The Role of Commodity Markets In India

Introduction

In India, you can invest money and diversify your portfolio to keep it healthy and profitable in several ways. One of the most popular methods is commodity trading.

While the commodity market has existed in India for over a hundred years now, the official trading mechanism was established in 2003. Though the commodity markets remain less popular than stock markets, they play a vital role in the functioning and development of the Indian economy.

In this post, let us try to understand the role and significance of commodity markets in India.

What Are Commodity Markets?

Just as the stock market facilitates trading shares, commodities like metals, gold, silver, agriculture products, and others are traded in dedicated markets called commodity markets. Traders, manufacturers, producers, and other people use these markets widely for price discovery of different commodities.

Like the stock market, there are standalone commodity exchanges for buying and selling. Currently, three main commodity exchanges operate in the country – MCX (Multi Commodity Exchange), ICEX (Indian Commodity Exchange), and NCDEX (National Commodity and Derivatives Exchange).

MCX is, however, the leading commodity exchange in India, with the highest daily turnover, in both spot trading and derivatives.
 

How Important Are Commodity Markets In India?

The commodity markets in India are quite significant for the country’s economy, investors, and people relying on commodities for their living. Some of the most important features of the commodity markets are:

Price Discovery

These markets allow people to find the real prices of various commodities, including agricultural products in India. These markets ensure that commodities are not sold at a lower price, thereby preventing any losses.

Quality Maintenance

The commodity markets have strict requirements concerning the quality of commodities available for buying and selling. Such policies ensure the goods have superior quality throughout the country, benefitting suppliers as well as consumers.

Leverage

Trading in commodity futures is based on leverage through margin maintained with the broker. A big transaction can be performed with a much smaller amount of cash on hand.

Diversification

Trading in commodity markets in India is a great way for investors to diversify their portfolios. As commodities have an inverse relationship with bonds and equities, investing in commodities would safeguard the investor money if other markets fall.

Role of Commodity Markets In India

Looking at its significance, it is easy to say that the role of commodity markets in India is pivotal to protecting citizens and the growth of the economy. Here are some of the ways the market plays its role.

Bigger Investment In The Agricultural Ecosystem

Today, one of the biggest challenges in the agriculture sector is the absence of a well-designed post-harvest system which leads to a substantial loss of food grains during the transmission, affecting the prices and putting the farmers at a loss.

A regulated commodity market serves as a rescue for farmers, brokers, consumers, and investors. Such a mechanism also encourages bigger investments in agriculture in improved transport facilities and warehousing systems. This will, in turn, result in a better-developed ecosystem.

Achieving Food Security

The Indian government achieves food security through commodity markets. Recent reports show how grains are worth more than Rs.800 crores were destroyed in Punjab because of poor warehousing.

Farmers in India face such a problem and are forced to risk the food they produce on farms. However, they can use the futures market to sell their grains by locking in a price to ensure the fluctuations don’t affect their situation.

Oversupply of a commodity in the market weakens the prices, which can be dealt with by selling futures on the commodity at a price that profits the farmers. Farmers living in Western countries generally use the futures market to hedge the price shifts for agricultural products.

Aggregation and Financing Mechanism

One of the biggest problems Indian farmers face is that they are small and dispersed. An aggregator is the only saviour in this scenario. At this time, the role of the aggregator is played by middlemen, but it does not ensure the transparency of the system.

A well-organized commodity market can prove to be an effective aggregator as it provides a guaranteed aggregation system that facilitates dispersed farmers. Financing is another significant aspect of commodity markets.

These markets enable raising finances against warehouse receipts and rid the agriculture sector of relying on unorganized financing.

New Asset Class For Retail Investors

The investment options for Indian traders have always remained limited to real estate, gold, equities, bonds, and FDs. Though investors can indirectly invest in commodities through equity markets, commodities were not available as an asset class for direct investment.

The commodity market allows investors, small and big, to diversify their portfolios and lower the risk of other investments. Traders can find a wide variety of commodities to put their money into.

Getting started with commodities investment India can seem daunting at first, but there is a strong ecosystem surrounding this market, focused on education and advisory services, increasing the reach and traction of the overall market.

Risk Distribution and Hedging

One of the most important functions of commodity markets is to protect the investors by reducing the risk and hedging prices. A trader, for example, interested in hedging against the price movements in a precious metal can lock in the price with futures.

An FMCG company can also hedge against the volatility in agricultural products by using the commodity futures market to protect themselves. A regulated commodity market distributes risk among a large number of investors to protect them.

Absorbing Speculative Excesses of The Spot Market

This is another important role commodity markets play. Take the example of gold to understand this point. Much of the demand for gold comes from speculative purposes. There is a limit on how much gold the country produces, and we depend on imports to meet the demand. Gold import has a big drawback.

A lot of valuable foreign exchange resources are being used up without any additional benefits. This increases as more and more traders choose to hold on to the asset. A robust commodity futures market can solve this problem by absorbing the speculative demand for gold, saving precious resources for the economy.

Final Thoughts

The Indian commodity market is growing and will continue to grow further. Despite being less popular compared to other markets, the commodity market plays a significant role in hedging risk, influencing prices, and positively affecting the agricultural sector and the Indian economy.