A PROJECT REPORT ON

“COMMODITY MARKETS”

SUBMITTED BY

MR. NISHIT MUKESH DHOLAKIA

FOR THE DEGREE OF

THE BACHELOR OF MANAGEMENT STUDIES

UNIVERSITY OF MUMBAI

UNDER THE GUIDANCE OF

PROF. KINNARRY THAKKER

S.I.E.S. COLLEGE OF SCIENCE, ARTS AND COMMERCE

SION (W), MUMBAI – 400022

ACADEMIC YEAR 2007-2008

1

DECLARATION

I, Mr. Nishit Mukesh Dholakia studying in the Third Year of

Bachelor of Management Studies course in the academic year 2007-2008 at

S.I.E.S. College of Science, Arts and Commerce, Sion (West), hereby

declare that I have completed the project titled “COMMODITY

MARKETS”, as a part of the course requirement of Bachelor of

Management Studies of University of Mumbai.

I further declare that the information presented in this project is true

and original to the best of my knowledge.

Date:

Place: Mumbai Mr. Nishit Mukesh Dholakia

2

CERTIFICATE

I, Prof Kinnarry Thakkar hereby certify that Mr. Nishit Mukesh Dholakia studying in

the Third Year of Bachelor of Management Studies course in the academic year 2007-2008

at S.I.E.S. College of Science, Arts and Commerce, Sion (West), hereby declare that I have

completed the project titled “Commodity markets”, under my guidance in the academic

year 2007-2008.

I further declare that the information presented in this project is true and original to the best

of my knowledge.

Date:

Place: Mumbai

Prof Kinnarry Thakkar

College Seal PRINCIPAL

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ACKNOWLEDGEMENT

I would like to express my gratitude and sincere thanks to my Project Guide Prof

Kinnarry Thakkar, S.I.E.S College of Science, Arts and Commerce for instilling confidence

in me to carry out this study and extending valuable guidance and encouragement from

time to time, without which it would not have been possible to undertake and complete this

project.

I also wish to extend my appreciation to the management and staff of my college

especially the chief co-ordinator of BMS Mr. Rajkumar Bagadia and our principal

Dr. Harsha Mehta, for their kind co-ordination and support. Last but not the least my

colleagues for their valuable comments and suggestions for making this a cherishable

experience for me.

Nishit Mukesh Dholakia

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Executive summary

Commodity markets are the basic necessities of everybody but due to the modern

technology, globalization, and liberalization, commodity markets can go across the world

with regards to commodity trading. Commodity markets are maturing day by day in

today’s market. Commodity market is an important constituent of the financial markets

of any country. Commodities are amongst the oldest market of the world. Commodities

can be classified into gold, silver, nickel, zinc, copper and so on. There are so many

commodities emerging at a very quick pace.

Investing in commodities is a very good option, but there are many risks involved in it as

involved in any investment. In order to avoid such risks the investor should carefully

examine the market before investing anything. The investor should keep regular check of

the market as the market fluctuates anytime so he should be careful about it as, if he

losses concentration he can incur a big lose. So investing in commodities is risky but

useful. There are many commodities for investing but the most likely ones are Gold,

Silver, soybeans castor oil and so on.

The future of commodities is very bright. Demand is increasing rapidly. Demand for a

wide variety of commodities covering food, fibre, metals and energy is certain to expand.

Competition from imports is increasing, Whether or not domestic producers like it, the

competition from imported commodities is inevitable. Competition is now driving

smaller players to explore opportunities for merger. There are risks involved because of

the increasing demand and pressure from the importers so the investors should invest by

emerging with an experienced broker who has every idea about the market happenings.

It is this emerging scenario that the investors must gear themselves to face.

HERE IT IS THE QUESTION OF INVESTING MONEY AND WHERE MONEY IS

INVOLVED RISKS TEND TO FOLLOW THEM.

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INDEX

Content

no

Particulars Page numbers

1] Introduction 7 – 10

2] Objective, Methodology &

Limitations

11 - 12

3] Need for the study 13 - 19

4] Commodity markets &

investing in commodity

markets

20 - 27

5] Trading in commodities 28

6] Commodities and types of

commodities

29 - 63

7] The future of commodities 64 - 66

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Chapter 1

INTRODUCTION

Linguistically, the word commodity came into use in English in the 15th century,

derived from the French word "commodité", meaning today's (2000) "convenience" in

terms of quality of services. The Latin root meaning is commoditas, referring variously to

the appropriate measure of something; a fitting state, time or condition; a good quality;

efficaciousness or propriety; and advantage, or benefit. The German equivalent is die

Ware, i.e. wares or goods offered for sale. The French equivalent is "product de base"

like energy, goods, or industrial raw materials.

India, a commodity based economy where two-third of the one billion population

depends on agricultural commodities, surprisingly has an under developed commodity

market. Unlike the physical market, futures markets trades in commodity are largely used

as risk management (hedging) mechanism on either physical commodity itself or open

positions in commodity stock. For instance, a jeweler can hedge his inventory against

perceived short-term downturn in gold prices by going short in the future markets.

A commodity may be defined as an article, a product or material that is bought and sold.

It can be classified as every kind of movable property, except Actionable Claims, Money

& Securities. The term commodities are often used to describe commodity trading. It can

be assumed as such terms which describe the markets.

Commodity markets are markets where raw or primary products are exchanged. These

raw commodities are traded on regulation commodities exchanges in which they are

bought and sold in standardized contracts. It covers the physical products or goods (corn,

soybeans, gold, crude oil, food, etc.) markets but not the ways that services, including

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those of governments, nor investment, nor debt can be seen as a commodity. It is the

relationship between simple commodity money and the more complex instruments

offered in the commodity markets. Commodities are those which we come across in our

daily life. Such markets are social institutions which facilitate exchange of goods for

money.

A market that transacts business with commodities of all nature referred as commodity

markets. Commodity market was initially meant only for agricultural products and that

too in the local market. Industrializations, globalizations, technological advancements,

increasing demand from consumers and intense competition from other players has paved

way for commodity markets to cross boundaries and break barriers with regards to the

commodity traded. Commodity markets deal in the trade of commodities like gold,

cotton, crude oil, orange juice etc. Many items both perishable non perishable, finished

goods, raw materials and semi finished goods will be traded in this market at the

international level. Commodity market does not necessarily require you to buy or sell the

commodities but you can even exchange them.

Commodity markets are maturing as a key investment option. Corporates with exposure

to commodities are using the commodity markets as a hedging option whereas the

investor community is diversifying their investments in equity markets with exposures to

commodity markets. Banks are trying to understand their risks in corporate credit and

trade finance portfolio with large commodity exposure. CRISIL Research aims to address

these needs through its new research solution CRISIL Commodity View.

The dynamic growths of commodities prices in recent years have put them in the center

of the scope of many investors’ interest. This is especially the case with oil, gold, silver

and industrial metals like copper, aluminum, zinc or nickel. The relatively high price of

raw materials has a significant impact on the condition of the global economy.

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Commodities are amongst the oldest market of the world. Their beginnings date back to

ancient times, and the first organized commodities exchanges were organized in Western

Europe in XII century. The history of financial markets has been marked by the first

infamous crash of the so called “tulip mania”. Development and burst of the speculative

bubble in XVII century markets in Amsterdam and London was the first, but not the last

example of the interplay between greed and fear dominating the process of speculative

trading. The development of new technologies that occurred at the end of XX-century has

resulted in the dynamic growth of volumes traded on commodities markets. Commodities

and their derivatives are quoted both on Over the Counter and regulated stock exchange

markets. Brokerage house X-Trade Brokers Trading offers the possibility to trade

contracts for difference on a broad range of commodity markets. Oil, gold, silver,

platinum, copper and many more are available for real trading. Real time quotes, charts

and analysis come as standard along with the real trading platform that we provide for

our clients.

Commodity market is an important constituent of the financial markets of any country.

It is the market where a wide range of products, viz., precious metals, base metals, crude

oil, energy and soft commodities like palm oil, coffee etc. are traded. It is important to

develop a vibrant, active and liquid commodity market. This would help investors hedge

their commodity risk, take speculative positions in commodities and exploit arbitrage

opportunities in the market.

The commodity market has evolved significantly from the days when farmers hauled

bushels of wheat and corn to the local market. In the 1800’s, demand for standardized

contracts for trading agricultural products led to the development of commodity futures

exchanges. Today, futures and options contracts on a huge array of agricultural products,

metals, energy products and soft commodities can be traded on exchanges around the

world.

