Commodities Trading in India

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Commodities Trading in

India

Northbridge Capital Asia

June 2010


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C o m m o d i t i e s t r a d i n g i n I n d i a

T a b l e o f C o n t e n t

I n t r o d u c t i o n 0 3

1 ) I n t r o d u c t i o n t o c o m m o d i t i e s t r a d i n g 0 42 ) P s y c h o l o g y o f t r a d i n g i n c o m m o d i t i e s m a r k e t 1 13 ) R i s k s o f T r a d i n g 1 34 ) B a s i c s o f c o m m o d i t i e s m a r k e t F A Q s 1 55 ) G o l d

F u n d a m e n t a l s 1 8 T e c h n i c a l s 2 1 P s y c h o l o g y i n G o l d t r a d i n g 2 6 T r a d i n g i n G o l d 2 7

6 ) S i l v e r F u n d a m e n t a l s 3 0 T e c h n i c a l s 3 3 T r a d i n g i n S i l v e r 3 8

7 ) C o p p e r F u n d a m e n t a l 4 0 T e c h n i c a l s 4 2 P s y c h o l o g y i n c o p p e r t r a d i n g 4 6

8 ) S u g a rF u n d a m e n t s 4 8

T e c h n i c a l s 5 1

G l o s s a r y 5 3


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Introduction

Indian markets have recently thrown open a new avenue for retail investors and traders to

participate: commodity derivatives. For those who want to diversify their portfolios beyond

shares, bonds and real estate, commodities are the best option.

Till some months ago, this wouldn't have made sense. For retail investors could have done very

little to actually invest in commodities such as gold and silver -- or oilseeds in the futures market.

This was nearly impossible in commodities except for gold and silver as there was practically no

retail avenue for punting in commodities.

However, with the setting up of three multi-commodity exchanges in the country, retail investors

can now trade in commodity futures without having physical stocks!

Commodities actually offer immense potential to become a separate asset class for market-savvy

investors, arbitrageurs and speculators. Retail investors, who claim to understand the equitymarkets may find commodities an unfathomable market. But commodities are easy to understand

as far as fundamentals of demand and supply are concerned. Retail investors should understand

the risks and advantages of trading in commodities futures before taking a leap. Historically,

pricing in commodities futures has been less volatile compared with equity and bonds, thus

providing an efficient portfolio diversification option.

In fact, the size of the commodities markets in India is also quite significant. Of the country's

GDP of Rs 13, 20,730 crore (Rs 13,207.3 billion), commodities related (and dependent)

industries constitute about 58 per cent.

Currently, the various commodities across the country clock an annual turnover of Rs 1,40,000

crore (Rs 1,400 billion). With the introduction of futures trading, the size of the commodities

market grow many folds here on.

Like any other market, the one for commodity futures plays a valuable role in information

pooling and risk sharing. The market mediates between buyers and sellers of commodities, and

facilitates decisions related to storage and consumption of commodities. In the process, they

make the underlying market more liquid

This book should help the reader to understand the basics of commodities trading system in

India. It will also introduce the reader with different terminologies, trading procedures, variouscommodities, futures trading and so on, which are available to trade in India. You will also read

about the four main commodities that are traded on the MCX and NCDEX Gold, Silver, Copper

and Sugar. Before trading in these commodities, you should have thorough knowledge about the

fundamentals of each of these commodities and how and what are the factors affect their demand

and prices.


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Commodities trading in India

Introduction

Indian markets have now started offering a new investment product for all retail investors, commodities

derivatives by setting up three multi-commodity exchanges. It is ideal for traders and investors who wish

to diversify their portfolio beyond stocks, bonds, mutual funds and real estate. Besides the retail investors

do not require to physically own the commodities they are trading in.

Commodities have potential to become a distinct asset class for skillful investors and traders.

Understanding commodities is relatively simple for investors as they are more align with the basic

fundamental economics of demand and supply. However retail investors should understand the risks

associated with commodities trading before investing in this new asset class.

Historically, commodity prices have been less volatile compared to equities, thus can be a good

diversification option.

Like any other market, the one for commodity futures plays a valuable role in information pooling and

risk sharing. The market mediates between buyers and sellers of commodities, and facilitates decisions

related to storage and consumption of commodities. In the process, they make the underlying market

more liquid.

Trading in Commodities market

Retail investors have three options to trade in commodities futuresNational Commodity and Derivative

Exchange (NCDeX), Multi commodity Derivative Exchange (MCX) and National Multi Commodity

Exchange of India Limited (NCME). All the three have electronic trading and settlement systems and a

national presence.

But before we begin trading in commodities, let us first understand the basic market structure and

mechanism. Commodities market like stock market works in spot or cash market and futures market.

Spot market

Market where commodities are bought and sold in physical form by paying cash is a spot market. The

price on which commodities are traded in this market is called spot price. For example, if you are a farmer

or dealer of Chana and you have physical holding of 10 kg of Chana with you which you want to sell in

the market. You can do so by selling your holdings in either of the three commodities exchanges in India

in spot market at the existing market or spot price.

Futures Market

The market where the commodities are bought and sold by entering into a contract to settle the transaction

at some future date and at a specific price is called futures market. The unique feature of futures market

is that you do not have to actually hold the commodities in physical form or for that matter take the

delivery in physical form. Every transaction is settled on cash basis.


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The prime objective of futures market is to hedge or mitigate the price risk in commodities. As you are

aware the prices in the spot market are volatile and are always fluctuating. And as a trader or investor,

you would want to eliminate or at least minimize your exposure to such price risk. Hence you can use

futures market to settle your contract.

For example, the current spot price of Gold is Rs 18000 per 10 grams. You expect the gold price to reach

Rs 18500 in next 1 month, but you do not want to miss this chance to earn money and at the same time

you dont even want to own any physical gold. Hence you enter into gold futures contract with a futures

price of Rs 18000 (the price at which the futures contract is currently being traded in futures market) with

an expiry date (the date on which the futures contract will be settled at futures price) of 1 month from

now. i.e. 30th June 2010. Hence you will make a profit if the spot or market price of gold is more than Rs

18000 on the settlement date or the expiry date of your futures contract.

Futures contract are standardized contracts made by the commodities exchange and come with specific set

of prices with minimum lot size to trade and with a specific expiry or settlement date. Let us look at each

of these terminologies and how are they used in a futures contract.

There are about 22 local Commodity Exchanges recognized by FMC (Forward Markets Commission),

Which is a division of Government of Consumer Affairs and Public Distribution that are permitted for

Futures Trading. The commodities are standardized as per the following criteria for facilitating trading in

the futures market: -

COMMODITY Commodity such as Gold, Silver Aluminum, etc

QUANTITY/ CONTRACT

SIZE OR TRADED ABLE

LOTS

These are the minimum quantity specified in a single

order and all orders should be in multiples of it. Just

like in case of stocks, when you fill-up an IPOapplication, you have to bid for some minimum

number of shares. Similarly in commodities futures

contract or for that matter in any futures contract,

there is a minimum specified limit in terms of

contract size to be traded in a contract. For example

100gms is the lot size for GOLD100 futures contract

on National Commodities Exchange of India, where

if you want to trade, you need to enter into futures

contract of minimum 100 gms.

DELIVERY MONTHS A commodity Futures contract can be traded for a

delivery of all those months for which the Exchange

has allowed it. So at a time there can be more than 1,

2 or 3 contract months of the same commodity for

which, the price might be quoted for trading with

different delivery months. (The time duration from

the start of the contract for trading until the expiry


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date is know as the cycle of the contract)

PRICE QUOTES Price for a commodity futures are quoted on its

minimum quantity tradable in the spot market,

irrespective of the contract or lot size of its futures.

