Commodity Markets in India

The commodity markets involve trading in raw or primary products. Unlike stocks or bonds, commodities are physical goods such as agricultural products, metals, and energy resources.

Commodity markets in India have evolved with the establishment of modern exchanges and regulatory oversight. This chapter covers the basics of commodity markets, key commodities and exchanges in India, and their role in the financial system.

What are Commodities?

Commodities refer to basic goods that are interchangeable with others of the same type. They are often categorized into:

• Agricultural commodities: e.g., wheat, rice, pulses, cotton, sugar, spices, oils (like soybean oil, palm oil), coffee, tea, etc.
• Metals:
• Precious metals like gold, silver.
• Base metals like copper, aluminium, zinc, lead, nickel, etc.
• Energy: e.g., crude oil, natural gas, coal.
• Others: Could include commodities like rubber, textiles (jute), etc.

Each commodity has a grade or specification (for quality) that is standardized for trading purposes. Commodities are fundamental to the economy because they are inputs to production and directly linked to supply and demand dynamics (e.g., a drought can affect crop output and thus commodity prices).

Commodity Market Segments

Similar to financial markets, commodity markets have two key segments:

• Spot Market (Physical Market): Where commodities are bought and sold for immediate delivery (or within a short period). For example, a grain wholesaler buying wheat from a farmer at the current price for delivery now. Spot markets can be local mandis (markets) for agri produce, or direct transactions between producers and consumers.
• Derivatives Market (Futures/Forwards): Where contracts for future delivery of commodities are traded. This is where commodity futures exchanges come into play. Participants agree on a price now for delivery at a future date, allowing hedging and speculation on price movements.

Commodity futures contracts are standardized agreements to buy or sell a certain quantity of a commodity (with defined quality specs) at a predetermined price on a future date through an exchange. They are similar to stock futures but underlying is a commodity. For example, a Gold 1kg futures contract for delivery in December at ₹X per 10 grams. Options on commodities also exist in some cases (e.g., options on gold futures), but futures are more common and older.

Importance of Commodity Derivatives

• Price Hedging: Commodity producers (like farmers, miners) and consumers (like food processing companies, jewellers, oil refineries) face risk of price fluctuations. Futures allow them to lock in prices. E.g., a farmer can sell futures on his crop at planting time to secure a price, thereby hedging against a fall in price by harvest. Conversely, a cereal manufacturer might buy wheat futures to lock in raw material costs.
• Price Discovery: Active trading on exchanges helps in robust price discovery that reflects broad market information (monsoon forecasts, global demand-supply, etc.). Farmers in remote areas get a reference of what future prices might be.
• Inventory Management: Holding physical stock has costs (storage, spoilage). Futures allow adjusting exposures without physically holding goods until needed.
• Investment and Speculation: Commodities are an asset class. Investors may invest in commodities for diversification (they sometimes move differently from stocks/bonds). Speculators provide liquidity and can profit from correctly anticipating price moves (e.g., oil price movements, gold as a safe haven bet, etc.).

Commodity Exchanges in India

India has had organized commodity trading for a long time (Cotton exchange in 1920s in Mumbai, for instance). However, many commodities futures were banned in mid-20th century. The modern era of commodity exchanges began in 2003 when the government allowed national-level commodity exchanges. The regulatory body originally was Forward Markets Commission (FMC), which in 2015 merged with SEBI to unify regulation of securities and commodities. The major commodity exchanges in India are:

Multi Commodity Exchange (MCX)

Established in 2003 in Mumbai, MCX is the largest commodity futures exchange in India by turnover. It primarily deals in metals and energy commodities. Key contracts on MCX:

• Precious Metals: Gold, Silver futures (Gold is one of the highest traded by value).
• Base Metals: Copper, Aluminum, Zinc, Lead, Nickel futures.
• Energy: Crude Oil futures, Natural Gas futures.

Some agricultural contracts were there (like cotton, mentha oil), but MCX is known for metals and energy mostly. MCX is a listed company itself and often features in exam questions (e.g., “Which exchange deals largely in metals and energy futures?” – answer MCX).