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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 equity markets, 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.

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Chapter 2

Objectives

The Objectives of the study are:

1. To study the types of commodities traded in commodity market.

2. To analyse the need for investing in commodity markets.

3. To study the market characteristics of selected commodities.

4. To study the future of commodity market.

Methodology

The data has been collected secondary primary as well as primary sources:

The main is collected from the Secondary Source which is as follows:

1. Published records of mcx

2. Websites

3. Books

The primary source of information has been obtained on interacted with the

officials of mcx [multi commodity exchange]

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LIMITATIONS

The study is restricted to only few commodities, as the data for certain commodities

was not available

The study was concentrated mainly on Indian scenario.

The majority of the data is collected from the secondary source of data.

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Chapter 3

Need for the study

The turn of the century has brought upon a change of guard for the financial markets.

The general stock markets peaked and a new secular commodities bull was born. Even

though many have had to endure the pain of a bursting stock-market bubble, the global

economy has been thriving since the turn of the millennium and people in the future will

look back on the 21st century and tag it as the consumption age.

Globally this consumption is not necessarily that of excess or overindulgence. Rather it

may be considered more or less a movement of economic progressivism. Lending part to

this trend is the fact that our global population is growing at a blistering pace and will

continue to do so for years to come. Many people overlooked the incredible milestone

that was attained in 1999.

To put this growing and changing world into perspective, it was only about 200 years ago

that the global population passed the one billion mark. According to the U.S. Census

Bureau it only took another 118 years for the global population to double, reaching two

billion in 1922. It then took 37 years to reach three billion, 15 years to reach four billion,

13 years to reach five billion and only 12 years to reach six billion.

Today the half-way mark to the next billion has already past. Now with 6.5 billion

potential consumers living in an era in which considerable industrial and technological

advances are demanding more resources than ever, it’s no wonder global demand for

commodities has soared. In this high-tech world, commodities are zealously sought after

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in order to maintain, support and develop this growing population. Because of this,

commodities of all types are soaring in value as their availability and economics are

continually being challenged. Simply put, supply has not been able to keep up with

demand.

This massively increasing population has contributed to an increase in consumption in

virtually all goods and services, and in turn has contributed to the robust economies that

are seemingly necessary in order to maintain status quo. Almost not surprising, GDP in

the U.S. has increased ten-fold since 1972, China has seen a ten-fold since 1978 and the

U.K. has seen its ten-fold since 1976. The macroeconomics here tell an incredible story

in which commodities have and will play a large part now and in the future.

It is important for everyone to understand why we are in the midst of a commodities

craze from a socioeconomic perspective, if for no other reason than to understand how it

may affect their everyday lives. It is especially important to understand this if you are an

investor. Investors and speculators who have taken part in the commodities bull thus far

have scored incredible gains if they have played the upside of this secular trend.

It’s not too late though to continue to profit from this commodities bull. To this day

commodities of all sorts are still in the midst of major economic imbalances. Global

demand for both soft and hard commodities is on the rise and supply is struggling to keep

up. It is the prudent investor or speculator who is able to recognize this pattern before it

corrects itself and is able to leverage his capital to take advantage of the upside.

Our task now is to determine which commodities to focus on from an investment

perspective. Now depending on whom you ask and where you look, the definitions for

soft and hard commodities tend to range across the board. Soft commodities tend to have

a renewing characteristic. Crops can be re-grown, and typically in the same spot as the

previous crop. And meat commodities are the result of animal breeding that has

remarkably accurate forecasting. Softs are integral in this bull market, but are not the

major player.

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Commodities such as coffee, cotton, cocoa, orange juice and hogs are examples of soft

commodities and are all non-finite in nature. As long as a global ice age doesn’t

miraculously strike the earth, crops will always be grown. And it is doubtful that cows,

pigs and chickens will ever become extinct.

Now there are external factors that can influence the pricing of these soft commodities

and they are certainly not exempt from supply and demand pressures. Weather, disease,

geopolitical unrest and labor are examples of some of these factors. But when an

economic imbalance presents itself, the fact that these commodities are renewable

typically avoids a pushing of the panic button.

Even so, soft commodities continue to play a large role in the overall futures markets and

are not exempt from the volatility most people associate with commodities. Farmers need

to lock in prices and speculators play the game to try and capture profits. Hards consist

mainly of energy and metals and require extensive capital expenditures in order to

retrieve these commodities from the earth. These commodities are finite in nature and

have limited resources. Hards have been on a tear the last four years, have captured

mainstream media attention and are the major player in this secular commodities bull

market.

Precious metals, crude oil and natural gas are not the only commodities that have taken

part in this bull. These commodities do command the lion’s share of attention but let’s

not overlook those others that play an integral part in the global economy. Below are

many of the popular hard commodities and their bull-to-date highs since the beginning of

2001.

15

- Aluminum +94%

- Gold +124%

- Silver +142%

- Platinum +159%

- Zinc +220%

- Lead +252

- Copper +280%

- Crude Oil +300%

- Nickel +302%

- Butane +330%

- Propane +346%

- Heating Oil +360%

- Gasoline +578% (+333% not including Katrina/Rita 3-day spike)

- Natural Gas +807% (+429% not including Katrina/Rita spike)

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As it is seen, these hards have had quite a run thus far. But in addition to these above,

there are many other soft and hard commodities that trade in the futures markets. As you

can imagine, barring the occasional bear-market rally, commodities have been out of

favor for quite some time. Today’s commodities bull is finally reflecting the importance

of commodities and the realization that in this growing global economy the resources that

support it are not to be taken for granted.

Sugar is the truly interesting story among the softs. It has performed very well in this

bull market, but for reasons that would exhibit the characteristics of a hard commodity. It

recently hit a 25-year high not because more people are putting sugar in their coffee, but

rather due to the huge increase in ethanol demand.

Sugar happens to be a common compound in ethanol production with well over 50% of

the global ethanol supply coming from it. Ethanol consumption has significantly

increased over the years and its demand is expected to continue to rise sharply in the

years to come. As more and more countries are implementing ethanol as an alternate

energy source we are now faced with a supply-deficit in sugar.

Even with sugar as the stand-out soft commodity, it is evident that hard commodities are

the strongest of the group and have been pulling their weight, hoisting the overall index.

Hard commodities now become more of a focus and the results going forward should

reflect more on their performance. A dollar today has nowhere near the purchasing power

it did in 1981. And it is necessary to highly consider this when the true value of a

commodity is involved.

Now that we’ve established the fact that commodities have enormous potential even at

the nominal highs we are seeing today, how does an investor jump on board and leverage

his capital in order to profit from this? Softs are nowhere near as exciting as hards, but

regardless, softs are just plain more difficult to invest in.

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Well, if you look real hard you will find various hedge funds out there that have

recognized sugar’s potential and have thrown capital in its direction. But ultimately for

the common investor there is really not an easy way to get a piece of the pie. Soft

commodities are almost exclusively traded in the futures markets. You would be hard

pressed to find a publicly traded company that produces a soft commodity and is exposed

to its price fluctuations.

Hard commodities, on the other hand, offer wonderful opportunities for investors to join

the party. Because of the massive capital expenditures and operating costs necessary to

produce hard commodities, and because funding is always a challenge, most producers

and servicers of these sorts are publicly traded in the stock markets. Its custodian’s goal is

to reflect the commodities that are most important and influential in today’s economy.

Energy and metals are such commodities today and are currently faced with serious

economic and fundamental challenges.

Demand for these resources has reached unprecedented territory in order to service

today’s global economy. And the supply that is being mined and drilled is not only slow

to meet this demand, but for many of these commodities the reserves for future supply are

quickly dwindling with new discoveries becoming increasingly difficult to find.

The reason you see these immense gains in hard commodities is because of the now and

future economic imbalances that present themselves. For many years capital has poured

into the general stock markets with focus on tech stocks, and though commodities need

significant funding in order to sustain future supply, the funds had just not made it their

way. For many years exploration budgets were slashed and new discoveries were few

and far between. This brazen ignorance of commodities for so long has finally

commanded the world’s attention.

It’s going to take many years for commodities producers to ramp up output in order to

meet this increasing demand and even more to renew and build reserves for future

18

sustainability. Because of this prices will most likely continue to rise as much-needed

capital is directed towards these commodities producers.

