How Does The Commodity Market Function in India 2024?

The history of commodity markets in India goes back to 1875, when the first futures contract was introduced in the country. This milestone marked the beginning of a remarkable journey that would alter the commodity world forever. Many assert that commodity trading began in India much before in another country. 

The commodity markets (especially futures) underwent a lot of struggles and remained dormant for quite a few decades post and pre-India’s independence. Trading remained limited to a handful of commodities, but after decades of dormancy and bans, in 2003, the Government of India allowed futures trading in all commodities, marking a new era in the industry. 

The subsequent establishment of national and regional commodity exchanges further propelled the growth of the commodity markets in India. Today, with regulatory reforms and technological advancements, commodity markets have become more accessible and efficient. They also play a vital role in supporting the agricultural and industrial sectors, besides actively contributing to the country's overall economic development. 

But how does a commodity market function, and who are the key market players? Let’s explore it in the chapter below. 

What Is a Commodity Market?

A commodity market is a platform where the buying and selling of raw materials or primary goods, known as commodities, take place. These could range from wheat, rice, and pulses to livestock, precious metals, and more. You can read more about commodities here.

You can also think of a commodity market as a marketplace where different buyers and sellers come together to trade tangible goods or commodities. The entire market functions on the principles of supply and demand, where the interaction between buyers and sellers determines the price of commodities. 

Now, commodities can be traded in various forms, like physical delivery or through derivative contracts. Remember, these markets and contracts serve as a crucial link between producers and consumers, allowing them to exchange commodities efficiently. Commodity markets are also essential for the global economy as they ensure the availability of and exchange of essential commodities and resources. 

Now that you understand what commodity and commodity markets are, let’s understand what determines the prices of different commodities 

Factors Determining Commodity Prices

Commodity prices are not linear, i.e., they are influenced and determined by various factors and can also vary depending on the commodity class. Here are some factors that can impact commodity prices –

1. Supply and Demand: The fundamental principle of supply and demand is a crucial determinant of commodity prices. For instance, think of a situation where, say, wheat is in excess supply. Now, naturally, the prices of wheat would tank. So, if the supply of a commodity increases relative to the demand, prices tend to decrease, while a decrease in supply or increase in demand leads to higher prices.
2. Weather: Weather patterns such as droughts, floods or extreme temperatures can have a significant impact on agricultural commodities. Think of crop failures or poor harvests, which can interrupt supply and drive prices. 
3. Economic Factors: Economic parameters such as GDP growth, inflation rates and interest rates can influence commodity prices. Strong economic growth, for instance, can lead to increased demand for commodities and vice versa. 
4. Geopolitical Events: Political instability, conflicts, policy changes, trade disputes and sanctions can disrupt commodity markets. These events can impact production, transportation and distribution, leading to price fluctuations. 
5. Currency Exchange Rates: Commodity prices are often denominated in a specific currency. Changes in exchange rates can affect the affordability and competitiveness of commodities for international buyers, theory influencing demand and prices. 

Commodity Exchanges in India

Just like a stock market facilitates different market players to buy, sell and conduct trade of shares, a commodity exchange provides a platform for buyers and sellers to come together and trade standardised contracts for commodities. These exchanges are crucial in facilitating the trade of various agricultural and non-agricultural commodities.

In India, there are six main types of commodities exchange –

•  Multi Commodity Exchange of India (MCX)

Located in Mumbai, the MCX was established in 2003 and is the largest commodity exchange in the country, with a market share of ~96% (in terms of commodity futures contracts). 

The MCX, which is an online platform, offers trading (through futures and options) in a wide range of commodities such as gold, silver, crude oil, natural gas, spices, pulses, agricultural products and more. It is a robot electronic trading platform that ensures transparent price discovery and risk management mechanisms, making it a preferred choice for market participants. 

• National Commodity and Derivative Exchange (NCDEX)

The NCDEX was established in 2003 and facilitates the exchange of various commodities, ranging from wheat and rice to an array of spices and essential oilseeds. 

It is a pivotal agricultural commodity exchange with a unique delivery-based system that allows commodities to be physically delivered upon a contract’s maturity. 

• National Multi Commodity Exchange (NMCE)

NMCE is India’s prominent commodity exchange. Founded in 2002, it specialises in the trade of both agricultural and non-agricultural commodities. Boasting futures contracts and cutting-edge electronics trading facilities, NMCE caters to the diverse needs of market participants. NMCE also plays a crucial role in assisting farmers, traders and other players to effectively manage price risks.  