National Commodity & Derivatives Exchange (NCDEX)

Also founded in 2003, based in Mumbai. NCDEX is the leading agricultural commodity exchange.

• Key agri contracts: Soybean, Mustard Seed, Refined Soy Oil, Chana (chickpea), Guar Gum & Guar Seed, Jeera (cumin), Turmeric, Sugar, Wheat (though govt policies often affect which agri futures are active).
• NCDEX has a benchmark index like NCDEX Agridex for overall agri commodities. NCDEX helps farmers and traders hedge against agri price risk, though sometimes futures trading on certain commodities is suspended if price volatility is extreme or for policy reasons (to control inflation, etc.).

Indian Commodity Exchange (ICEX)

Smaller exchange, which notably launched a unique contract for Diamond futures in 2018. However, ICEX struggled with volumes and, as per SEBI, it was granted exit in late 2024 (meaning it shut down).

• Regional Commodity Exchanges: There were some older regional commodity-specific exchanges (e.g., for pepper in Kochi, or oils in Indore). Many have now either closed or have low activity, especially after national exchanges took prominence.
• Others: National Multi Commodity Exchange (NMCE) was an earlier exchange that merged with ICEX. Regional exchanges like Ace Derivatives (in Ahmedabad) also wound up.
• Exchange Traded Commodity Derivatives now effectively concentrate on MCX and NCDEX.

Commodity Stock Exchanges vs Commodity Exchanges: Don’t confuse with stock exchanges – commodity exchanges deal in commodity contracts, not company stocks. Although now SEBI has allowed stock exchanges to also offer commodity derivatives (so BSE and NSE have launched commodity segments too). For example, BSE offers Gold, Silver, Oil contracts, but their market share is very low compared to MCX.

Trading and Settlement in Commodity Futures

• Contract Specifications: Each commodity future has a standard lot size (e.g., Gold 1kg, or Gold Mini 100g, Silver 30kg, Crude Oil 100 barrels etc.), a grade/quality definition, delivery center (city/warehouse for delivery), price quotation (e.g., ₹ per 10g for Gold), and expiry date (usually a specific day of the month).
• Margins: Just like financial futures, traders must deposit initial margin and daily Mark-to-Market margins.
• Delivery: Unlike index futures which are cash settled, many commodity futures can go to physical delivery if positions remain open at expiry. For instance, if you hold a long position in wheat futures at expiry and don’t square off, you are obligated to take delivery of the wheat as per exchange rules (you’ll be given warehouse receipts for wheat at designated warehouses). Similarly, short must give delivery. However, many participants close out before expiry to avoid delivery unless they need the commodity. Some contracts also have compulsory delivery (must deliver if open) vs both option (where it could be cash settled if both parties agree).
• Warehousing & Logistics: A robust commodity market requires good warehousing facilities and quality check systems. The exchange authorizes warehouses and assayers (for quality certification). When a trader wants to make delivery, they deposit the commodity in an approved warehouse and get a warehouse receipt, which is used to settle the futures delivery.
• Example: On NCDEX, if a farmer hedged by selling a Soybean futures contract for October expiry and at expiry chooses to deliver, he will deliver soybeans of specified quality to an NCDEX warehouse. The buyer who held the corresponding long will pay and receive that warehouse receipt representing the soybeans.

