Commodity Market : Definition, Types, Working & Advantages

The commodities market is an important aspect of the global economy because it allows traders to purchase and sell physical products that are commonly utilised as inputs in the manufacture of other goods or as a store of value.

 

The market enables producers, consumers, and traders to hedge against price volatility and manage risks. In this article, we will look at the intricacies of the commodities market. So stick with it till the end!

 

Brief Introduction about Commodity Market

 

A commodity market is a marketplace for exchanging primary goods or raw materials including gold, silver, crude oil, agricultural products, and base metals. It is a marketplace where buyers and sellers can trade commodities in cash or futures contracts.

 

These markets play an important role in connecting commodity producers and consumers. It lets producers sell their products and hedge against price volatility, while consumers can get the items they need at the greatest price available. The commodities market can be physical, in which products are physically delivered, or futures-based, in which settlement occurs at a future date.

 

The commodity market is significantly older than the financial money market and has evolved. The first commerce known to humanity was barter trading, in which goods such as food grains were exchanged between farmers and customers. The earliest documented fully functional commodity market was established in Amsterdam in the early sixteenth century.

 

The pricing of commodities traded on the commodity market is highly complex and based on individual features. For example, commodities market pricing for goods such as wheat and barley include a storage cost in addition to the dynamics of demand and supply. The storage cost is necessary because these commodities require suitable storage systems to protect them during transportation or from natural disasters.

 

Also Read | All you need to know about Commodity Money

 

Working and Types of Commodity Markets

 

The commodities market operates similarly to other financial markets, such as the stock market and the bond market. Buyers and sellers come together to exchange commodities based on their perceived value and current market conditions. The market is influenced by a variety of factors, including supply and demand, geopolitical events, and weather.

 

Traders can access the commodity market through a variety of channels, including futures contracts, options, and exchange-traded funds (ETFs). These investment vehicles enable traders to participate in a wide range of commodities while limiting their exposure to price volatility.

 

Commodities were legalized in 2001, and the MCX and NCDEX began operations in 2002. However, only a few commodities saw significant volume increases. To begin with, commodity exchanges simply provided futures on commodities. However, being a commodity market, commodity futures allowed for both speculation-based and delivery-based trading. That means the exchange had agreements with warehouses to supply the underlying product to the two parties at a predetermined price. The risk belonged to the two parties and the exchange was only a facilitating platform.

 

Commodity markets were governed by the Forward Market Commission (FMC) until 2015. Following the National Spot Exchange (NSEL) scam in 2013, there was widespread concern about the FMC's operation and regulation, and the management of the commodity futures market was eventually shifted entirely to SEBI. Since 2015, the Securities and Exchange Board of India (SEBI) has regulated commodity markets. Commodity dealing on these exchanges necessitates standard agreements that follow the guidelines so that trades can be conducted without visual scrutiny. 

 

The commodities market trade can be divided into two broad categories based on the commodity kind. The two categories are:

 

1. Hard commodities

 

Hard commodities are the commodities that are required by the manufacturing industry. These should be mined and painstakingly retrieved from the land or sea. They have limited reserves and are mostly influenced by geopolitical and economic factors. Examples of such commodities are gold, oil, silver, rubber, and copper. The majority of the pricing is due to the method of removing them.

 

2. Soft commodities

 

Soft commodities are primarily agricultural or livestock-related goods. Unlike hard commodities, they are neither mined or removed, but rather created using suitable techniques. They have essentially infinite reserves and are unaffected by geopolitical events, only by the weather or natural disasters. Corn, wheat, barley, sugar, pork, coffee, and tea are some examples of such commodities.

 

Also Read | Commodity Trading: An Overview

 

Advantages of Trading in Commodity Markets

 

Investing in commodities can present you with a variety of rewards. Some of the advantages of investing in the commodity market are the following:

 

1. Diversification

 

Commodity instruments can be useful to any trading portfolio since they provide significant diversification. Many commodities are negatively connected with other financial markets, which means they move in opposite directions and offer numerous trading opportunities.

 

2. Hedge against inflation

 

Commodities, particularly precious metals such as gold, are frequently used as a hedge against inflation. As the value of currency falls, the value of commodities may rise, providing a potential hedge against the declining value of money.

 

3. Stable demand

 

Commodities remain in high demand regardless of the situation of the global economy. People always require energy and nourishment. Even if oil and gas are replaced by clean and renewable energy, and precious metals run out, humans will always require agricultural products, therefore there will be a consistent demand.

 

4. Substantial Rewards

 

The commodity market offers the potential for big gains, but it also carries a significant risk. Some commodities, such as oil and gas, experience price volatility due to supply and demand, geopolitical events, and natural disasters. However, great gains are accompanied by substantial losses.

 

5. Tangible asset ownership

 

Unlike stocks and bonds, commodities are considered tangible assets. Some investors find that owning commodities such as precious metals or agricultural products gives them a sense of ownership and security.

 

Examples of Commodities Market

 

Crude oil and silver were among the most widely traded commodities on India's major commodity exchanges. While crude oil is one of the most significant energy sources required by almost every business, silver is one of the most valuable metals other than gold, with a consistent demand.

 

Although crude oil is in short supply locally, nearly 82% is imported from OPEC and Middle Eastern countries. Similarly, silver is traded in large quantities from countries like Mexico and Peru.

 

Final remarks include, The commodity market is a critical component of the global economy that provides numerous advantages to investors. Understanding the elements that influence commodity pricing is critical for investing in this market.

 

To be successful in this market, you must undertake thorough research and analysis, establish investing objectives and risk tolerance, diversify your portfolios, and analyse and alter your investments on a regular basis.

Also Read | What is Monopoly in Economics?