E.g.: - Silver may be quoted as RS/25000 per kg

(which is the minimum tradable quantity in spot

market) while the contract size is 30 kgs. Therefore

in this example the Price quoted has to multiplied by

30 to get the trade value of one contract in Silver

QUALITY SPECIFICATIONS They are quality or grades and other specifications of

the commodities are also standardized and will beavailable with the Business rules of the exchange

Market Participants

Brokers: The first kind of participant that comes to our mind when we talk about exchanges is the

brokers. Commodity brokers like stock broker are the people who take orders from clients and trade on

clients behalf in the exchange. They provide all the basic services like research reports, daily price

updates, trading information, news and other information that will help their clients to enter into a

transaction. Basically they smoothen the entire trading process for the clients.

Besides the commodity Brokers there are other participants whose purpose to trade in the futures market

could be quite interesting to know for all those who intend to participate in the Futures market.

They can be broadly classified into two main categories. First, the profit seekers who want to benefit from

the price fluctuations in the commodities with sole purpose of making money. People like investors,

traders, speculators and portfolio or hedge fund managers.

While the others are know as Hedgers

In order to hedge something, one needs to physically own it or is contemplating to buy and take a

physical delivery. The hedgers are basically people how actually own the commodities in physical formwith them.

These are the people who are worried about the potential losses they could incur due to volatile prices of

the commodities they could be physically holding with them. They trade in the futures market to transfer

their risk of movement in prices of the commodity they are actually physically dealing. Some of the

hedgers are listed below and their objective fro trading in this market: -


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EXPORTERS: People who need protection against higher prices of commodities contracted from a

future delivery but not yet purchased.

IMPORTERS: People who want to take advantage of lower prices against the commodities contracted for

future delivery but not yet received.

FARMERS: People who need protection against declining prices of crops still in the field or against the

rising prices of purchased inputs such as feed

MERCHANDISERS, ELEVATORS: People who need protection against lower prices between the time

of purchase or contract of purchase of commodities from the farmer and the time it is sold.

PROCESSORS: People who need protection against the increasing raw material cost or against

decreasing inventory values.

Margin System

Futures market work on system called as Margin System

Margin is good faith deposit money that has to be kept with a registered Member of the exchange (they

can be clearing member, trading cum clearing Member, register broker or any other category of

membership of the exchange who are permitted to accept orders for the clients), in order to initiate or be

eligible for trading in commodity futures. The Member in turn has to maintain a MARGIN ACCOUNT

with the Exchange besides keeping a security Deposit with the clearing house of the Exchange

While the exchange takes care of the smooth and orderly execution of the trades, the clearinghouse acts asthe third party entity to ensure and guarantee all the trades done on the exchange floor or the electronic

platform. So trader need not have to directly deal with another trader, the clearing corporation takes the

role of the buyer for every seller and the role of the seller fro every buyer. In order to see and guarantee

the financial fulfillment of the trade, it takes margin deposit from both the buyer and seller before

allowing them to trade.

Every exchange is a Membership organization, regulated by the FORWARD MARKETS

COMMISSION, a division of Government of India, Ministry of Consumer Affairs and Public

distribution. While the Exchanges establish the rules for trading, the FMC establishes the regulations forcontrolling the functioning of these commodities futures markets.

So when a trader wants to trade in commodities worth say 25,00,000 then he need not have to invest that

much. He can trade that much by keeping a margin amount that is a certain percentage of the actual value

(usually that is around 2% to 15%) depends on exchange to exchange and on commodity to commodity.


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This is called as leveraging it can work for you Or against youdepend on how your trading style,

rule and need are???

Things to know before your first futures trade

Since Futures Contract are contracted for a future date, it is important know where the spot market is,

before you can make your analysis of what the futures price might be at the time of delivery, to arrive at a

reasonable level to buy or sell. While an Hedger would be just making his calculation to arrive at the price

protection level and the quantity that has to hedged.

The spot prices of various commodities that are permitted for futures trading are available at various

private and Government Sponsored web sites. We are in synergy with institutes to get the real time spot

market prices on our web site very soon. You can also get some fundamental news about the markets and

of the commodity of your choice in leading newspapers or other web-news agencies.

Theoretical relationship between the spot and futures prices are calculated as follows: -

Futures Price= Spot Price + Cost of Carry

A futures Trade necessitates storing and carrying the underlying commodity until the delivery date. This

entails costs, Benefits, or both to the potential deliverer. Cost of Carry includes storage costs,

transportation costs, insurance costs, interest costs, other opportunity costs as well as benefits.

Also the actual difference between the futures price and the spot price traded on a particular day is called

as the BASIS for that particular contract month of the commodity.

Usually the Futures Price of Commodity > Spot Price (With the further months contracts priced slightly

Higher). However it is not necessary in all cases.

For most storable commodity the difference between the spot price traded on a particular day is positiveand as the contract month keeps coming nearer to the expiry date, it goes on decreasing and finally on the

day of the delivery, the Future Price is nearly the same as the spot price.

Having Know this you will have to find out the following informations for making the first trade.


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Of course a few practices and mock trades are recommended. The initial preparation would involve like

getting to know which commodities are traded on which exchanges, who are registered members, what

are the delivery months for those commodities, what are the margin requirements, what is the volume of

activity on those commodities, etc. Much of these required initial informations you would find it in our

site.

Having collected all this informations, you are now ready for you first trade.

Your First Trade

Now let us assume that the spot price of Silver on 9th May 2010 is 27550/kg and the prices quoted on the

exchange are available for June, July, Oct, and Nov.

Earlier contract months wont be available as they are already expired, while the later months beyond Jan

are also not available, as they are not yet started. Note again the present Month that is May; here there

wont be much volume as it has entered into the delivery period. (Assuming that the delivery period forthe contract is from 1st to 15th of the Delivery Month). Avoid taking fresh positions in such contracts.

Instead go for the next immediate contract month that is June.

Let us say after you analysis about the market, you are bearish about the market and would like to SELL

30Kg of Silver @ 27550 for June Delivery.

Having sold in the market, we will have to wait for the market to gives us a lower level to buy back the

contract before the delivery date in June.

The obligation to take delivery by a BUYER can be removed by selling back the contract before thedelivery period.

The obligation to gave delivery by a SELLER can be removed by Buying back the contract before the

delivery period

So now you your first sample trade as follows: -

SELL 1 lot June Silver @ Rs 27550/kg

Profit or Loss

Your order was: -

SELL 1 June Silver @ 27550

Lets say after a few days the market goes down and you are able to come buy back it from the market at

27350/ kg. Then your square off trade or liquidation would be


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BUY 1 June Silver @ 27350

Your profit and loss calculations will be as follows: -

PROFIT/=

(Selling Price- Buying Price) X No of Units or lotsFees

Price Factor=Contract Size/Price Quotes quantity

Now,

The PROFIT/=

=(27550- 27350) X 1 X 30Fees

=RS 6000Fees

Fees are usually charged only once during entry and exit. There is no carry forward cost involved.


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Psychology of trading

Basics in trading psychology

Understanding the psychology of the market is crucial to make money in the market. Be it stocks, bonds,

gold or any other asset or commodity. Most of the people just get carried away by seeing increasingnumber of volumes in trade turnover or by seeing a sudden jump in prices. Basically the daily market

volatility, news and the rumors about a particular commodity dominates a persons behavior while trading

in the market.

The first rule of trading in the commodities market is to think from your brains and not with your heart!

Second, whenever you do not understand the logic or reason behind sudden change in the price of gold,

stay out of trading. Third, understand the news in totality. Not all the news affects the gold price equally

and not all bad news are actually bad for gold trading.

However, effective technical analysis allows us to use trends, patterns and other indicators to evaluate the

market's current psychological state. It takes a disciplined trader to be able to watch and listen to the

market doing one thing, filter out the noise, then do the opposite - all in a controlled manor.

