn.

What are your top five commodities?

Your top five commodities should depend on your risk tolerance, commodity niche and your preferred market. However, you can consider trading in Crude oil, Coffee, Natural gas, Gold, Wheat, and Cotton.

What are the basic commodities?

Basic commodities are those commodities that are vital for people in their day to day operations. These can be natural gas, wheat, eggs, sugar, cattle etc.

Who regulates the commodity market in India?

The Securities and Exchange Board of India, or SEBI, oversees the regulation of the Indian commodity market, guaranteeing openness, ethical trade, and the efficient operation of commodity exchanges.