9 COMMON MY THS.

Money Mail speaks with market players to clear the misconceptions surrounding commodity trading

1 COMMODITY TRADING IS FOR SPECULATORS

FOR years, commodity trading has been a part and parcel of the economy. Market participants, particularly hedgers, arbitrageurs and speculators, help in efficient price discovery and price- risk management. " Speculators are an important link in the market. They can work only because someone is hedging their risk," says Naveen Mathur, associate director, commodities and currencies, Angel Broking.

Ashwin Vidhate, economist, NCDEX, says, " Trading in commodity futures is not different from trading in stock or currency futures. Speculation does not amount to gambling. Speculators are important market participants who inject liquidity and help hedgers transfer risk. The absence of speculators will mean fewer players the market, making it difficult and expensive participants to transfer risk." Speculators are prepared to assume the risk which hedgers are trying to transfer in the futures market. Market experts say speculators add depth and liquidity to the market.

2 UNDERSTANDING THE MARKET IS TOO DIFFICULT

MANY investors think the commodity market is difficult to understand. Vivek Gupta, head of research, CapitalVia Global Research, does not agree. " All commodities are internationally traded and the global- demand supply situation is widely known and available to anyone who reaches out for it. So, understanding commodities is not complex as it is basic economic factors and seasonal cycles that affect prices."

3 THERE IS NO ASSURANCE ON THE QUALITY OF COMMODITIES DELIVERED

MOST exchanges put quality control measures in place to ensure that commodities delivered to their warehouses meet high- quality standards. They also make efforts to ensure that only quality stocks are delivered to buyers.

Experts say commodities delivered within the final validity period are of standard grade and quality.

Dilip Bhatia, chief executive officer, Ace Derivatives and Commodity Exchange, says, " The exchanges have well- established inspection and audit processes to ensure adherence to the highest standards in testing, assaying and storage of commodities, ensuring the quality of commodities delivered." " The buyer also has the option of getting the stock examined for quality while taking delivery," he says.

4 COMMODITY MARKETS ARE TOO VOLATILE

MOST investors have to invest four to 10 per cent value of the commodity, far less than in stock futures.

However, they do not know how to gain from such a high leverage. They overtrade and use the margin to the hilt. Therefore, if prices rise, investors can double their money, but if prices fall, they can lose all their money.

Harish Galipelli, head ( commodities), JRG Securities, says, " Prices of derivatives are directly linked to prices in spot markets." Unlike stocks, metal and energy contracts can rise or fall up to six per cent in a day. In agri commodities, the range is four per cent.

5 COMMODITY EXCHANGES FUEL INFLATION

COMMODITY exchanges promote price transparency. Today, a copper wire manufacturer in Punjab can see the live international price of copper in London his trading terminal. Similarly, farmer in Haryana can know the current price of wheat in New Delhi. By allowing wider participation, exchanges discourage cartelisation by local traders and associations and facilitate fair price discovery.

By providing futures trading in far- month contracts, exchanges provide price signals to farmers, policymakers and other value chain participants," says Ashwin of NCDEX.

6 DIFFICULT TO MAKE MONEY IN COMMODITY TRADING

IT IS generally believed that most investors lose money in commodities futures. " This happens when market participants do not trade with discipline and fall victim to greed and fear," says Mathur of Angel Broking.

For example, investors hold on to losses in expectation that prices will recover. In case of profits, they square off positions for the fear of losing the earned money.

Professional help is useful in such cases.

Gupta of CapitalVia Global Research, says, " Professional traders make huge money for clients. They have spent time in understanding market movements and apply the right blend of technical and economic analysis. Many fund managers and hedge funds trade only in commodities."

7 COMMODITY TRADING IN ONLY FOR LARGE TRADERS & HIGH- NET- WORTH INVESTORS

THIS is not the case. Dharmesh Bhatia, associate vice- president ( research), Kotak Commodities Services, says, " I don't think the commodity market is only for investors who have a lot of money. It is like any other derivatives market in which any person can trade by paying a small percentage of the total value of the contract." " Lot sizes are low in India's commodities markets and any retail investor can participate by paying a margin of four to 10 per cent," says Hoda of Religare Broking.

Exchanges such as the Multi Commodity Exchange ( MCX), National Commodity and Derivatives Exchange, the National Multi Commodity Exchange and the Indian Commodity Exchange have many options for high- networth investors and small investors.

For instance, the exchanges first launched gold contracts on 1 kg bars.

Later, they brought out 100 g, 8 g and 1 g contracts to attract investors. MCX formed 1 g gold petal contract in 2011 with a four per cent margin requirement.

DELIVERY OF COMMODITIES IS A MUST

8 THERE is a common belief that anyone who buys commodity derivatives has to take delivery as well.

Delivery is mandatory only in specific commodities and that too only if one keeps the position open after the delivery notice period.

There is compulsory delivery in commodities such as chana and gold.

However, an investor cannot take delivery of crude oil and metals, as trades in these commodities are cash- settled.

Settling a futures contract by payment of price difference rather than delivery of the physical commodity is called cash settlement.

Bhatia of Kotak Commodity Services says, " It is not necessary to take delivery as long as the trader squares off his positions before the contract's expiry.

Only commercial players take delivery."

9 PRICES ARE EASY TO MANIPULATE

MOST commodities are produced and consumed across the globe.

Any person or a group of persons cannot easily manipulate prices.

However, illiquid commodities can be easily manipulated, say experts.

Harish Galipelli, head, commodities, JRG Securities, says, " Price manipulation is possible only when production is concentrated in an area. It does not happen in essential commodities. Regulators and governments across the globe monitor prices of essential commodities and take measures whenever there is an attempt to manipulate the markets." Mathur of Angel Broking says, " One cannot change a commodity's fundamentals. Commodity prices reflect demand- supply dynamics."

BACK TO SCHOOL

HEDGERS

have an underlying interest in specific delivery or ready delivery contracts and use futures market to insure themselves

SPECULATORS

may not have an interest in ready contracts but seek opportunities in price movements. They assume risk which hedgers try to transfer in futures market

ARBITRAGEURS

make sale and purchase in two markets to gain from the price difference. They remove price imperfections in different markets

FORWARD CONTRACTS

are for supply of goods and payment where supply of goods or payment or both take place after 11 days from date of contract

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