There are two types of traders:

1. Herd Mentality Trader - Someone who trades off fear and greed buying near tops and panicselling out at the bottom with the masses. Basically his trading pattern replicates most of the other

participants in the market.

2. Black Sheep Trader - A trader who stand apart from the masses and trades opposite to the"herd" during extreme levels. It will help you to trade better if you follow this one rule, Buywhen the prices are falling and everybody is moving out of the market out of fear, and sell when

people are greedy buying in the market at astronomically high prices.

Market Psychology Trading Conclusion:

Most get involved with the market because it looks like something they can quickly learn and start

making money from home. But it doesn't take long before they quickly realize there is more to trading

than meets the eye.

While trading looks easy from a glance, in actuality I think its one of the toughest jobs out there.

Why? Well, this is what you are up against:

1. You are trying to predict something that is unpredictable2. You are trading against millions of other highly skilled traders


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3. You are trading against automated computers with complex algorithms4. You are trading with your hard earned money which causes fear and greed5. You must accept losing trades as that is part of the business6. You must trade with a proven trading strategy and follow the system7. You must understand money management and apply it to every trade8. You must truly love the market cause it will break you down mentally

I don't want to say you must be a contrarian, but in reality you must do the opposite of the masses during

times of extreme price behavior.

These extremes happen on a daily basis when trading intraday charts and every 4-6 weeks when looking

at daily charts. The toughest part is to pull the trigger when emotions are flying high in the market and

you are looking to do the opposite. It takes several trades before you even start to get comfortable doing

this.


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Risks of Trading

Before becoming too excited about the substantial returns possible from commodity trading, it is a good

idea to take a long, sober look at the risks. Reward and risk are always related. It is unrealistic to expect to

be able to earn above-average investment returns without taking above-average risks as well.

Most people are naturally risk averse. Commodity trading has the reputation of being a highly risky

endeavor. It is true that a high percentage of traders eventually lose money. Many people have lost

substantial sums.

Commodity trading is the same in the sense that the individual is the one who decides how he wants to

operate. He can make large bets or small ones. One can trade commodities carefully and risk as little as

Rs 4000 or Rs 6000 on a trade. You could trade a long time this way and only lose a few thousands.

However, most people are not that patient. The unfortunates who lose big are those who can't control

themselves. They take big risks in an attempt to get rich quick. Another way to lose big is blindly to turn

your money over to others to trade such as brokers or money managers.

Anyone who is going to try speculation should be fully aware of and be comfortable with the risks

involved. Managing the risks of trading is a very important part of any trader's success. Although the risks

can be managed, they can never be eliminated. Remember that the high returns successful speculators can

earn are available only because the speculator is being paid to take risk away from others.

When a commodity trader buys a futures contract, he will lose if the price declines. His risk is

theoretically limited only by the price of the commodity going to zero. If he sells, he will lose if the price

goes up. The risk is theoretically unlimited because there is no absolute ceiling on how high the price of

the commodity can go.

For example: If you buy a gold futures contract @ Rs 18000/10 gms. You will lose your money if theprice falls below Rs 18000, till you either exit out of the contract or till the expiry of the contract.

In practice, however, the trader can offset his position when the trade is going against him to limit his

loss. While a prudent trader always has a plan to limit his losses when trades don't work, it is not possible

to guarantee a particular loss limit amount. As a practical matter, however, you can usually limit losses to

within a few thousand rupees of an intended amount. Very often losses are within Rs 1000 of the amount

you project. Only when very unusual things happen suddenly can losses balloon to thousands of rupees

more than you expected.

Other kinds of surprise situations that can cause unpredicted losses are freezes, floods, droughts,

government currency interventions and crop reports. With attention and foresight a trader can sidestepthese risky situations. The best way to control unpredictable risks is to trade conservatively so larger-than-

expected losses are still only a small percentage of the total account.

Another thing to understand about risk in trading is that you cannot avoid losses by careful planning or

brilliant strategy. Numerous losses are part of the process. Trading is a business of making and losing

money. Any trade, no matter how well thought out, has a chance of becoming a loser. Many people think


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the best traders don't lose any money and have only winning trades. This is absolutely not true. The best

traders lose a lot of money, but they eventually make even more over time.

There is no point trading commodities if you cannot handle the psychological discomfort of making

losing trades. While people tend to take losses personally as a sign of failure, good traders shrug them off.

The best trading plans result in many losses. Because of the amount of randomness in market price action,

such losses are inevitable.


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Basics of Commodities market

How do I choose my broker?

Several already-established equity brokers have sought membership with NCDEX and MCX. The likes of

Refco Sify Securities, SSKI (Sharekhan) and ICICIcommtrade (ICICIdirect), ISJ Comdesk (ISJSecurities) and Sunidhi Consultancy are already offering commodity futures services. Some of them also

offer trading through Internet just like the way they offer equities. You can also get a list of more

members from the respective exchanges and decide upon the broker you want to choose from.

What is the minimum investment needed?

You can have an amount as low as Rs 5,000. All you need is money for margins payable upfront to

exchanges through brokers. The margins range from 5-10 per cent of the value of the commodity contract.

While you can start off trading at Rs 5,000 with ISJ Commtrade other brokers have different packages for

clients.

For trading in bullion, that is, gold and silver, the minimum amount required is Rs 650 and Rs 950 for on

the current price of approximately Rs 65,00 for gold for one trading unit (10 gm) and about Rs 9,500 for

silver (one kg).

The prices and trading lots in agricultural commodities vary from exchange to exchange (in kg, quintals

or tonnes), but again the minimum funds required to begin will be approximately Rs 5,000.

Do I have to give delivery or settle in cash?

You can do both. All the exchanges have both systems - cash and delivery mechanisms. The choice is

yours. If you want your contract to be cash settled, you have to indicate at the time of placing the order

that you don't intend to deliver the item.

If you plan to take or make delivery, you need to have the required warehouse receipts. The option to

settle in cash or through delivery can be changed as many times as one wants till the last day of the expiry

of the contract.

What do I need to start trading in commodity futures?

As of now you will need only one bank account. You will need a separate commodity demat account

from the National Securities Depository Ltd to trade on the NCDEX just like in stocks.

What are the other requirements at broker level?

You will have to enter into a normal account agreements with the broker. These include the procedure of

the Know Your Client format that exist in equity trading and terms of conditions of the exchanges and

broker. Besides you will need to give you details such as PAN no., bank account no, etc.

What are the brokerage and transaction charges?


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The brokerage charges range from 0.10-0.25 per cent of the contract value. Transaction charges range

between Rs 6 and Rs 10 per lakh/per contract. The brokerage will be different for different commodities.

It will also differ based on trading transactions and delivery transactions. In case of a contract resulting in

delivery, the brokerage can be 0.25 - 1 per cent of the contract value. The brokerage cannot exceed the

maximum limit specified by the exchanges.

Where do I look for information on commodities?

Daily financial newspapers carry spot prices and relevant news and articles on most commodities.

Besides, there are specialised magazines on agricultural commodities and metals available for

subscription. Brokers also provide research and analysis support.

But the information easiest to access is from websites. Though many websites are subscription-based, a

few also offer information for free. You can surf the web and narrow down you search.

Who is the regulator?

The exchanges are regulated by the Forward Markets Commission. Unlike the equity markets, brokersdon't need to register themselves with the regulator.

The FMC deals with exchange administration and will seek to inspect the books of brokers only if foul

practices are suspected or if the exchanges themselves fail to take action. In a sense, therefore, the

commodity exchanges are more self-regulating than stock exchanges. But this could change if retail

participation in commodities grows substantially.

Who are the players in commodity derivatives?

The commodities market will have three broad categories of market participants apart from brokers and

the exchange administration - hedgers, speculators and arbitrageurs. Brokers will intermediate, facilitating

hedgers and speculators.

Hedgers are essentially players with an underlying risk in a commodity - they may be either producers or

consumers who want to transfer the price-risk onto the market.