Now, the wonderful thing about these hard commodities producers is that most are

publicly traded companies. Investors and speculators indeed have the opportunity to

leverage their capital at the epicenter of this global commodities shortage.

Some commodities producers are more leveraged than others to their underlying product,

but ultimately the stocks of these producers can be looked at as non-expiring call options

in their various sectors that should continue to soar as this secular bull market in

commodities climbs.

The stocks for many of these companies have produced gains far better than those of their

underlying commodities thus far. And as the prices of their products rise as we expect

them to, if they are leveraged correctly so will their profits rise. The continued

appreciation of their stock price will reflect such.

So as an investor or speculator looking to invest in these stocks, which ones do you

choose? There are literally hundreds upon hundreds of stocks that fall into this category.

As the short-term cycles within a long-term trend flow and ebb with upward momentum,

it will be profitable to invest and speculate in metals and energy-related stocks.

The bottom line is commodities are still in the early part of a secular bull market. The

global economy is starved for commodities and producers are struggling to keep up with

demand. It will take many years for today’s economic imbalances to correct themselves

and prices should only continue to rise.

The best way for investors and speculators to leverage their capital in order to take

advantage of this commodities bull market is to invest in the stocks of the companies that

produce these commodities.

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Chapter 4

Commodity Markets - To or Not to Invest?

A market that transacts business with commodities of all nature referred as commodity

markets. Commodity market was initially meant only for agricultural products and that

too in the local market. Industrializations, globalizations, technological advancements,

increasing demand from consumers and intense competition from other players has paved

way for commodity markets to cross boundaries and break barriers with regards to the

commodity traded.

Commodity markets deal in the trade of commodities like gold, cotton, crude oil, orange

juice etc. Many items both perishable non perishable, finished goods, raw materials and

semi finished goods will be traded in this market at the international level. Commodity

market does not necessarily require you to buy or sell the commodities but you can even

exchange them.

Commodity market works on certain principles. Firstly the trading has to be done only

for standard products. Secondly the transaction takes place through a future contract.

According to this contract the commodities will be sold or bought on a future date.

However the price at which they are sold will be the price agreed during the contract.

Similarly commodity marketing also makes use of another type of contract called spot

contract. In this contract the goods are to be transferred as soon as the contract is made.

However it has also been argued that the purpose of a spot contract is to exercise a future

contact in due course of time. Some of the commodities investing market are commodity

food market, commodity petroleum market and commodity fund investing.

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Investing in Commodities

Commodity investing was initially received well only by a few sectors. Commodities

investing were first restricted to the trade and exchange of commodities meant for regular

and day to day use. However the awareness in the subsequent stages has brought all

sectors into the manifold of commodity investing and has enabled speedy movements,

transfer and transaction of goods and services.

Reduced Risks

As an investor your chances of risks are very less if you choose to invest in commodity.

Therefore the gains from commodity investing will be helpful for you to balance other

losses due to other financial instruments in your portfolio. The chances of risks are lower

because commodity investing primarily deals with diverse items. Moreover when the

contracts are entered for a future date at the current time you can exercise reasonable care

and see to it that the chances of risks are reduced or nil

Helps to Fix Price Easily

The performance of commodity market can be monitored by analyzing the performance

of bond and share market because in most cases a commodity market will perform well

when the others don't perform and vice versa. It is therefore possible to easily predict the

prices and make the contracts by considering the ups and downs in other markets. A

prerequisite for this is that the assets in the commodity market should not be correlated

with the stock and bond market.

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Why do retail investors lose in commodity markets?

There has been a strong buzz in the market that retail investors lose more than they gain

in the commodity market. In most cases, it is more important to know HOW one is

investing than WHO is investing.

Reports indicate weak retail investment in UK commodity markets but more interest

shown in Germany, Asia.

Small retailers and investors usually are looking for an avenue to diversify their portfolio,

to invest their hard earned money to get decent returns. Studies indicate that commodities

are an effective portfolio diversifier and have been around for some time now. It has

taken the recent economic climate for commodities and not just a cyclical opportunistic

market to be regarded as a genuine asset class.

Small investors do have an opportunity to make money in the commodity market, but you

need to work equally hard to multiply your money. Finding a good broking house is

important, but even more important is understanding the trade, researching on your own

and taking responsibility of your money.

It is always considered better to start with a couple of commodities you like or

understand better. More preferred commodities can be ones information on which are

easily and widely available. Trading on tips and judgment of others would not assure

gains for a longer time.

Sort for an accurate information medium, be it a newswire, a website, periodical or an

expert. Make a combination and use your judgment. Understand your risk taking

potential and play with stop losses.

22

Trading in commodities can provide you with kind of returns that you may not find in

markets due to high leverage advantage. And there are other instruments also opening for

retail participants, latest being ETFs.

There are some lags in the system though. The Indian markets are yet to come out of

clutches of the big groups, who tend to manipulate the markets. Scarcity of experienced

professionals who understand the nitty gritty of the market is widely felt. The challenge

has grown even tougher with several new firms launching commodity desks and

expanding operations. Given these factors there always is a risk that individual investors

or retail participants may be putting in their hard earned money without sufficient

understanding of the associated.

Why Invest in Commodities? Diversification and Inflation

Protection

Investor interest in commodities has soared in recent years as the asset class has

outperformed traditional assets such as stocks and bonds. The performance of

commodities as an asset class is usually measured by the returns on a commodity index,

such as the Dow Jones-AIG Commodity Index, which tracks the return from a passive

investment in 19 different commodity futures contracts. Over the five-year period ended

March 31, 2006, the Dow Jones AIG Commodity Index has returned 10.6%, versus 2.6%

for the S&P 500.

Commodity prices have been driven higher by a number of factors, including increased

demand from China, India and other emerging countries that need oil, steel and other

commodities to support manufacturing and infrastructure development. The commodity

supply chain has also suffered from a lack of investment, creating bottlenecks and adding

an “insurance premium” and/or a “convenience yield” to the returns of many commodity

23

futures. Over the long term, these economic factors are likely to support continued gains

in commodity index returns.

The potential for attractive returns is perhaps the most obvious reason for increased

investor interest in commodities, but not the only factor. Commodities may offer

investors other significant benefits, including enhanced portfolio diversification and a

hedge against inflation and event risk.

Commodities are “real assets”, unlike stocks and bonds, which are “financial assets”.

Commodities, therefore, tend to react to changing economic fundamentals in ways that

are different from traditional financial assets. For example, commodities are one of the

few asset classes that tend to benefit from rising inflation. As demand for goods and

services increases, the price of those goods and services usually rises as well, as do the

prices of the commodities used to produce those goods and services. Because commodity

prices usually rise when inflation is accelerating, investing in commodities may provide

portfolios with a hedge against inflation.

Q. Don’t you think stock market is simpler than commodity

market? So why should an investor invest in commodities

market?

This question is very valid. Do you know in 1992-93 if you had gone to marry daughter

of a stock broker, your father would have been horrified. After 15 years, people don’t

find stock market as a bad profession. In fact, most people go to broking companies as

research analysts and it is a very reputed job. Now that mindset is there in commodities.

Today, maybe after 10 years why people were against commodity broking? It’s a matter

of time that things will change.

24

Commodity Investment Strategies

Capturing the full benefits of commodity exposure has been a challenge in the past.

Investing in physical commodities—a barrel of oil, a herd of cattle or a bushel of wheat—

is impractical, so investors have tended to seek commodity exposure either by purchasing

commodity-related equities or through actively managed futures accounts.

However, these investment strategies may not capture the potential diversification and

other benefits of commodity exposure in a portfolio. For example, commodity-related

equities will not necessarily reflect changes in the price of commodities.

If an oil producer has already sold its supply on a forward basis, the producer’s stock

price may not fully benefit from a rise in the price of oil. Commodity-related equity

returns can also be affected by the issuer’s financial structure or the performance of

unrelated businesses. In fact, commodity-related equities may actually have a higher

correlation to movement in equities than the commodity market. Actively managed

commodity futures accounts also may not provide the benefits of commodity exposure

suggested by historical commodity index performance, because these accounts tend to

reflect the manager’s skills at selecting the right commodities, at the right time, rather

than the inherent returns of the commodity market.

The emergence of investment vehicles that track commodity futures indices has provided

investors with another option for gaining exposure to commodities that may offer better

potential to capture the full benefits of the asset class. Investment vehicles that track

commodity futures indices are not the same as actively managed futures accounts.