• Indian Commodity Exchange (ICEX)

Established in 2009, the Indian Commodity Exchange primarily focuses on diamond derivatives. Recognised for instilling transparency in diamond trading, the ICEX basically facilitates the buying and selling of standardised diamond contracts. Beyond diamonds, the ICEX is also actively looking to diversify into different commodities. 

• ACE Derivatives & Commodity Exchange

ACE Derivatives & Commodity Exchange was established in 2010 and stands out for its robust tech infrastructure and trading solutions. It offers trade in a spectrum of agricultural and non-agricultural commodities.

• Universal Commodity Exchange

Universal Commodity Exchange Limited, founded in 2012, is another addition to the commodity exchanges in the country. From agricultural products to metal and energy, this exchange facilitates commodity exchange in a transparent manner through reliable trading mechanisms. 

How Does a Commodity Market Function? 

Markets of any kind, whether stock markets or commodity markets, function on the basis of interaction between certain components. Let’s discover how a commodity market works. 

1. Market Participants: The commodity markets involve different participants, including producers, consumers, traders, speculators, hedgers, arbitrageurs and investors. We shall explore this in detail below. How these participants interact and the timing of their entry and exit determines the basic functioning of the commodity markets. 
2. Commodity Exchange: As covered above, trading in the commodity market generally occurs through commodity exchanges. These exchanges provide an electronic platform for participants to place buy and sell orders for specific commodities. 
3. Standardised Contracts: Commodities traded in the market have standardised contracts specifying quantity, quality, delivery terms and other relevant information. These contracts ensure uniformity and facilitate fair trading. Market participants can buy or sell these contracts instead of physically trading the actual commodities. 

In India, the commodity markets have three types of contracts – spot, futures and options. Spot contracts involve immediate delivery of the commodity and are settled on the ‘spot.’ Futures and options are both derivative contracts used in commodity trading; futures involve buying or selling at a predetermined price and date, while options provide the right but not the obligation to buy or sell at a specified price within a period

When all the players, exchanges and contracts engage, they facilitate price discovery. The price is reflected through continuous trading and displays the market’s perception of the commodity’s value. Do note commodity markets also offer a layer of security as they are regulated and governed by different acts to ensure transparency and investor protection. 

Let’s now explore various market players in the commodity markets. 

Various Players in the Commodity Derivatives Market

• Speculators:

Speculators are individuals or entities who aim to profit from market price fluctuations without owning the physical assets. The only aim here is to capture price differences and book profits. Speculators may enter the market for a very short period of time and generally move in the direction of a trend in a commodity. These market players rely on a lot of technical analysis and charts to spot entry and exit points and generally have a very thin spread of margins/funds.

Speculators can bring good liquidity and trade into the markets however, volatility may enter the market if there is excess speculation. 

• Arbitrageurs:

Arbitrageurs, in simpler terms, are market participants who exploit price differences between markets across different time periods. They typically buy commodities at a lower price in one market and simultaneously sell them at a higher price in another market, thereby capitalising on the temporary price imbalance. 

For instance, an arbitrageur might purchase gold in the spot market and sell equivalent gold futures contracts, taking advantage of different prices across different markets. These arbitrageurs have a unique place in the market as they help, to some extent, align prices and ensure market efficiency.

• Hedgers:

Hedgers are entities that use commodity derivatives to manage or mitigate risk associated with price fluctuations in commodities they produce, consume or trade. Their primary objective is to protect themselves from adverse price movements. For instance, a farmer may enter into a futures contract to sell upcoming crops at a predetermined price. Lay emphasis on the word ‘predetermined’ here. So, now the farmer is no longer concerned if the crop price shoots up or down, as the futures contract safeguards him against potential price declines. 

Besides these three types, other players include banks and intermediaries, which offer financing, liquidity, risk management and derivative products to the participants, producers and consumers that maintain the whole supply and demand chain. 

Commodity Spot Market vs Derivatives Market

The commodity market consists of two primary segments: the spot market and the derivatives market. Now, let’s understand the very basics here. We will do a full dive in the next chapters. 

The spot market is where commodities are bought and sold for immediate delivery. It involves the physical exchange of commodities, such as wheat, metals or other commodities. Here, buyers and sellers agree on a price immediately or what we call ‘on the spot’, and the prices will be driven by multiple factors. 

On the other hand, the derivatives market deals with financial contracts that derive value from underlying assets, which in this case will be commodities. Derivative markets have two main types of contracts – Futures and options. 

With this, the chapter is concluded. In our next chapter, we dive deeper into the world of commodity derivatives.