Producer-hedgers are those who want to mitigate the risk of prices declining by the time they actually

produce their commodity for sale in the market; consumer hedgers would want to do the opposite.

For example, if you are a jewellery company with export orders at fixed prices, you might want to buy

gold futures to lock into current prices. Investors and traders wanting to benefit or profit from price

variations are essentially speculators. They serve as counterparties to hedgers and accept the risk offered

by the hedgers in a bid to gain from favourable price changes.

What happens if there is any default?

Both the exchanges, NCDEX and MCX, maintain settlement guarantee funds. The exchanges have a

penalty clause in case of any default by any member. There is also a separate arbitration panel of

exchanges.


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Are any additional margin/brokerage/charges imposed in case I want to take delivery of goods?

Yes. In case of delivery, the margin during the delivery period increases to 20-25 per cent of the contract

value. The member/ broker will levy extra charges in case of trades resulting in delivery.

Is stamp duty levied in commodity contracts? What are the stamp duty rates?

As of now, there is no stamp duty applicable for commodity futures that have contract notes generated in

electronic form. However, in case of delivery, the stamp duty will be applicable according to the

prescribed laws of the state the investor trades in. This is applicable in similar fashion as in stock market.

How much margin is applicable in the commodities market?

As in stocks, in commodities also the margin is calculated by (value at risk) VaR system. Normally it is

between 5 per cent and 10 per cent of the contract value.

The margin is different for each commodity. Just like in equities, in commodities also there is a system ofinitial margin and mark-to-market margin. The margin keeps changing depending on the change in price

and volatility.

Are there circuit filters?

Yes the exchanges have circuit filters in place. The filters vary from commodity to commodity but the

maximum individual commodity circuit filter is 6 per cent. The price of any commodity that fluctuates

either way beyond its limit will immediately call for circuit breaker.


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Gold

Since ancient times, gold has been accepted and appreciated as a commodity, an investment and an object

of guarantee. Since the development of the financial markets, investors have lost tough with this

wonderful asset called gold, which they now only acts as an asset of last resort. However, in recent years

gold has tremendous demand and interest from investors around the globe. While this outreached rally in

recent price of gold is obviously suggesting that demand surpassed the supply, which is clearly a positive

factor, there are many reasons why people and institutions around the world are once again investing in

gold. Let us look at what are the fundamental reasons behind interest in gold as an investment.

Fundamentals behind Gold price movements

1) Supply and Demand. The ultimate negotiator of any price is supply and demand. Whendemand exceeds supply, prices rise and vice versa. In case of gold, its global demand is growing

much faster than its global mined supply, so the only possible economic resolution to fix this

imbalance is for the price to rise to the extent where demand equals supply. This means that theprice at which now gold trades is the maximum price investors are will to pay to buy gold.

Unlike almost every other business, gold mining is totally dependent on highly local geology.

Since gold is so scarce in the natural world, it is very difficult to find a site with enough gold to

mine economically.

Global gold mined supply is therefore very inelastic (unresponsive to price). Looking at the

complex gold mining and producing structure, it is not unlikely to see gold demand far exceeding

supply for many more years to come.

2) Long Valuation Waves. The general stock markets move in great 33-year cycles known asLong Valuation Waves. Although stocks make horrible long-term investments during the latter

half of these Long Valuation Waves, thankfully commodities and hard assets flourish.

Commodities also move in roughly one-third-of-a-century cycles over time, but they tend to

swing 180 degrees out of phase to the equity valuation waves.

Our current commodities bull launched in 2001, just after the secular top in the general stock

markets capping a mighty equity bull lasting for half of a 33-year valuation cycle. Market history

is very emphatic in demonstrating that the 17 years after this parallel commodities bottom and

equities top should be great for commodities but very poor for equities. Since we are now about

7 years into this usually 17-year trend, this precedent suggests commodities should be strong and

equities weak for another decade or so yet.

3)

Ultimate Alternative Investment. Physical gold is easy to buy, requires no maintenance, and agreat deal of wealth can be secured and stored in a relatively trivial volume. Unlike many other

major commodities, physical gold is not perishable and can be stored indefinitely. Gold has

always been the ultimate commodities investment. Some investors will buy gold to ride the

commodities bull, while others will buy gold to escape the equities bear. This distinction may

seem subtle, but it is very important. Gold is a natural destination for equity flight capital since it

is the ultimate alternative investment in world history.


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Gold is the ultimate alternative investment because it is tangible. It is a real physical asset that

has intrinsic valuein and of itself, never dependent on someone elses mere promises to pay.

Besides, central banks in various countries their currency backed by gold. Hence they always buy

and stock physical gold and maintain gold reserve and print money.

4) Negative Real Rates. When the rate of underlying true monetary inflation exceeds the nominalinterest rates available in the markets, bond investing becomes a losing proposition. Now pleaserealize I am talking about the true inflation rate here, which is the growth rate in broad money

supplies, not the watered-down government-reported inflation numbers.

Free markets hinge on the crucial concept ofmutually beneficial transactions. The bond markets

are where savers, who consume less than they earn, meet up with debtors, who earn less than they

consume, to consummate capital transactions. True free-market prices for this money, or interest

rates, provide a reasonable return to the saver and a reasonable cost to the debtor, a mutually

beneficial transaction. Interest rates should always be set by the free markets instead of the

central banks.

As such, when central banks artificially manipulate interest rates too low, bond investors

gradually pull out of the rigged market. Since they cant beat inflation in bonds, they gradually

migrate into gold so they can at least maintain their purchasing power. Negative real rate

environments are one of the most bullish scenarios imaginable for gold investment demand, since

they drive capital out of bonds and into gold.

5) Free Market in Information. Gold is the ultimate free-market asset and currency. TodaysInformation Age is witnessing the greatest free-flow of information in all of world history. Today

investors around the world can easily learn about monetary history, stock-market history, gold,

the immoral stealth tax of inflation, and countless other crucial core topics essential to long-term

wealth building. Investing in gold is the inevitable outcome of learning more about the

treacherous history of markets and money. The deeper you understand these topics, the more youwill respect and want to own gold.

6) The Rise of Asia. With China destined to become the next superpower while the West wanes,the locus of global economic might is shifting to the Far East. As Asian investors grow wealthier,

their traditional love for gold will ultimately lead to huge amounts of capital shunted into physical

gold as they diversify their investments. Asias hard-working ethic will lead to greater general

affluence, and its aggregate gold investment consumption will utterly dwarf that of the

West. Asia is probably the single biggest gold investment demand story in world history. It

should ultimately dwarf US equity and bond flight capital and could very well lead to the biggest

gold boom the world has ever seen.

Conclusion

If gold is indeed destined to thrive in the years ahead, then fortunes will be won investing in gold and

gold stocks. The bottom line is gold fundamentals remain very bullish today.


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And also realize that the greatest growth in gold investment demand will probably come not out of the US

or Europe, but out of a rapidly-industrializing Asia generating phenomenal amounts of wealth. This is a

global gold bull that is notdependent on the falling US dollar, valuation mean-reverting US stock

markets, or central banks. Golds universal bull market far transcends these provincial American

concerns.


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The Technicals of Gold

Things you should look before trading in gold

Like stocks, even gold has a technical side of the causes that makes the price movements for the gold in

the market. Besides fundamental reasons, there are some technical reasons too that act as a catalyst inprice movements of gold.

There are numerous indicators and parameters one can use to look at as a part of technical analysis of

gold. But I would suggest, you stick to the following key parameters and try to understand the impact of

each on the golds price.

Current and historical global demand for gold Foreign exchange rate Volumes of gold futures contract traded on various exchanges Inflation rate

Now let us try and understand each of these above factors in detail

1) Global Demand for gold: Demand for gold as an investment or a object to guarantee or backyour monetary system in the country are the prime motives that are fueling the global demand for

this asset.