Regulatory and Government Influence

• SEBI Regulation: Since 2015, SEBI regulates commodity exchanges. It brought stricter norms on speculation and algorithmic trading similar to stock markets. SEBI has also introduced new products like Commodity Options (with commodity futures as underlying, e.g., Gold options that end in delivery of a Gold futures position).
• Government Policies: Commodities, especially agri, are sensitive. Government sometimes imposes curbs: e.g., suspending futures trading in certain commodities if it believes speculation is fueling price inflation (e.g., tur dal, rice futures have been suspended at times). It also has stock limit norms, import-export restrictions that influence prices. In late 2021 and 2022, SEBI suspended futures trading in a few agri items like wheat, rice, etc., due to high inflation.
• Essential Commodities Act: Historically used to regulate storage and movement to prevent hoarding. Recently diluted for most items, but still invoked in emergencies.
• Forward Contracts Regulation: The Forward Contracts (Regulation) Act 1952 governed commodity derivatives until merger into SEBI’s regime. Now, the Securities Contracts (Regulation) Act and SEBI Act cover them.
• FPI in Commodities: Earlier, only domestic participants (including domestic institutions and companies) traded commodity futures. Gradually, institutional participation increased (banks and mutual funds have been allowed limited participation for hedging or specific products like Gold ETFs taking delivery). In 2022, SEBI allowed Foreign Portfolio Investors (FPIs) limited access to commodity derivatives (in non-sensitive commodities).
• Integration with Global Markets: Commodity prices in India are influenced by global prices (since many commodities can be imported or exported). E.g., Gold prices are basically global (London/New York) plus import duty, currency rate. Oil is priced off global Brent/WTI prices (India imports ~80% of its crude). Thus, Indian futures reflect global trends. Arbitrage (via import/export) keeps prices aligned when possible.

Key Commodity Market Facts and Terminology

• MCX: Known for Gold, Silver, Crude Oil, Base Metals. For instance, MCX Gold contract (1 kg) is very actively traded and often used by jewelers to hedge. Crude oil contracts swing with global oil news.
• NCDEX: Known for agri like Soybean, Mustard, Jeera. Eg: If monsoon is weak, you might see prices of certain crops rising on NCDEX futures in anticipation of lower supply.
• Price Limit/Circuit: Commodity futures have daily price movement limits (if hit, trading may halt or only resume after cooling period).
• Open Interest: A measure of how many contracts are open (not offset) in the market. Important to gauge market participation.
• Backwardation and Contango: Terms describing futures price relative to spot.
  • Contango: Futures price > Spot price (common if costs of carry – storage/insurance/interest – are significant, e.g., gold often has futures slightly above spot by cost of carry).
  • Backwardation: Futures price < Spot price (can happen if strong immediate demand or storage shortage, e.g., some agri after harvest might go into backwardation if near month is pricier due to lack of supply).
• Delivery vs Cash Settlement: Some contracts are settled in cash (no actual delivery, just price difference paid). Many commodity futures allow actual delivery – which differentiates them from financial derivatives and ensures connection to physical market reality.
• Commodity Indices: There are indices (like Bloomberg Commodity Index globally, or NCDEX Agridex) reflecting a basket of commodity prices, sometimes used for passive investment products or benchmarking.

Commodity Market Participants

• Hedgers: Farmers, producers, consumers, processors. E.g., a jeweler hedges by buying gold futures to lock in his cost, an oil marketing company might hedge crude price by buying crude futures when they need to buy physical later.
• Speculators: Traders who seek profit from price moves. They may not have any link to physical commodity; they typically close out positions before delivery. They play an important role in providing liquidity.
• Arbitrageurs: Those who exploit price differences, e.g., between NCDEX and a regional mandi price, or between MCX gold and international gold (accounting for currency and duty).
• Investors: Some treat commodities as an investment class. E.g., people buy gold (or Gold ETFs) as a long-term investment or inflation hedge. Silver also often seen similarly. However, direct trading in commodity futures requires expertise and appetite due to volatility.

Example to Illustrate Hedging

Imagine a farmer expecting to harvest 100 quintals of soybeans in 3 months. Currently, soybean price is ₹4,000/quintal. The farmer fears a price drop at harvest due to a good monsoon (excess supply). He sells soybean futures at, say, ₹3,900 for harvest-month delivery on NCDEX for 100 quintals (assuming 10 tons total, matching roughly one contract if that’s the lot). If at harvest the spot price falls to ₹3,500, he sells his crop in the market at ₹3,500 but simultaneously closes his futures position (buying back) at ₹3,500, netting a profit of ₹400/quintal on futures. Effectively, he realizes ~₹3,900 (spot 3500 + futures profit 400) for his crop despite the price drop, thus hedging his risk. If instead price rose to ₹4,500 (and he had not hedged, he’d get more), his futures hedge would cause a loss ₹600/quintal, offsetting the extra gain, effectively locking him around ₹3,900. So he gave up upside to avoid downside – that’s hedging.