Raise participation of hedgers to increase trade volumes

Declining trade volumes in commodity futures exchanges has become a matter of concern for market participants. In the first nine months of the current fiscal, commodity futures trade have shrunk in volume and value. Some analysts have attributed the fall to imposition of the commodity transaction tax, a favourite whipping boy of the industry. Payment crisis at National Spot Exchange Limited is cited as reason for retail participants staying away.

Price discovery Without a doubt, a deeper and wider market would help price discovery. Rising trading volumes may signify robust and active participation; but there are risks associated with generalising this to suggest a well balanced market. It is important to be aware of the “quality” of market participation. Indian commodity futures market is characterised by the dominance of speculators (euphemistically called investors), while hedger participation is rather limited.

While it may be a little too harsh to suggest that commodity futures exchanges have failed to attract adequate hedger participation over the last ten years, it is clear that their attempts, generally feeble, to attract genuine hedgers — those with exposure to the underlying commodity and run the risk of adverse price movement — have not brought any notable success. For the current fall in trade volumes, there are two principal reasons that observers are either generally unaware or too shy to admit. Indian speculators by their nature know to play only a rising market. Because the country is in an expansionary mode, commodity prices have generally been on a rising trend, exacerbated by domestic cost factors and global market conditions.

Over the last ten years or so, commodities covering energy products (mainly crude), metals (precious, industrial and base metals) as well as major agricultural goods witnessed a rising price trend driven by a series of factors including those on the demand side and the supply side. Especially since 2009, commodity price hikes were largely liquidity driven because of a host of stimulus packages and easy money policy.

Global Growth All of us are well aware, barring a collapse in 2008-2009, how crude prices have risen consistently, gold and silver prices witnessed double digit growth for 10-long years until 2011 and how prices of major farm crops stayed at elevated levels for three years during 2010-2012 because of adverse weather.

Global growth is returning to trend. Geopolitical tensions have somewhat eased. The US Fed has begun to taper quantitative easing that is gradually reducing asset purchase and thereby reducing liquidity. Weather in 2013 was benign triggering an output rebound. Commodity prices have generally turned softer. Investing in a rising market does not require any great commercial intelligence or research capability; all you need is some capital to buy today or “go long” with the intention to sell later when the price rises.

Because they have been used to a rising commodity price trend, Indian investors are too scared to play a falling market. To benefit from a falling market, one needs in-depth product knowledge and market knowledge in addition to courage. Market entry and exit strategies have to be in place. A falling market offers more exciting opportunities than a rising market provided the investor knows the product and the market well. It is from this perspective that one must examine how best to reverse the falling trade volumes in the bourses.

Falling market In a falling market, consumers do not hedge their full exposure (similar to a rising market where producers do not hedge their full exposure). Educating investors about benefiting from a falling market is necessary. Importantly, hedger participation has to be increased. It may not be easy; but the process must begin. As an example, take the oilseeds and oils sector.

There are 15,000 oil mills, 1,000 refineries, 800 solvent extraction plants and 240 vanaspati units, most of them with some level of exposure to the underlying commodity; but how many actually hedge their price risks in the futures market? This analogy can be extended to other commodities. Exchanges have their job cut out for reversing the declining trend in trade volumes.

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