Instead, commodity index returns provide passive exposure to a broad range of

commodities. For example, the Dow Jones AIG Commodity Index tracks the futures

price of 19 different commodities, including energy, livestock, grains, industrial metals,

25

precious metals and “soft” commodities. Changes to the composition of the index are

determined by preset rules rather than a manager’s discretion.

Dow Jones-AIG Commodity Index Components

As of March 31, 2006

Source: AIG

One advantage of commodity exposure that tracks a broad index is that commodities are

not highly correlated with each other and index returns should be less volatile than the

returns on an individual commodity. Another advantage is that commodity indexes

themselves have existed for decades, providing ample historic data for asset allocation

studies and research.

While broad commodity exposure can provide investors with a number of potential

benefits, investing in commodities entails risks as well. In particular, commodities may

not perform well during cyclical downturns in the U.S. or global economy, when

consumer and industrial demand slows. Commodities have historically been about as

26

volatile as the equity market. For example, from December 1990 through March 2006,

annualized monthly volatility for the Dow Jones-AIG Commodity Index was 12.2%

compared to 13.8% for the S&P 500. More recently, from June 2001 through June 2006,

annualized monthly volatility for the Dow Jones-AIG Commodity Index was 13.9%,

slightly above the 13.5% volatility of the S&P 500 over the same period. Commodities

are a distinct asset class with returns that are largely independent of stock and bond

returns. Therefore, adding broad commodity exposure can help diversify a portfolio of

stocks and bonds, lowering risk and potentially boosting return. Achieving this

diversification has been made easier with the development of investment products that

passively track a broad range of commodities.

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Chapter 5

Why Trade In Commodities?

Although commodity derivatives command a humble share of 6% in the derivatives

segment across the world, yet these record high volumes in the markets the world over

compared to equity derivatives. In an era where risks to investments are on the rise, India

needs to switch to commodity derivatives and also to weather derivatives (when these are

launched), if it needs to top the list of developed nations.

Of course with the other asset classes offering attractive returns, "Why Commodities?" is

the inevitable question that pops in one's mind today, more so considering that the BSE

Sensitive Index is scaling new highs by the day. Well, despite offering relatively lower

returns, commodity derivatives provide unique money-making opportunities to a wider

section of market participants, starting from planters to exporters, importers at all. And to

the agrarian Indian population commodities are obviously not new, nor are the

advantages of trading in them unknown. No balance sheet, P&L statement, EBITDA and

reading between the lines. Commodity trading is about the simple economics of supply

and demand. Supports are known, only resistance matters! Minimum support price acts as

a statutory support for many commodities. No Dollar-Rupee premiums/discounts. No

hedging on the NYMEX. Indian commodity derivatives hedge both forex and commodity

specific risks at a single cost. No breaking of heads over market direction. Seasonality

patterns quiet often provide clue to both short- and long-term players. No scam, no price

rigging. Commodity trading comes with nil insider trading and company specific risk.

What's more, why invite risk by investing in a metal company when you can trade in the

metal itself? After all, while the stock price of the company is dependent on several

factors including the company's own fundamentals, the price of the metal is driven by the

simple economics of demand and supply. The more the demand for the metal, the higher

its price and vice versa. Also compared to equities it is much cheaper to trade in

commodities, where margin requirements are lower.

28

Chapter 6

Different types of commodities

A} METALS

Different types of metals are as follows:

1} GOLD:

Introduction:

Gold is primarily a monetary asset and partly a commodity.

More than two third of gold’s total accumulated holdings, relating to “value for

investment”, is with central banks’ reserves, private players, and high-karat

jewelry.

Less than one third of gold’s total accumulated holdings is a “commodity” for

jewelry in western markets and usage in industry.

The Gold market is highly liquid and gold held by central banks, other major

institutions and retail Jewellery keep coming back to the market.

29

Due to large stocks of Gold as against its demand, it is argued that the core driver

of the real price of gold is stock equilibrium rather than flow equilibrium.

Economic forces that determine the price of gold are different from, and in many

cases opposed to the forces that influence most financial assets.

South Africa is the world's largest gold producer with 394 tons in 2001, followed

by US and Australia.

India is the world's largest gold consumer with an annual demand of 800 tons.

Market Characteristics:

The gold market is highly liquid. Gold held by central banks, other major

institutions, and retail jewelry is reinvested in the market.

Due to large stock of gold, against its demand, it is argued that the core driver of the

real price of gold is stock equilibrium rather than flow equilibrium.

Effective portfolio diversifier: this phrase summarizes the usefulness of gold in

terms of “Modern Portfolio Theory,” a strategy which is utilized by many

investment managers today. Using this approach, gold can be used as a portfolio

diversifier to improve investment performance.

Effective diversification during “stress” periods: Traditional methods of portfolio

diversification often fail when they are most needed, that is during financial “stress”

(instability). On these occasions, the correlations and volatilities of return for most

asset classes (including traditional diversifications, such as bonds and alternative

30

assets) increase, thus reducing the intended “cushioning” effect of a diversified

portfolio.

Demand and supply:

South Africa is the world’s largest gold producer with 297 tonnes in 2005,

followed by the US and Australia.

India is the world’s largest gold consumer with an annual demand of 800 toones.

Demand and supply of gold:

Supply in tonnes

2005 2006 Change%

Mine production 658 635 -3

Net producer

hedging

-14 62 -

Total mine supply 644 573 -11

Official sector sales 85 59 -31

Old gold scrap 211 192 -9

Total supply 940 824 -12

31

Demand

Fabrication - - -

Jewelry 659 664 1

Industrial & dental 108 114 5

Sub total of above

fabrication

768 778 1

Bar & coin retail

investment

93 100 7

Other retail

investment

-8 -8 0

ETFs & similar 38 19 -49

Total demand 890 889 0

Balance 50 -65 -

Factors influencing the market:

Above ground supply from sales by central banks, reclaimed scrap, and official

gold loans.

Producer/ miner hedging interest.

World macroeconomics factors such as the US dollar and interest rate.

Comparative returns on stock markets.

32

Domestic demand based on monsoon and agriculture output.

2} SILVER :

Introduction:

Silver has unique properties such as its strength malleability, ductility, electrical and

thermal conductivity, sensitivity, high reflectance of light, and reactivity.

There are few substitute metals for silver in most application, particularly in high-tech

uses in which reliability, precision, and safety are paramount.

Today, silver is sought as a valuable and practical industrial commodity and as an

appealing investment.

The largest industrial users of silver are the photographic, jewelry, and electronic

industries.

Newly-mined metal provides most of the needed supply.

Mexico, United States, and Peru are the primary producers.

Secondary silver sources include coin melt, scrap recovery, and dis-hoarding from

countries where export is restricted. Secondary sources are price sensitive.

Demand for silver is based on three main factors: industrial and decorative uses,

photography, and jewelry and silverware. These three categories together have more than

95% of annual silver consumption. In 2005, 409.3 million ounces of silver was consumed

33

for industrial applications, over 164.8 million ounces I the photographic sector, and 249.6

million ounces in the jewelry and silverware markets.

Indian Scenario:

Silver imports into India for the domestic consumption fell sharply by 25% to

about 3400 tonnes in 2005, against the record year 2001 when over 4540 tonnes

of silver was imported.

Indian industrial demand was estimated to about 1680 tonnes for the year 2005.

India is one of the largest users of silver in the world, ranking alongside industrial

giants like Japan and United States.

GFMS data shows Indian jewelry and silverware fabrication was around 1520

tonnes in 2005.’

World markets:

Silver is predominantly traded on the London Bullion Association (LBNA) and

COMEX in New York. LBNA is the global hub of over-the-counter (OTC)

trading in silver and is the main physical market. Comex is the futures and

options exchange, where most fund activity is focused.

Silver is invariably quoted in US dollars per troy ounce.

34

Demand and supply:

After seeing a solid growth in 2005, total fabrication demand slightly dipped by

around 3% in 2006.

Industrial demand marginally increased year-on-year in 2006.

Photographic demand continuously dipped due to impact of digital technology.

Import of silver into collapsed in 2006 due to impact of high prices, stocks carried

over from 2005, and the government selling silver in local markets.

Coins demand has increased in 2006.

Investment demand has grown again.

35

Demand of silver in 2006:

Supply of silver in 2006:

3} COPPER:

Introduction:

Copper is a metal that has the desirable

physical properties of being malleable (it can

be hammered and molded into shapes) and

Hedging 1%

Government

sales

8%

Scrap silver 21%

Mine

production

70%

36

Coins 5%

Investment 9%

Photography 16%

Jewellary&

silverware

24%

Industrial 46%

ductile (it can be drawn into wire). As a result, copper pipes are used to bring water to

and from our buildings.