As you could see from the above chart, the demand fell down drastically in year 2009 after rising

for past two consecutive years, mainly due to global recession and liquidity crunch. Although the

price didnt react to this fall in the demand. Actually if you could notice, the demand picked up

and increased in 2008 over 2007. But during the same period, the price gradually reacted and

changed the direction. In fact the price remained almost flat in 2008 and only picked up at the

0.00

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2007 2008 2009

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Pricein

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DemandinTonnes

Global Demand for Gold and its price

Demand

Price


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onset of 2009. Hence we can suggest one thing from the above graph that the price of gold takes

time to react to the change in its demand. There is a lag in the movement of price of gold to its

demand.

Similar findings can be noticed in the above chart representing the domestic demand for gold in India.

As you could see from the above chart the price of gold rose significantly in Q2 over Q1 of 2007. Still the

price over the same period instead of increasing, it slipped further down and rose in Q3 of 2007 and kepton rising without honoring to the demand conditions. Again if you note, in Q1 of 2009 there was a fall in

demand for gold on QoQ basis, but still the price kept increasing and came down only when the demand

increased in next month and afterwards it followed along with the demand.

So from the above two charts, we can conclude that the price of gold at macro level does not react quickly

to the change in demand and follows a time lag.

2) Foreign exchange rate movements: As you know the physical gold is traded on internationallevel among countries with US dollars. Hence the currency fluctuations of the domestic currency

with respect to the US Dollar play an influential role in determining the direction of the gold price

movements. Although this factor is a minor contributor to the price movements, it has a material

impact on the trading investors in the gold futures. Let us now look how the Indian rupee

exchange rate against US dollar been in the past visa vie the gold price.

Ideally when Indian rupee depreciates against US dollar, the price for gold in the domestic market

increases and vice versa. Hence fundamentally if the price for any commodity rises, the demand


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should fall. But again it depend to what extend does currency rate fluctuations brings fluctuations

in price of gold. If there are other factors that play a dominant role in determining the price of

gold, then currency rate fluctuations will not have much of an impact on demand for gold or

change in its domestic price.

In the above chart it is evident that in past 15 months, the domestic prices in Indian rupee almost

perfectly correlated to the international gold prices quoted in US dollars. The correlation on the

above currency exchange rate for INR/USD and Indian rupee prices for the gold comes to 72%. It

means 72% of the times change in the foreign exchange rate has brought about corresponding

change in the domestic prices for the gold. Hence it is very important to look for cues in the

foreign exchange rates to understand the variations in domestic prices it can bring. This helps intrading in gold futures.

44.00

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Domestic Gold prices Vs INR/USD

INR

INR/USD

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It is also imperative to look from a cue in the global gold price and how well is the domestic price

synchronized with international market for gold. Here in the above chart, you could see how well

the Indian rupee gold prices are correlated with the international price of the gold traded in US

dollars. This kind of analysis will help you to find a direction of the gold futures prices by taking

cues from the international market.

3) Gold futures prices and contracts: You as an investor should track the prices of the goldfutures traded on commodities exchanges and their total volume in terms of contracts traded. It

will help you find the price lag, the direction of the price movement and the sentiments of the

trading participants in the gold futures, as in what is the consensus of people have for the gold

prices. Let us now look at what is the usually trend in the futures market with the prices and the

contracts traded.

It is evident from the above chart that the price for the gold has not been very sensitive to the total

volume being traded on the exchange. If you could see, in March 2009 when total contracts

traded increased, the price for the gold futures also increased but very little as against July 2009

sharp fall in the number of contracts traded from April 2009, the price just remained flat and did

not fall along with the contracts traded. Though there have been some spikes in the price of gold

futures, whenever there has been rise in the contracts traded like in November 2009 and in April

2010. Hence we can say that number of contracts do not have any say in determining the price of

the gold futures and you should not be worried about the a fall in contracts in the gold futures, as

the price just dont react to the decrease in the contracts traded.

4) Rising InflationThis is true for any commodity but it has more impact on the gold trading.People consider gold as a safe metal to hedge against the rising inflation.

0

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Gold futures price and contracts traded

Contracts

(in Lots)

Price


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As you can see from the above chart, the price of the gold in Indian market felt along with the fall in therate of inflation. It only picked up when inflation started to increase. Once the inflation felt below 0%, the

price for gold stayed flat as long as the inflation stayed in the negative zone. This suggests that people buy

gold when inflation is rising, hence the price rises.

-2.00%

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Gold

Inflation


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Psychology in gold trading

Among gold investors, the major drivers of the gold price are well-known. From mine production and

central-bank sales to jewelry and investment demand,golds fundamentalshave been and will continue to

be extensively studied. But over the past year, a curious and sometimes dominating new gold driver has

emerged.

US Stock Markets

Historically, secular gold bulls happened during secular stock bears. Over these long time frames (17

yearsor so), persistent stock-market weakness gradually ramped up gold investment demand. But over

the past year, weve seen something quite different from this precedent.

Rather than moving in opposition to the stock markets strategically, gold has often moved with them

tactically. On a day-to-day basis, there has actually been a highpositive correlation between the stock

markets and gold! This peculiar tendency was driven by the sheer craziness of the stock panic. And even

though it is gradually abating today, gold traders can only ignore it at their own peril.

The stock markets newfound influence on gold is two-pronged. The primary way they drove gold into

an odd positive correlation with stocks was through their impact on the US dollar. Thankfully this link

will continue to fade as the post-panic normalization continues. The secondary way is through stock-

market capital chasing gold via the GLD gold ETF. As GLD grows, so will stock-market capitals impact

on gold prices.

US Dollar currency

As the fear surrounded with the stock market, investors fled with their money from stocks to the US

dollar which lead to sudden plunge in the stock market and the gold prices. This event signifies the quest

of investors for safe heaven which they consider US dollar and treasuries fulfill their needs.

Investment Demand

Gold as such is not a great investment asset. If you look at the historical performance, Gold has never

outperformed equities in long run. In fact the CAGR of gold has been poor 1% for past 300 years. The

only reason people like to invest in gold is that they consider it as a good hedging asset against inflation.

People consider it as a safe asset to invest in times of panic. Hence this particular psyche of people

influences the demand and price of gold.

Conclusion

The bottom line is the US stock markets have become a major driver of gold over the past year. And this

is not the traditional inverse secular relationship, but a positively-correlated tactical one. Intense fear in

stocks led to flight capital flooding into the US dollar. The resulting sharp dollar rally hammered gold,

causing it to plunge with stocks. And as recovering stocks led to dollar selling, gold rallied with the SPX.

As it is very unlikely for US dollar to appreciate any further, this leaves a good scope for Gold investment

in coming future.
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Trading in Gold

There are many ways that you can profit from the up and down movements in the price of gold. One way

is to play the long side, which is where you are speculating that prices will rise in the future. Another way

is to play the short side, which is when you are speculating that prices will fall in the future. When you

are going to be trading any of the different commodities it is important to pay attention to the tick that istaking place.

This is where as futures contract is being purchased or shorted it is reflected by a positive up tick or a

negative down tick. What you want to do is enter a position on a negative down tick if you are planning

on going long or a positive up tick on the short side, helping you to enter the futures contract at the right

time. A common strategy used to trade gold is the straddle, which is where you are going long and short

at the same time. The idea is to purchase both contracts at the same price and time frame so that you can

take advantage of the volatility to make money.

Let us now look at different scenarios and how will doing trade in Gold would make you fetch money or

at least minimize your losses.

