Commodity market

1. Commodities Market
6. Commodities as a new asset class
An asset class is a collection of securities, manifesting comparable traits and goes through similar market
fluctuations. Similar legalities almost always bind securities in one asset class. Risk factors, taxation,
return rates, liquidity, tenures and market volatility differ according to asset classes. Hence, investors
often rely on asset category diversification to earn maximum returns with minimal costs.
Commodities can be anything ranging from goods, properties or products that can be traded for
different purposes. Gold, silver, bronze, food crops, petroleum, etc. are some examples of commodities
under the asset class, and the market undercurrents vary for each. The price can rise or fall as per the
demand. Merchandises are not meant for long-term investments unless it is gold or silver. Just buy
when the prices are down and sell when the prices go up.
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,
potentially lowering the risk of an overall portfolio and boosting returns. Given their impact on
consumer goods prices, commodities can also offer a hedge against inflation. It is historically seen that
the commodities and other asset classes such as equities and bonds carry an inverse correlation. This
characteristic will give an opportunity for investors to have commodities in their portfolio and make
their portfolio a balanced one.
Investment in commodities gives three benefits to an investor such as hedge against inflation,
diversification with other asset classes, and return potential which is independent of equities and bonds.
Since commodities are real assets, they tend to react to changing economic fundamentals in different
ways than stocks and bonds, which are financial assets. Commodities tend to benefit from rising
inflation as the rising price of commodities tends to rise in inflation. On the other hand, rising inflation
pressurizes the equities market. Stocks and bonds perform better when the rate of inflation is stable or
slowing.
7. Design of a commodities derivative market
1. Meaning of Commodity Derivative Market: Commodity Derivative is Market is a place, where the
investor can directly incest in Commodities, rather than investing in those companies that trade in these
commodities. In other words, Commodity Derivative markets are the market, where the trade is
undertaken through a future/options/swap contracts. Under these contracts, as the name suggest,
transaction is completed at a future date.
Commodity Derivatives markets are a good source of critical information and indicator of market
sentiments. Since, commodities are frequently used as input in the production of goods or services,
uncertainty and volatility in commodity prices and raw materials makes the business environment
erratic, unpredictable and subject to unforeseeable risks.
2. Commodity Derivative Contract: A derivative contract, which has a commodity as its underlying, is
known as a ‘commodity derivatives’ contract. According to clause (bc) of section 2 of the SCRA,
commodity derivative” means a contract: (i) for the delivery of such goods, as may be notified by the

2. Central Government in the Official Gazette, and which is not a ready delivery contract; or (ii) for
differences, which derives its value from prices or indices of prices of such underlying goods or activities,
services, rights, interests and events, as may be notified by the Central Government, in consultation with
the Board, but does not include securities as referred to in sub-clauses (A) and (B) in the definition of
Derivatives.
3. Types of Derivative Contracts: There are 4 types of derivative contracts are involved in the commodity
market : √ Forwards – Private agreements where the buyer commits to buy, and the seller commits to
sell. √ Futures – Standardized forms of forwards that trade on exchanges. √ Options – Give the holder
the right to buy or sell the underlying asset on a fixed date in the future. √ Swaps – Contracts through
which two parties exchange streams of cash flows.
4. Trading Mechanism: In this market, the Commodity Derivative Trading is done by people who have
no need for the Commodity itself, but who first speculate on the direction of the Price of these
commodities, hoping to gain if the Price movement is in their favour.
5. Settlement: The most vital function in a Commodity Derivatives Market is the settlement and clearing
of trades. Commodity Derivatives can involve the exchange of funds and goods. There are separate
bodies to handle all the settlements, known as Clearing House. Example: The holder of a Future Contract
to buy Gold might choose to take delivery of Gold rather than closing his position before maturity. The
function of Clearing House, in such a case, is to take care of possible problems of default by the other
party involved, by standardizing and simplifying transaction processing between participants and the
organization.
6. Need for Commodity Derivative Market
There are two types of needs for Commodity Derivative Market, such as; (a) Instrumental Needs:
Hedgers needs for price risk reduction are called as Instrumental Needs. Their main requirement is to
reduce or eliminate Portfolio Risk at a Low Cost. (b) Convenient Needs: The other aspects that are to be
considered are flexibility in doing business, easy access to the market, and an efficient clearing system.
These are called Convenience Needs. It deals with Customer’s need to able to use the services provided
by the Exchange with ease. The extent of satisfaction of convenience needs determines the Process
Quality. 7. Features of Commodity Derivative Markets The followings are the features of commodity
Derivative Market; (a) Complement to investment in Companies that use commodities. (b) Defines
pattern of Country’s Production and Consumption. (c) Gains are in the forms of Price increases, not
dividends.
8. Issues related to trading in commodity market
Cash:
Many commodities traders rely on cash a lot longer than needed. We see large or relatively
established traders recycling their own funds, as they have not explored the various
solutions on the market. Much of this is due to distrust and perceived slow speed.
Inadequate banks:

3. Sometimes large banks or funders are inadequate in addressing the needs of certain clients.
While another funder may be more than happy to quickly amend facilities and increase limit
sizes. This reason for this mismatch mainly focuses on working with the right person and
understanding both the lender and borrower’s requirements. This includes security, products
and cycles. This is always changing.
False Truths:
We were recently with a large bank that told us they were financing in the way it had to be.
This was simply incorrect, by understanding the way other large funders and alternative
financiers may look at facilities; it is possible to explain and restructure facilities.
Wrong Leverage:
Due to larger companies having relatively opaque funding structures, it is not always
understood how a facility should look and what funding level is appropriate. Sometimes this
may be lead by new bank policy or relationship managers at banks who do not want to push
the boundaries.
Poor Structure:
Sometimes the wrong facilities are used and certain elements are not known about. This is
due to funders providing the wrong solutions and a business not having long-term plans in
place. There may be trades that a company use their own cash for, which can fit into a
facility. There may also be no pre-export finance facilities used, alternative repo structures or
receivables finance wrongly utilised when an alternative structure could be more beneficial.
Unnecessary security:
Security is sometimes asked for when it shouldn’t be; this can be negotiated out of and used
in various ways. By providing security when not necessary, this could be disadvantageous in
the long run.
Poor jurisdictions:
It may be easy for certain companies to set up in more favourable jurisdictions or trade with
alternative countries. This may be advantageous when looking at the companies’ long-term
growth.
Being a burden:

4. The funder and client relationship should be one of partnership in growth as it is in both of
their interests to make this work. It is too often thought of as a struggle where difficulty is
often found.
9. Relation between crude oil and gold
Gold-oil ratio determines the number of barrels of oil to buy with an ounce of gold. It means that the
higher the ratio, cheaper the oil and the greater the purchasing power of gold. Currently (Jan 30th) an
ounce of gold will get you 30 barrels of crude oil.
Oil is often considered the leader in commodity markets, where a change in oil price affects the prices of
other commodities, including that of gold. This implies that changes in the gold price may be monitored
by observing movements in the oil price, through several factors.
In order to disperse market risk and maintain commodity value, dominant oil-exporting countries use
high revenues from oil sales to invest in gold. Since several countries including oil producers retain gold
as an asset in their international reserve portfolios, rising oil prices (and hence oil revenues) may have
implications for increases in gold prices. This holds true as long as gold accounts for a significant portion
of the asset portfolio of oil exporters and if these exporters purchase gold in line with their rising oil
revenues. Therefore, the expansion of oil revenues enhances gold market investment, and this causes
oil price and gold price levels to trend upward together. In such a scenario, an oil price increase leads to
a rise in demand for (and hence the price of) gold.
inflation seems to be the most common channel for explaining the relationship between oil and gold
markets. According to this, a rise in crude-oil prices leads to an increase in the general price level.
When the general price level goes up, the price of gold, which is also a good, will increase. This gives rise
to the role of gold as an instrument to hedge against inflation, and gold is indeed renowned as an
effective tool in this regard. Hence, inflation, which is strengthened by high oil prices, causes an increase
in demand for gold and thus leads to a rise in the gold price.
10. Major geopolitical changes events in 2022 which affected commodities
market.