Copper is a good conductor of electricity; million of miles of copper wire crisscross

the landscape and run through our buildings.

Copper alloys (such as brass) are important components in many household products

and machines.

It is believed that the amount of copper a society consumers is a direct indicator of the

advancement of that society.

Demand and supply:

Copper is not a rare metal; it is produced in many countries. Today, copper supply arises

from two sources; its majority (88%) comes from primary production-new copper that is

mined from the ground. But the most important is its secondary supply, which accounts

for 12% of total refined copper supply. The secondary supply comes from recycling of

the copper scrap.

Between 1900 and 2000, copper demand grew from02 million tonnes to around 13

million tonnes with an accelerating growth since the 1950s. With many widespread uses,

copper demand is growing. Now with China, India, and many other developing countries

starting to industrialize and urbanize, copper demand is likely to grow extensively. The

per capita demand for copper rises in line with GDP. Japan consumers around 12 kg of

copper per capita, north America around 10 kg per capita, and Europe around 9 kg per

capita. The large populations of China, India, Eastern Europe, and South America are all

consuming less than 2 kg per capita. This is a clear indicator of the future copper demand.

37

Indian scenario:

Major producers of refined copper: Hindalco, stertile industries, and &

Hindustan copper.

Indian copper market: roughly 3% of the global market.

Indian production of refined copper: 650000 MT annually.

Indian demand for refined for refined copper: 450000 MT annually.

India is emerging as a net exporter of refined copper.

Over 90% of the concentrate requirement is imported.

Factors influencing the market:

There are numerous factors that can influence production-consumption of copper and so

its prices. In North America and South America, copper production is often affected by

labor unrest; in parts of Asia and Africa, the production can be affected by political

unrest; additional influences can be from weather, floods, and droughts either hitting the

production process or the transport of raw materials. New production also takes years to

38

commission as the scale of mining is large, it takes enormous financing and requires

endless environmental permissions and needs extensive infrastructure as well. All these

factors make it hard for the market to balance the supply and demand.

Copper prices change constantly as the market attempts to balance the supply and

demand at any given time. Price fluctuations generate risk and opportunity to different

participants in the market, and the metal exchanges around the world provide the means

for all those involved with the market to either hedge their risk or take risk as an investor

or speculator.

4} ZINC:

Introduction:

Zinc is the fourth most widely used metal after steel, aluminium, and copper.

39

Zinc also exists in many compounds.

Due to its resistance to non-acidic atmosphere corrosion, zinc is instrumental in

extending the life of buildings, vehicles, ships, and steel goods, structures of every

kind.

Zinc is a bluish white lustrous metal. It is normally covered with a white coating

on exposure to the atmosphere.

Zinc dust is flammable when exposed to heat and burns with a bluish green flame.

Zinc plays a very significant role in normal human growth, but exposure to high

levels of zinc through inhalation,

Ingestion and dermal contact can cause adverse health effects.

Galvanized steel is used extensively in construction, engineering, and auto industry to

increase the corrosion resistance of cars, trucks, and trailers.

The engineering industry also uses zinc pressure die casting to produce thousands of

components for cars, household items, and industry in general. These range from

carburetors, casing, water pumps, moldings, the side and back panels of washing

machine, cooker, etc. Zinc sheet is used in some countries for roofing, guttering, and

general weather-proofing.

Demand:

The growth of Zinc demand in the western world is relatively quiet, and downturn in

construction and auto industries is likely to depress the western demand further.

However, Asia, and especially China, has seen a remarkable increase in Zinc demand.

40

And with an increasing infrastructure development in china, Zinc demand is likely to

grow strongly for many years to come.

Supply:

Zinc production stars with the mining of bulk ores, which often contain a mixture of lead

zinc, and silver. Zinc concentrates are electrolytically smelted to produce “high grade”

and “special high grade” zinc, with purities of 99.95%and 99.99% respectively. The

latter-quality zinc is the benchmark grade for LME contracts. Zinc is produced

extensively in North America, South America, Asia, Australia, and Europe.

Indian Scenario:

The Indian zinc industry entered its transformation phase with the privatization of the

largest zinc producer, Hindustan Zinc Ltd. The domestic zinc industry is now completely

under private sectors and is in the midst of an extensive expansion program. The size of

the Indian zinc market is 4.5 lakh tones per annum.

By 2020, India is expected to attain a complete self sufficiency in meeting its zinc

demand. Thereafter, the process of India becoming an important zinc supplier to the

world would be initiated, provided that another phase of capacity expansion is effected.

Hindustan Zinc Ltd. Is the largest zin producer in India with a capacity of 4 lakh tones

per annum. Binani Zinc is the other major player with a capacity of 38000 tonnes per

annum. Over the next five or six years, zinc demand is likely to grow at 12-15 percent

41

annually, against the global average of 5 %. Even if one assumes that the zinc demand

grows by 10% till 2010 and at slower 7%, India would require zinc capacity of 14 lakh

tpa by 2020 in order to be self reliant. The next round of large capacity addition would,

therefore, be warranted from 2008 onward. Buoyancy in the domestic zinc demand

primarily emanates from the boom in the steel industry, given that over 70% of zinc is

used for galvanizing.

Factors influencing the market:

Changes in inventory level at LME warehouses

Economic growth rate of major consuming countries

Global growth and demand in major consuming industries

Prices of the alternative metal(s)

Participation of funds

5} ALUMINIUM:

Introduction:

Aluminium is the third most abundant element found in the earth’s crust. It exists

in very stable combinations with other materials particularly and oxides.

42

Aluminium is lightweight and weights only one third as compared to copper;

while its density is only one third that of steel.

It is resistant to common atmosphere gases and a wide range of liquids. Hence,

aluminium is known for its durability and high resale value.

It has high reflectivity and therefore has more decorative uses.

Besides a good conductor of heat and electricity, aluminium also keeps its

toughness down to very low temperature without becoming brittle like carbon

steels. So, it is easily worked and molded.

Applications:

Aluminium is widely used in the construction, transportation, and packaging industries.

Its attributes are ideal for the construction business. The metal is strong, light, corrosion

resistant, and versatile. It is used in constructing windows, doors, cladding, weather-

proofing, and in light constructions such as conservatories and canopies. In the

transportation industry, aluminium is used in the auto, aerospace, railways, and marine

industries. Its strength, light, and resistance to corrosion are ideally suited for the

construction of the shell and bodies as well as in working parts, fixtures, fittings, and

engine components. In air craft, aluminium and aluminium alloys account for around

80% of unladen weight. In auto production, aluminium is gaining market share from

steel.

In packaging industry, aluminium is used extensively for the protection, storage, and

preparation of food and drinks. It can also be easily recycled, which makes it an

43

environment-friendly packaging material. Aluminium is used in overhead and

underground power lines and power cables.

Demand and supply:

Aluminium is the largest base metal consumed annually. It benefits the rapid

industrialization and urbanization of developing countries like china and India. The

aluminium demand is set to accelerate sharply. The primary aluminium demand has risen

from 2 million in 1950 to 9.5 million tones in 1970, and then 15 million tonnes in 1990,

which is expected to rise to 35 million tonnes in 2007.

There are three stages of production of primary aluminium. It starts with the mining of

bauxite, a reddish brown aluminous earth found in tropical latitudes in Australia, South

America, India, the Caribbean, and Africa. Bauxite is then refined to produce alumina,

which is then smelted to produce aluminium. To produce one tonne of primary

aluminium, we need two tonnes of alumina, which in turn takes about four tonnes of

bauxite. The reduction of aluminium from its oxide, alumina is very power-intensive,

which is why the significant world primary aluminium production is located near cheap

energy sources, whether it be hydroelectric power in Canada or oil and gas fields in

middle east. It is important to understand the huge energy requirement to produce

primary aluminium. The Hillside smelter in South Africa produces around 460000 tpy of

aluminium, but to do so it consumes about 5% of all electricity consumed in South

Africa.

Global Scenario:

Aluminium ores (most commonly, bauxite) are in abundance and found mainly in

tropical and subtropical areas of Africa, West Indies, South America, and Australia.