1) When gold prices are falling

This the chart for gold price traded on a particular date lets say 12th may 2010. It shows the opening

price, the high price for the day, the lowest price for the day and that days closing price. From the above

chat we can see that on 12th

may the gold traded between the range of 18250 and 18175. In such ascenario, what should be your strategy? You should short or sell the gold futures of 100 gms at the

opening price of 18250 and close your short position before the close of the trading session or whenever

the price start moving upwards. This way you could have made Rs 750 (price quoted is for 10 gms and

your contract is for 100 gms, hence you make 75 per 10 gms) per contract.

18120

18140

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18200

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18260

Open Price High Price Low Price Close Price

Price

Price


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2) When there is no direction in the price of goldSimilarly, when during the intra day trading session, when you see that there is not specific direction or

trend in the movement of price, youll have to improvise a different trading strategy.

Like in the case of above chart, it is gold futures expiring on 5th aug 2010. It is clear from the graph, that

the gold price behavior has no specific direction in it and its volatile. As a trader, it becomes really

difficult to make money in such a market condition. Then what can be done in such a scenario? Youshould use a strategy called straddle. It means you should buy and sell the futures contract at the same

price having a stop loss on both the contracts. It is always advisable to wait and observe for any patterns

or direction if you are able to spot in the price movement. Lets say after some observations, you decide

to trade in the futures contract at about 11:30 AM. You use the strangle strategy where you bought and

sold gold futures at the same price of Rs 18535 keeping a stop loss of Rs 18525 on long contract

(basically assuming that the price have bottomed out and there is not much room for price to fall further)

and Rs 18550. Now using this strategy will hedge your position and minimize your losses. When the price

moves up, you will make money on the long (the one that you bought) futures contract and at the same

time you will lose the same amount on the short futures contract. Hence your position is hedged.

Now let us calculate how much profit/loss you have mad at different point in time. At 12 noon, when the

price is at Rs18540, you made Rs 5 (18540-18535) on the long contract and lost Rs 5 (18535-18540) on

the short contract. Both the contracts are still valid as none of them have actually triggered their

respective stop losses. Now at 12:30, the gold is trading at Rs 18558. Now here your short futures

contract got executed at the stop loss price of Rs 18550 which means you made a loss of Rs 15 on the

short contract. On the other hand you have a profit of Rs 23 (18558-18535) on the long contract. Hence

you made a net profit of Rs 8. Once one of your contracts gets its stop loss triggered, it means the price


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movement has found itself a direction and you can hang-on to another contract for a while. In this case it

requires you revise your stop loss slightly on the upside from Rs 18525 to Rs 18535 as the price has move

up in the direction. If you observe, the price again came down and reached Rs 18538 levels at about

12:45. And then it shoot up Rs 15575 about 1 pm. This is the time you get out of the contract as you have

made a profit of Rs 50 (18575-18535) on a single contract which seems to be a big fluctuation in todays

trade ( Todays high is Rs 18580 and low of Rs 18525 which is like a difference of 55). Hence byexceeding at Rs 15575 you have made a net profit of Rs 35 (50-15).

The key to make money in this strategy is the stop loss. You have to be really smart at calculating the

appropriate stop loss for your contracts and revising the stop losses according to changing conditions.

Risk in this strategyThe only risk the trader faces in this kind of strategy is that he will make loss if

one of the contracts gets executed due to triggering of stop loss and the other one obviously is till on. In

such case you could either hang on to the other contract for few more price fluctuations and then exit out

of it or if you are a risk taker, then you can either continue holding your active contract like In the case

above or can even enter into another contract (go short if you are long on the other contract) at the current

price. Thats how you can minimize your risk. Or at the end of day if none of your contracts trigger theirrespective stop loss limit, you will end up making no money as your position will be perfectly covered

and hence no profit no loss for you.


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Silver

Fundamentals of Silver

Silver has been used as a medium of exchange since ancient times. Throughout history, silver coins were,

and still are in many places, essential for internal and international trade.

Silver has been a great store of value since 2003 since it has been actually increasing in value at a much

faster rate than the stock market or bonds. There is now a small, but rapidly growing demand for silver as

a store of value. In 2007, it was about 20 to 60 million ounces, depending on if you trust the statistics of

the Silver Institute, or the CPM groups, respectively. In 2008, investment demand was up to 150 million

oz/year since the introduction of the new Silver ETF, or the raging physical demand of silver as seen by

the doubling of production of Silver Eagles by the U.S. Mint, and respective shortages of that silver

product and others such as scarce 100 oz bars.

Most of the demand for silver today is for Industrial, Healthcare, Jewelry, & photography purposes. More

than is produced each year.

That does not leave much room for investment, or monetary demand, (which is termed a "surplus" by the

groups who publish statistics on silver).

Silver is produced throughout the world but an interesting fact remains that the primary source of silver is

not the silver mines but the other sources of silver. Silver mines produce a small amount of silver that is

25% of the worlds total production and the rest of it is derived as a by-product from gold mines (15%),

copper mines (24%), lead and zinc mines (34%) and other sources. The total production of silver in the

world figures to be around 615 million ounces and Mexico is the leading silver producing country.

Now let us look at each of these segments and their potential demand for the Silver

Industry: Silver has numerous uses and applications in various industries, especially in the electrical

appliances segment. Ordinary household switches, which normally carry high electric current for

electrical appliances from irons to refrigerators, use silver. Silver is the metal of choice for switch

contacts because it does not corrode, which would result in overheating, posting a fire hazard.

Industrial demand has grown with the increasing use of electronics and electrical uses. From mirrors to

paints, and dental alloys to coins, silver is used in numerous areas. Today industrial uses account for 44%

of worldwide silver consumption.

Healthcare: Silver contains anti-bacterial properties and researchers have found that silver can be used as

a biocide. Burn units in hospitals use bandages that release silver ions that help with healing and reduce

the need for frequent dressing changes

Research shows that silver promotes the production of new cells, increasing the rate of healing in wounds

and bone. The regeneration of whole areas of lost skin is being accomplished by the use of silver

treatment.

Research indicates that silver-based purification systems are effective in disinfecting water.


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As part of a growing trend in silver-based bandage usage, two wound dressing makers, Curad and

Johnson & Johnson, have introduced products into this growing field.

For the health care professional market, Johnson & Johnson has introduced their SILVERCEL

antimicrobial alginate dressing, providing the protection of silver and the absorption of alginate.

Jewelry and Photography:

126 million troy ounces of silver were used worldwide in 2007 for photography. Although a wide variety

of technology is available, silver-based photography is expected to dominate the market for the

foreseeable future due to its superior definition and low cost. Over 1.5 billion silver oxide-zinc batteries

are supplied to world markets yearly, including miniature-sized batteries for watches, cameras and small

electronic devices, and larger batteries for tools and commercial portable TV cameras.

India is the biggest and still an emerging market for silver jewelry market in the world. Worldwide use of

silver for jewelry markets amounts to over 163 million troy ounces in 2007.The array of large silver

pendants and other jewelry available in the market today is quite mind boggling! Silver pendants come in

a wide range of styles. The most common style incorporates one or more gemstones. The pendant canhave a single large gemstone that forms the focus of the pendant and the sterling silver setting can be

simple and elegant or intricate and ornate.

The present day standard for jewelry is Sterling silver. Sterling silver is an alloy of silver and copper,

with the silver content being at least 92.5 percent.

New Uses of Silver creating new demand: Research on silver use in fuel cells and catalysts is well

underway by the auto industry. Silver has a significant cost advantage when compared to platinum.

The electronic industry is continuing to reduce the amount of gold used in bonding wires and plating. The

industry is replacing it with silver, a cheaper and equally durable substitute.

Silver coins that are investment grade 99.9% pure are permitted to be included in Individual Retirement

Accounts

Conclusion

Silver enjoys the dual role of an important industrial as well an investment metal. Silver's role in

photography, numerous industrial applications, silverware and jewelry, and medicine, is expected to rise

as the global economy continues to rebound.

There are many potential new uses of silver, which would lead to increased silver offtake in future years.