Some deposits are also found in Europe. The leading aluminium producing countries

include the United States of America, Russia, Canada, the European Union, China,

44

Australia, Brazil, Norway, South Africa, Venezuela, the Gulf countries (Bahrain and the

United Arab Emirates), India, and New Zealand. These countries together represent more

than 90% of the global primary aluminium production.

Indian Scenario:

India is the fifth largest producer of aluminium in the world. India produces

approximately 3037 million tonnes of all categories of bauxite.

At current levels of consumption, the existing reserves will have an estimated life of over

350 years. India’s reserves are estimated to be 705% of the global deposits, and the

installed capacity is about 3% globally. In terms of demand and supply, India is self

sufficient and has a competitive export potential. India’s annual export of aluminium is

about 82000 tonnes. India’s annual consumption of aluminium is around 0.61 million

tonnes and is projected to increase to 0.78 million tonnes during 2007. The primary

Indian aluminium producers include NALCO, HINDALCO, and Vedanta Group.

Aluminium prices in India are fixed on the basis of the prices prevailing on LME.

Factors Influencing the Market:

The production of aluminium requires alumina and uninterrupted supply of electricity.

However, in recent years there have been a host of issues, which have affected aluminium

supply; most important of these is electricity. In 2001, energy shortages in US resulted in

electricity prices spiraling higher to the extent that it was more profitable for some

aluminium smelters to stop producing aluminium and to sell their electricity quotes to

other users. So at peak energy usage times, such as during the summer when air

conditioning consumes huge amounts of energy, aluminium smelters have to cut

production to release electricity for other users.

The following are some other factors that can influence the aluminium market:

45

Changes in inventory stocks at LME, SHFE, COMEX, and TOCOM warehouses

World aluminium mine production through exploration of new mines and

expansion of existing mines

Economic growth of major consuming nations such as China, Japan, Germany,

etc.

Growth and demand in the construction, packaging, and transportation industry.

6} NICKEL:

Introduction:

o Nickel is the main alloying metal used in producing certain types of stainless

steel.

46

o The strength and durability of products built with stainless steel is vastly superior

to similar products built with non stainless steel.

Applications:

Among base metals, nickel is the most volatile owing to its strong demand and light

supply. Nickel demand is derived based on the growth of different industrial sectors and

thus exhibits high volatility. Nickel’s primary use (65%) is in the manufacturing of

stainless steel, 20% in other steel and nonferrous alloys, 9% in electroplating, and about

6% used in coins and nickel chemicals. Demand foe stainless steel took off in the mid-

1980, especially in the chemical engineering, paper and food processing industries, where

stainless steel’s high melting point, high resistance to corrosion and oxidation, and

strength, made It invaluable as it could withstand the heat, chemical, acid, and pressure

that these industrial processes require. Stainless steel is also used in construction and

household items such as kitchen sinks, pots, pans, utensils, and work surfaces. Nickel is

also used to produce super-alloys which are used extensively in the aerospace industries.

Mobile phones, computers, digital cameras, etc., all need small, lightweight, high-

capacity power sources. Nickel cadmium and other nickel alloys have been used to

produce some of these batteries

Demand and supply:

Nickel, or more to the point stainless steel, Is a relatively new metal; its use has grown

significantly as Asia and China have built up their infrastructure. Growth in nickel

demand is expected to come primarily from further growth in stainless steel. In recent

times, high nickel prices resulted in rise in the number of stainless steel producers

47

switching from producing high nickel based stainless steel (austenitic stainless steels or

300 series) to low nickel based stainless steel (200 series).World nickel market is

characterized by rising demand and constrained supply. More than 54% of the world’s

total supply comes from only five companies. Global nickel consumption is growing at a

rate of 3.1% a year. Nickel occurs as oxides, sulphides, and silicates. Nickel ores are

mined in about 20 countries and smelters (or refined) in about 25 countries. Primary

nickel is produced and used in the form of Ferro-nickel, nickel oxides, and other

chemicals as more or less pure nickel metal. Nickel is also readily recycled in many of its

applications. A large amount of secondary or “scrap” nickel is used to supplement newly

mined metal.

For a long time, about 1.4 MT nickel production has been in the hands of a few large

producers; the largest producer’s base is in Russia. The combination of a small producer

base and the lack of transparency show that the nickel supply has at times been volatile.

A strike at a producer can quickly tighten its supply. Likewise, unclear and secretive

production and shipping production and shipping schedules, combined with ever

changing export and tax legislation in Russia, can have a big impact on the market

sentiment. Although nickel is concentrated in the hands of a few producers, its

geographical production base is quite evenly spread. About 29% nickel is produced in the

former eastern bloc, 21% in the Americas, 16% in Europe, 15% in Australia, 14% in

Asia, and 5% in Africa. The aggregate worldwide production is estimated to be 1.30 MT.

Indian Scenario:

Nickel market in India is totally dependent on import. India imports around 30000 tonnes

of nickel. With a growth in the stainless steel sector, the nickel import demand is

expected to increase in the coming years. Steel scrap has emerged as a good substitute for

the primary metal.

48

Factors Influencing the Market:

Above ground supply from scrap

New mines discovery

Nickel demand is a derived demand thus is the situation in various industries

Growth in consumption of stainless steel.

7} LEAD:

Introduction:

Lead is a very corrosion-resistant, dense, ductile, and malleable blue-gray metal that has

been used for at least 5,000 years. Early uses of lead included building materials,

49

pigments for glazing ceramics, and pipes for transporting water. Today's major use of

lead is in lead-acid storage batteries. The electrical systems of vehicles, ships, and aircraft

depend on such batteries for startup, and, in some cases, batteries provide the actual

motive power. It is also for soundproofing in office buildings, schools, and hotels. It is

widely used in hospitals to block X-ray and gamma radiation and is employed to shield

against nuclear radiation both in permanent installations and when nuclear material is

being transported. .

Supply & Demand Scenario:

Domestic Scenario

Lead production equalled approximately 82,000 tonnes in 2004, mostly from

secondary sources.

The main constraint in lead production in the country is the lack of lead ore

reserves, which necessitates large-scale imports and recycling.

Lead demand in India was estimated at 150,000 tonnes for 2004. Due to huge gap

in demand-supply, India imported nearly about 50% of its domestic demand.

The major suppliers for the imports were China, the Republic of Korea and

Australia: 54%, 15% and 10% respectively.

The domestic industry is characterized by the presence of only a few players in

the primary segment. The primary lead industry in India is divided between the

following main players: Binani Industries Limited and Sterlite Industries (India)

Ltd. (Hindustan Zinc Ltd.). Due to increasing use of lead in domestic market both

players are expanding their smelting capacities for lead.

50

World Scenario:

o USA, Japan, China, EU and India are the major consumers of Lead

o Supply is controlled by Australia and China.

o Lead in the global market is traded as soft lead, animated lead, lead alloys and

copper-base scrap.

Factor influencing demand and supply:

o Changes in inventory level at LME warehouses

o Economic growth rate of major consuming countries

o Global growth and demand in major consuming industries

o Prices of the alternative metal(s)

o Participation of funds

B} ENERGY:

1} BRENT CRUDE OIL:

51

Introduction:

Brent crude oil is a light sweet crude oil from North Sea.

It has API (American Petroleum Institute) gravity between 38-39 and has higher

sulphur content than the other well-known benchmark, WTI crude oil.

Brent crude oil is a global benchmark for other grades and is widely used to

determine crude oil prices in Europe and in other parts of the world.

Brent is typically refined in Northwest Europe, but a major portion is been exported

to the US Gulf and East Coasts, and also to parts of Mediterranean.

It is more expensive than the Organization of Petroleum Exporting Countries (OPEC)

basket, but lesser than West Texas Intermediate (WTI) because of higher sulphur

content than the WTI crude.

Crude Oil Units (average gravity)

1 US barrel = 42 US gallons.

1 US barrel = 158.98 litres.

1 tonne = 7.33 barrels.

1 short ton = 6.65 barrels.

Note: barrels per tonne vary from origin to origin.

Global Scenario

Oil accounts for 40 per cent of the world's total energy demand.

The world consumes about 76 million bbl/day of oil.

United States (20 million bbl/d), followed by China (5.6 million bbl/d) and Japan

(5.4 million bbl/d) are the top oil consuming countries.

Balance recoverable reserve was estimated at about 142.7 billion tons (in 2002),

of which OPEC was 112 billion tons.

Indian Scenario:

52

India ranks among the top 10 largest oil-consuming countries.

Oil accounts for about 30 per cent of India's total energy consumption. The

country's total oil consumption is about 2.2 million barrels per day. India imports

about 70 per cent of its total oil consumption and it makes no exports.

India faces a large supply deficit, as domestic oil production is unlikely to keep

pace with demand. India's rough production was only 0.8 million barrels per day.

The oil reserves of the country (about 5.4 billion barrels) are located primarily in

Mumbai High, Upper Assam, Cambay, Krishna-Godavari and Cauvery basins.

Balance recoverable reserve was about 733 million tons (in 2003) of which

offshore was 394 million tones and on shore was 339 million tons.

India had a total of 2.1 million barrels per day in refining capacity.

Government has permitted foreign participation in oil exploration, an activity

restricted earlier to state owned entities.

2} NATURAL GAS:

Introduction:

53

Natural gas is a colorless, odorless, environment-friendly energy source, which is

cleanest of all the fuels that are traditionally being used in India.

Natural gas is a highly flammable hydrocarbon gas chiefly consisting of methane

(CH4). It may also include other gases such as oxygen, hydrogen, nitrogen,

ethane, ethylene, propane, and even some helium.

In India’s energy mix, natural gas is fastest growing energy source. Its

consumption in India is expected to grow by 10% during 2005-2010. This can be

met by liquefied natural gas (LNG) imports as well as domestic gas discoveries.

Natural gas is used mainly in industrial, commercial, transportation, and domestic

sectors. The power and fertilizers sectors are the largest consumers of natural’s

gas.

Natural gas, converted into a liquid state by cooling it to -161’c, is termed as

LNG. LNG is more compact than natural gas and occupies 1/600 th of its gaseous

volume.

Natural gas, when compressed at a pressure of 250 bars, is termed as compressed

natural gas (CNG).

Applications:

Electricity generation by utilities: fuel for base power plants and

cycle/cogeneration power plants.

Public and commercial: A natural gas is a clean fuel for use in household use of

piped natural gas (PNG) is expected to increase in future.

Industrial: Natural gas s used as a fuel for all the utilities like boilers, furnaces,

banking ovens, air conditioning, etc.It is also used as a feedstock by fertilizer

companies.

Alternative motor fuel: Used in compressed (or CNG) form.

54

Petrochemicals: A variety of chemical products (for example, methanol) can be

derived from natural gas.

Demand and supply:

Natural gas supply is expected to increase by 143% over the next five years,

because many gas discoveries are starting their production and various LNG

projects are being commissioned or expanded.

Transactional gas being planned and pursued with great vigor by companies like

GAIL, Reliance, etc. This will result in a better flow of gas to the deficit regions

in the country.

As per India Hydrocarbon Vision 2025, the natural gas demand is expected to be

313 million standard cubic meter per day (MMSCMD) by 2011-2012.

New sources of gaseous fuel, like coal bed methane, underground coal

gasification, etc., will be opened up.

The latent demand of gas is estimated to be twice its supply.

Factors influencing the market:

OPEC output and supply.

Geopolitics.

Dollar fluctuations.

US natural gas inventory data.

Weather conditions.

3} CRUDE OILS:

Introduction:

55

Crude oil is a mixture of hydrocarbons that exists in a liquid phase in natural

underground reservoirs. Oil and gas account for about 60 per cent of the total

world's primary energy consumption.

Almost all industries including agriculture are dependent on oil in one way or

other. Oil & lubricants, transportation, petrochemicals, pesticides and insecticides,

paints, perfumes, etc. are largely and directly affected by the oil prices.

Aviation gasoline, motor gasoline, naphtha, kerosene, jet fuel, distillate fuel oil,

residual fuel oil, liquefied petroleum gas, lubricants, paraffin wax, petroleum

coke, asphalt and other products are obtained from the processing of crude and

other hydrocarbon compounds.

The prices of crude are highly volatile. High oil prices lead to inflation that in turn

increases input costs; reduces non-oil demand and lower investment in net oil

importing countries.

Crude Oil Units (average gravity)

1 US barrel = 42 US gallons.

1 US barrel = 158.98 litres.

1 tonne = 7.33 barrels.

1 short ton = 6.65 barrels.

Note: barrels per tonne vary from origin to origin.

Global Scenario:

Oil accounts for 40 per cent of the world's total energy demand.

The world consumes about 76 million bbl/day of oil.

United States (20 million bbl/d), followed by China (5.6 million bbl/d) and Japan

(5.4 million bbl/d) are the top oil consuming countries.

Balance recoverable reserve was estimated at about 142.7 billion tones (in 2002),

of which OPEC was 112 billion tones.

56

Indian Scenario:

India ranks among the top 10 largest oil-consuming countries.

Oil accounts for about 30 per cent of India's total energy consumption. The

country's total oil consumption is about 2.2 million barrels per day. India imports

about 70 per cent of its total oil consumption and it makes no exports.

India faces a large supply deficit, as domestic oil production is unlikely to keep

pace with demand. India's rough production was only 0.8 million barrels per day.

The oil reserves of the country (about 5.4 billion barrels) are located primarily in

Mumbai High, Upper Assam, Cambay, Krishna-Godavari and Cauvery basins.

India had a total of 2.1 million barrels per day in refining capacity.

C} OIL & OILS SEEDS:

1} CASTOR OIL:

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Introduction:

Castor oil is used as a raw material in the manufacture of a number of chemicals used in

the manufacture of surfactants, specialty soaps, surface coatings, cosmetics and personal

care products, pharmaceuticals, perfumes, plasticisers, greases and lubricants, and

specialty rubber etc.

Indian Scenario:

India is the world leader in castor seed and oil production and dominates the

international castor oil trade.

The Indian variety of castor has 48 % oil content of which 42% can be extracted,

while the cake retains the rest.

India's castor oil production fluctuates between 2.5-3.5 lakh tons a year. In 2003-

04, India's estimated castor oil production was 2.8 lakh tons.

Gujarat accounts for 86% of India's castor seed production followed by Andhra

Pradesh and Rajasthan. Castor is mainly grown in Mehsana, Banaskantha and

Saurashtra/Kutch regions of Gujarat and Nalgonda and Mahboobnagar districts of

Andhra Pradesh.

Castor is a Kharif crop. The sowing season of castor is from July to October and

the harvesting season is from October to April.

The annual domestic consumption of castor oil in India is only about 80,000-

1,00,000 tons. Of this, the soap industry consumes about 25,000 tons, the paint

and allied industries 35,000 tons and the lubricant and derivatives industry 20,000

tons.

India annually exports around 2.0 - 2.4 lakh tons of commercial castor oil. From

India castor oil is exported in two forms - First Special Grade and Castor Oil

Commercial through mainly Kandla port.

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World Scenario:

India is the leading producer of castor oil in the world, followed by China and Brazil with

0.8 and 0.4 lakh tons respectively. The present annual world trade in castor oil is

estimated at about 2.0 - 2.50 lakh tons. The major importers of castor oil in the world

market are European Union, US and Japan. The world demand for castor oil is estimated

to be growing at the rate of about 3 to 5 % per annum. Both Brazil and China have

experienced a steady increase in their domestic castor oil consumption in the recent years

and thus utilize almost their entire production. India consumes only a quarter of its castor

oil production and exports the rest.

Market Influencing Factors:

Variations in castor seed domestic acreage based on yield and price realization.

Crop development based on monsoon progress in key growing regions.

Chinese and Brazilian crop size.

Comparative price with other vegetable oils in the domestic market.

Upcountry demand of castor oil from the major cities, Export demand of castor oil

from US, Europe and Japan.

The castor seed price tends to firm up during the planting period and eases down

during the harvesting period. Prices tend to show inter-seasonal variation of

almost Rs 200 - Rs 350 per quintal.

Castor seed growers and crushers hoard the commodity before selling in

expectation of better prices. Castor oil too can be kept in containers without

spoilage for long period.

2} REFINED SOYA OILS:

Introduction:

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Soybeans on crushing and solvent extraction yield soy oil at 18% recovery and

soymeal. About 85% is crushed worldwide.

Soybean and soyoil production of 170-185 and 25-31 million tons account for 55-

58% and 25-30% of global oilseed and oil production respectively.

US, Brazil, Argentina, China, India are the major producers in order of

production. In US, India, China crop starts arriving from Aug-Sept, while it starts

from Jan-Feb in S. America.

In the world 55-60, 8-10 and 42-45 million tons of beans, oil and meal are traded

annually.