Fuel cells, silver-based wood preservatives, and superconductivity, are some of the innovative potentialnew uses for silver.

Today, millions of people throughout the world recognize silvers intrinsic value and have made it

popular as an affordable investment.


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Although silver is relatively scarce, it is the most plentiful and least expensive of the precious metals. For

the average investor, silver can be an effective means of diversifying investment assets and preserving

wealth against the ravages of inflation.


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Technical drivers of Silver

Like any other commodity, price of Silver is also influenced by its demand for various purposes and its

total available and potential supply. Besides this fundamental reasons, there are few more factors that

indirectly affect silvers demand and hence its price. Here are some identified factors

Foreign exchange Oil price Industrial output Gold prices.

Let us first understand the basic factors i.e. demand and supply of silver and their effect of the silver

prices.

Demand and Supply and price of Silver: As the basic micro economics states, when demand is morethan the supply of any commodity, the price of that commodity should be high or should be rising and

vice versa. But it seems the story is completely different in case of the Silver.

Well as could see fro the chart, that the demand has been consistently falling short of total available

supply of silver since 2002. But still there has been consistent rise in the price of silver since 2003. Well

there has to be some reason why would price rise despite fall in demand against the supply. Well therecould possibly be only two reasons, both of them not available in the above chart. First, being there has

been growing demand for silver from the unconventional uses like industries, photography, etc. Or

secondly, there are other factors that are affecting the price of the silver to behave in this manner.

Let us try to analyze if there are any other areas or segments from where there is a rising demand for

silver.


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Well it is clearly visible from the above chart, that the new area where there has been rising demand forsilver is the investment and hedging needs of the investors. It has been the investment demand for silver

that has single handedly pushed the price up, since 2004. The major buyers of the silver for investment

purpose are the hedge funds and investors investing in the silver ETFs.

Foreign exchange movement: Since Silver is a globally traded commodity and is mined and consumed

by different countries in the world, it is priced and traded in the US dollar on various exchanges of the

world. Hence the foreign currency movement of US dollar against your domestic currency naturally

affects the price of the silver in your country, just like any other metal commodity. But the only valuable

insight you as an investor should be looking to get out of such analysis is to find out two things about

foreign exchange movement and silver price, First the relative strength in their relationship that makes

silver price to react to the change in currency fluctuation and second is the time lag, if any for silver price

to react to the change in the foreign currency market. Let us look at historical data to answer our

questions.


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As it is evident fro the above chart, the silver price does get influenced by the fluctuations in the Indianrupee exchange rate. They both share a strong negative relationship with a correlation of -0.84, which

means that 84% times the silver price has changed to the change in the foreign exchange rate of rupee.

And the negative sign indicates that they have an inverse relationship, meaning that whenever the Indian

rupee depreciated, the price for silver has increased and vice versa.

Crude oil prices to Silver: Like in case of most of the commodities, Silver also shares a strong

relationship with the crude oil price movements. Oil is demanded in huge quantity, which is even bigger

than the silvers production. Hence it becomes important factor influencing the consumption of other

commodities like silver and thus the price.

Looking at the chart, it is little difficult to conclude that which direction does the silver price move on the

change in the price of oil. For the first quarter of 2009, the silver price fell whenever the oil prices went


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up. Then from Sept 2009 onward they showed a strong positive relationship and silver price movement

replicated the move of oil prices. Overall they have a strong positive correlation of 0.85.

Industrial Production in India: Since silver is used for industrial production in various sectors and for

various products, it is evidently dependent on the industrial performance and demand outlook. The

performance of industries output is measured using index of industrial production (IIP) number which is

published on monthly basis.

From the above chart, it appears that the silver price shares a strong relationship with the IIP. They have a

strong correlation in the movement of price and the index number of 0.86. If you take a closer look at the

chart above, you will be able to find an important trend in the movement of price of silver with the IIP.

The price of silver reacts to the change in IIP in the time lag of 1 month. For example, in the months ofFebruary and March 2009, IIP fell below 0% i.e. posted a negative output, but in the month of February

2009, price of silver increased and decreased only in Mar 2009, to react to the fall in the IIP output.

Similarly, the IIP output increased in April 2009 but silver price kept falling to react in a months lag to

the fall in IIP output. Hence there is a 1 month lag in the change in price of silver to the change in IIP

output. You as an investor can surely make use of this relationship in taking your trading positions.

Gold demand and prices: As you all know, investors never appreciated Silver as a metal for investment.

It was and is still considered as a secondary investment commodity over gold. Like crude oil, Gold also

influences the price of the silver and even the investment demand for silver.


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As you can see from the above chart both gold and silver move in the same direction, as expected. Butsilver appears relatively volatile. The correlation between gold price and silver is a whooping 0.95. It

means you can safely bet on silver based on the price movements of gold. In fact the volatility of silver

can be of great trading opportunity for taking short-term positions by looking at the gold prices.


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Trading in Silver

In India you can trade in commodities only by using futures. There are no other derivative instruments

available in the Indian commodities market. There can be numerous trading strategies one can think of.

Let us try to look at different scenarios and understand what trading style or strategy one should adopt to

gain in each of those situations.

1) When the price of Silver is on the rise: It means the sentiments are bullish and generalconsensus is that the prices for silver will rise for near future to come. In such a case you should

enter into a long futures contract of silver i.e. buy silver futures. Lets say you buy silver futures

on 3th june 2010 at a price of Rs 28000 with expiry of 20th june 2010 on NCDEX. The minimum

lot size of the silver contract is 30 kgs. You have to keep aside a minimum margin in your trading

account with the broker. The margin requirement varies from 3% to 20% depending upon the

volatility of the commodity. Lets say the margin requirement for silver is 10%. It means you will

have to keep aside Rs 84000(28000X30X0.1). Let us now see how your long futures position

look on different days and at different price.

Date EOD_Silver

price

Lot size (in

Kgs)

Profit/(loss)

4-Jun-2010 28150 30 4500.00

5-Jun-2010 27945 30 (1650.00)

20-Jun-2010 28345 30 10350.00

As you can see from the above table, on the next day of your purchase of the futures, you made a profit ofRs 450 ((28150-28000)*30) on your investment of Rs 84000 (initial minimum margin). Similarly, on 5th

june 2010, you incurred a loss of Rs 165 as the futures price felt below Rs 28000 (i.e. your purchase

price). As the contract expired on 20th june 2010, you made a total profit of Rs 1035 on your initial price

of Rs 28000. Hence your net return on investment (ROI) came to 12.3% (1035 on 84000) in 16 days. This

feature of leverage actually helped you to earn 10 times more return than you would have earned had you

actually purchased 30 kgs of silver. Because you would have invested Rs 840000 and still would have

earned same profit of Rs 10350.

2) When the price of Silver is falling: It means the sentiments are bearish and general consensus isthat the prices for silver will fall for near future to come. In such a case you should enter into a

short futures contract of silver i.e. sell silver futures. Lets say you sell silver futures on 3th june

2010 at a price of Rs 28000 with expiry of 20th june 2010 on NCDEX.


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Date EOD_Silver

price

Lot size (in

Kgs)

Profit/(loss)

4-Jun-2010 28220 30 (6600.00)

5-Jun-2010 27945 30 1650.00

20-Jun-2010 27860 30 4200.00

As you can see, you initially made a loss of Rs 6600 on your short position in silver futures since the

price went above Rs 28000 (Remember, when you short or sell futures, it is favorable for you if the price

of silver falls below your purchase price). At the end of expiry date you had a favorable position on your

short position and earned a profit of Rs 4200, clocking you ROI of 5% in 16 days.

Before adopting any trading position, you should look at various indicators covered in the previous

chapter to determine the price movement in silver.

3) Trading strategies using technical indicators: We saw few technical factors that influence theprice of silver to some extent. We even saw the kind of relationship each of those factors share

with silver. Let us now formulate a strategy using couple of those indicators. Let us consider

foreign exchange and IIP number as the indicators for predicting silvers price.