USA (20-30 million tons), Brazil (12-18 million tons), Argentina (5-10 million

tons) are the exporters of beans, while China (18-20 million tons) and EU (15-18

million tons) are the major importers.

Argentina (3-5 million tons) and Brazil (2-3 million tons) are the major exporters

of oil. China (1.5-2.5 million tons) and India (1-2 million tons) are the major

importers of oil.

Indian Scenario:

India produces 5-7 million tons of beans, 1 million ton of oil and 3-5 million tons

of soymeal in a normal year.

With imports, the total oil availability in the country is around 2.5 million tons.

Madhya Pradesh (3.5-4.5 million tons), Maharashtra, Rajasthan are the major

producers of soybean in India.

The production is highly dependent on the monsoon and fluctuates between years.

Soy is a Kharif crop, sown in June-July and harvested by September-October.

Peak arrivals are from October-November.

Market Influencing Factors:

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Weather at all the producing centers, domestic and international. The pod bearing

period, being the most crucial.

The area planted, determined by the price of soybean against that of competitive

crops, viz., maize, jowar, bajra.

International price movement, the futures market at CBOT being the major

international reference market.

Pests and diseases.

The supply-demand and price scenario of competitive oils, viz., palmoil.

D} CEREALS:

MAIZE:

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Introduction:

Maize (Corn), is of American origin, and after wheat and rice, it is the most important

cereal grain in the world.

It provides nutrition to both humans (33.3%) and animals (66.6 %).

Serves as basic raw material for the production of starch, oil and protein, alcoholic

beverages, food sweeteners and more recently fuel.

Special crops grown primarily for food include sweet corn and popcorn, although

dent, starchy or floury and flint maize are also widely used as food. Flint maize is also

used as feed. Immature ordinary corn on the cob either boiled or roasted is widely

consumed.

Global Scenario:

World corn production in the year 2003 was 614.3 million tons while in year 2004

total world corn production is expected to be 642.6 million tons.

Major producing countries are United States, China, EU-25, Brazil, Mexico,

Argentina and India. These countries accounts for around 80 % of total world corn

production. Major consuming nations of corn are China and USA.

There has been continuous increase in the consumption demand of corn mainly owing

to increase in the demand from meat and starch sector. There is growing requirement

of maize from poultry sector, which uses corn as feed.

Major importing nations of maize are Japan, Korea, Taiwan, Mexico, Egypt,

Malaysia, EU and Colombia.

Indian Scenario:

India's maize production fluctuates between 10-14 million tons, with 80-90% of

the production being in the kharif season.

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Major states that contribute in Maize productions are Karnataka, Andhra Pradesh,

Bihar, Punjab, Uttar Pradesh and Madhya Pradesh.

Around 6.5 million tons (roughly 50 % of total consumption) goes for feed use,

primarily for poultry feed. Another 1 million tons of corn is used by the starch

industry.

India is traditionally a maize importer, and Govt. permits a fixed quantity

(determined each year) to be imported at 15%. Extra has to be imported at 50%.

Factors that Affects Rice/Wheat/Maize Prices:

Role of weather in crop production is immense.. Further, natural calamities like

typhoon, floods, droughts and earthquake can also affect crops.

Changes in the minimum support prices (MSP) by the government also have

immense impact on the prices of the commodity.

Breakthrough in the technology may increase the productivity and would lead to

more supply. This may bring some softness in the price.

Breakthrough in the technology may increase the productivity and would lead to

more supply. This may bring some softness in the price.

Chapter 7

Conclusion

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The future of commodity market:

A strong and vibrant cash market is a pre-condition for a successful and transparent

futures market.

As funds seamlessly flow from one market to the other and the Indian commodity market

begins to integrate with the global market, the risk perception is beginning to heighten.

Adoption of risk management or risk mitigation tools is now sine qua non for success in

businesses with exposure to commodities. A serious look at futures trading as a tool for

price discovery and price risk management is inevitable.

Before we examine commodities futures trading — its principles and benefits — it may

be worthwhile to crystal gaze into the future of this market. Some features of the

emerging scenario in India as far as the commodity market is concerned:

Expansion of commodity trade: Very clearly, trade volumes are set to expand rapidly.

Demand for a wide variety of commodities covering food, fibre, metals and energy is

certain to expand. India is likely to produce many of the aforesaid commodities, as

investment in production facility expands. If demand growth outstrips domestic supply

growth, imports will become inevitable. The possibility exporting certain commodities

also exists. In commodity production, consumption and trade, India will become an

important player in the international market. This will lead to a massive expansion in

commodity trade volumes over the next, say, 15-20 years.

Competition from imports: Whether or not domestic producers like it, the competition

from imported commodities is inevitable. This could be true in case of food crops, metals

and energy. In the short/medium-term, indigenous output will trail consumption demand

because of the lagged effect of investment. To fuel growth and rein in inflation, the

government and the business houses will have to resort to imports. As imports are

unrestricted (Quantitative Restrictions have been abolished), there will be liberal inflow

of goods from abroad. Often, imports from developed countries are low-priced and

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subsidised. Such competition will result in inefficient domestic units falling by the

wayside, but will eventually lead to greater efficiency among domestic producers.

Role of MNCs: Multinational corporations cannot be wished away. They bring with them

a certain superior knowledge of operating in developing or emerging economies. They

also have deep pockets and, often, are long-term players. In the Indian commodities

sector, global companies will increasingly play a role as producers, suppliers, traders and

service providers. Indian producers will have to learn to face competition from MNCs.

Consolidation of fragmented capacities: It is well-known that commodity producers and

industrial consumers in India suffer poor scale economies because of their small size.

Fragmentation of business that is resulting in scale-diseconomies and other infirmities is

likely to give way to consolidation.

Competition is now driving smaller players to explore opportunities for merger. Bigger

companies with expansion plans follow the acquisition route. Mergers and acquisitions

will lead to consolidation of fragmented businesses, albeit slowly.

Dominance by a few large firms: In the developed economies, a handful of companies

share a big slice of the business pie. Typically, four-five companies would account for,

say, 60-75 per cent of aggregate business and several smaller players compete for the

rest. The commodity sector will inevitably move towards such a situation. The process of

consolidation and dominance by a few large firms is already visible, however incipient.

Take edible oil imports, for instance. Of the total imports of 45-50 lakh tonnes a year

worth over Rs 10,000 crore, five companies (of which two are MNCs) account for

roughly 70 per cent of business; the rest being shared by over 20 importers.

Waning role of government: As part of the economic liberalisation process, the

Government has not only freed the commodities market of controls and restrictions but

has also, by and large, distanced itself from the market. The interventionist role of the

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government is now minimal. Of course, some restrictions still remain, like those on the

sugar industry.

The government's role is changing from controller to facilitator. It must, however, be

mentioned that "liberalisation is not licence''.

Use of information technology: Very clearly, IT will play a key role in bringing about

greater transparency in the commodities market. The country's strengths in IT will

increasingly be leveraged to connect stakeholders and link markets. IT will be used for

delivering price and market information to primary producers (farmers). E-commerce

will be the modern way of doing business. Several corporates have already begun to

employ IT to derive value, ITC's e-chaupal being a remarkable initiative. The agricultural

produce markets (numbering nearly 7,500 across the country) will soon be networked so

that growers can get to know prices prevailing in various marketing yards or mandis.

Strong cash market: These developments will result in a stronger cash market for

commodities. Initiatives are already underway to launch electronic spot trading in farm

commodities that will help growers and others not only discover prices almost real time,

but also help capture value by taking trading positions. A strong and vibrant cash market

is a pre-condition for a successful and transparent futures market. It is this emerging

scenario that market participants must gear themselves to face.

RECOMENDATIONS

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1) It is observed that the commodity markets are upcoming market to watch for

investment.

2) Trading in gold will be more beneficial because it is more reliable as it is more

expensive.

3) Although investing in commodity markets is risky but a systematic & close study

of the markets before investing will make it more profitable.

BIBLIOGRAPHY

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Published records :

Scott Wright, 21st Century Commodities Bull, February 3, 2006.

Manisha Gupta, Awaaz Commodity Editor, May 28, 2007.

Websites:

Money control.com

Sharekhan.com

Nseindia.com

Bseindia.com

Mcx.com

Ncdex.com

Finc.gov.in

Books:

The commodity market module [Ncfm]

Commodities Market - An Introduction Author(s): N Janardhana Rao

All about Commodities: From Inside Out by Wasendorf, Russell R

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