As we have seen that silver and foreign exchange rate share a negative correlation and silver and IIP

output numbers share positive correlation. Moreover, silver moves in a one month lag to IIP numbers.

Using these factors you can take a month long futures position in silver.

Conditions for our strategy: You see rupee has been depreciating in past 2 to 3 months and there are

news that it rupee will be weak against dollar for coming few months. It is safe to take a long position in

silver futures.

Industrial production has been posting a strong performance for past 3 months. It indicates that silver

price will also go up for next month, due to one month lag to the change in IIP numbers. Hence even this

indicator is favorable in taking a long position in futures.

Thus by considering both the indicators in totality, we reach to a decision that silver price is set to

increase over a period of 1 month and thus probable trading strategy would be to go long on futures.


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Copper

Fundamentals of Copper

Introduction

Copper is an industrial metal that is mainly used in building construction (electrical and plumbing).

Copper is an excellent conductor of electricity and is very resistant to corrosion.

Copper is often considered an accurate indicator of economic growth. An economic expansion is usually

present or beginning if demand for copper is increasing.

The largest producers of copper are Chile, Peru, South Africa, North America, and Russia. In the US,

Arizona is responsible for about 65 percent of production. The US, Russia, and Japan are the three largest

consumers of copper

Copper and copper alloys meet the challenges of modern life in many ways. Often seen in plumbingsystems and good quality roofing and cladding, they are also frequently unseen providing essential

services inside equipment in houses, offices, commercial and industrial buildings. They are amongst the

most necessary materials needed to provide the means to keep home, commerce and industry running.

Main uses of copper

Electrical Applications

Approximately 65% of copper produced is used for electrical applications. Copper has the highest

electrical conductivity of any metal, apart from silver, leading to applications in:

Power generation and transmission - generators, transformers, motors, and cables provide and

deliver electricity safely and efficiently to homes and businesses.

Electrical equipment - providing circuitry, wiring and contacts for PCs, TVs and mobile phones.

Copper has a key role to play in energy efficiency - the judicious use of 1 tonne of copper in the energy

sector makes it possible to reduce CO2 emissions by 200 tonnes per year on average.

The top two market segments, power utilities and telecommunications, account for almost two-thirds of

the copper it consumed by this market. A key driver for power utilities is electrical distribution and

control, which includes transformers, switchgear and industrial circuit breakers, and industrial controls.

Electrical distribution and control in turn is driven by both residential and nonresidential construction

Construction

25% of all the copper produced is used in buildings - for plumbing, roofing and cladding. Copper

provides light, durable maintenance-free structures that are naturally good looking, long lasting and fully

recyclable. Copper's naturally antimicrobial properties can be exploited in hygienic surfaces for hospitals

and healthcare facilities. Copper is also used on a lager scale for residential as well as non-residential

construction purposes. As the real estate market is on the growth track, more and more demand for copper

could be expected fro this sector.


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Transport

Trains, trams, cars and lorries all need copper and transport accounts for 7% of copper usage. The high

purity copper wire harness system carries the current from the battery throughout the vehicle to

equipment such as lights, central locking, on-board computers and satellite navigation systems. Electric

super trams in cities such as Manchester, Sheffield and Croydon, provide clean, efficient transport

powered by electric motors. The overhead contact wires are either copper-silver or copper-cadmiumalloys.

Other

The remaining 3% is used for coins, sculptures, musical instruments and cookware


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Technicals of Copper

World demand for copperhas been rising much faster than the growth in market supply that result from

new discoveries of copper and increased extractionrates of known reserves.

The world supply of and demand for copper

Most copper ore is mined or extracted as copper sulfides from large open pit mines in copper porphyry

deposits that contain 0.4 to 1.0 percent copper. Over 40 per cent of world copper supply comes from

North and South America; 31 per cent from Asia and 21 per cent from Europe. Chile is the worlds

biggest supplier of copper (it provided 35 per cent of the total in 2003 with Indonesia and the USA each

contributing 8 per cent).

Copperan example of derived demand

Because copper is malleable and ductile, there is a huge industrial demand for copper. Like most metals

the demand for it is derived in part from the final demand for products that use copper as an important

component or raw material. Nearly 50 per cent of the demand for copper comes from the construction

industry, and 17 per cent is from the electrical sector. Copper is also used extensively in heavy and light

engineering and in transport industries. From copper wire to copper plumbing, from the use of copper in

integrated circuits to its value as a corrosive resistant material in shipbuilding and as a component of

coins, cutlery and to colour glass, copper has a huge array of possible industrial uses.

The volatility of commodity prices

As we have seen, price volatility stems from a lack of responsiveness of both demand and supply in the

short term, i.e. both demand and supply are assumed to be inelasticin response to price movements.

The low price elasticity of demand for copper usually stems from a lack of close substitutes in the market.For some products and processes, aluminum or plastic may act as a substitute to copper for some uses, but

there are costs and delays involved in switching between them.

The elasticity of supply is also low. Supply is usually unresponsive to price movements in the short term

because of the high fixed costs of developing new extraction plants which also involve lengthy lead-

times. If existing copper mining businesses are working close to their current capacity then a rise in world

demand will simple lead to a reduction in available stocks. And as stocks fall, so buyers in the market will

bid up the price either to finance immediate delivery (the spot price) or to guarantee delivery of copper in

the future (reflected in the futures price). It can take huge price swings in the market for supply and

demand to respond sufficient to bring the market back to some sort of equilibrium.

The demand for copper will continue to remain strong provided that the global industrial sectors continue

to expand production. But if price remain high then we can expect to see some shifts occurring. For a

start, copper can be recycled although the costs of doing so are often high and there are fears concerning

the negative externalities arising from the pollution created by trying to recycle used copper. These

external costs include atmospheric emissions from recycling plants and waste products dumped into

rivers. Nonetheless price theory would predict an increase in demand for scrapped copper and perhaps

a substitution effect away from copper towards aluminium. And in the medium term high prices and


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emerging new technologies may cause an even bigger shift in demand away from copper based products.

Plastics provide lower material and installation costs for businesses. And the take off in wireless

technology and fibre optics will also have an impact.

And higher prices might also be the stimulus required for an expansion of copper ore production as

supply responds to the incentives of increased potential revenues and profits. In recent years, copper

mining production has fallen short of expectations

Growth in Emerging economies

The major driver for the demand for copper in past decade has been the emerging economies like China,

India, Brazil and so on. According to reports, the Bric nations are expected to grow at the average growth

rate of 5% till 2020. This growth will need lot of infrastructure development like constructions, real estate

and other industrial development to sustain this growth rate. Due to which there will be high demand for

copper as it is one of the basic components used in these sectors.

Over half of the global GDP contribution comes from emerging economies. The continued growth of the

world economy will fuel the growth in the demand for copper.

As you can see from the above chart, emerging economies have always outperformed the world economy

in the past decade and are likely to continue to outperform for next decade or so.

Global Demand and Supply of copper

The supply of copper has always been more than the total demand till 2009. This is largely due to

slowdown in the global economic activity, which dragged the total demand for copper. But this slow


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down even affected the supply side as the cost of production and mining copper shoot up which made lot

of companies to delay their capacity expansion plane. Hence more or less the demand supply condition

has remained unchanged to that of pre-recession period. Although the emerging economies like China and

India are expected to recover faster from the slowdown and regain the long term growth track. Hence the

demand for copper is expected to rise faster than the supply side improvements in near term by 2015.

Copper consumption in China

Chinas demand for copper is estimated to double by 2015 to 8Mt. What is driving the demand

specifically? We know that urbanization of China is the leading contributor to this demand but the

unknown factor really is just how big the infrastructural requirement

Commodities Trading in India

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