Commodity Analysis

‘Commodity market is not for investors’

Lokeshwarri S K | Updated on January 16, 2018 Published on September 25, 2016

AUROBINDO GAYAN, Vice-President-Research, Kotak Commodities

It is a place where users can hedge to mitigate the risk in the physical market

Commodity exchanges are witnessing a lot of action since SEBI took charge. With the trading and other processes getting streamlined, these could be an alternate asset class that investors could consider in the future. In a chat with BusinessLine, Aurobindo Gayan, Vice-President-Research, Kotak Commodities, discusses the various aspects of agri-commodity investments.

Do you think that the agri-commodity space is apt for retail investors or traders too?

From my perspective, the commodity market is not for investors. It is a place where users such as farmers, importers, exporters, traders or companies can hedge to mitigate the risk that they face in the physical market.

As far as investment in commodity market is concerned, yes, anyone can invest in commodity futures as the government does not state explicitly that you cannot trade in commodity futures without an exposure to the physical commodity. But one has to take a decision on buying or selling a commodity based on someone’s recommendation or his or her own analysis. If I have a view on jeera or guar seed or cumin seed, I can buy or sell them. But before doing that I need to understand that commodity. As a retailer, I might be holding sugar, but I might not know where it is produced or consumed, the extent of external trade, etc. For instance, today, sugar is trading at around ₹50 per kg in the physical market but a year ago it was available at ₹25. There is almost 100 per cent appreciation in price. If someone took a position in the wrong direction, he could have been killed.

These contracts are, however, very useful for importers and exporters. Say, I am an importer of sugar from Brazil, I face two risks — price risk and currency risk. I should take a long position in the futures market so that if the price goes up in the physical market, the simultaneous increase in price of future contract will help me bridge the gap.

What are the factors an investor should consider while selecting a contract?

As a retailer or user, the choice is simple, I select the commodity where I have an exposure. For investing or trading, the first thing I need to check before buying these commodities is the participation rate. At the exchange level, ₹2,500-3,000 crore of trading takes place in agri-commodities everyday. Out of this the edible oil cluster is the most liquid, followed by sugar, cotton and other commodities.

Another factor that needs to be checked is the sowing and harvesting pattern of commodities. Most commodities see greater demand and hence trading in these seasons. For instance, sugar has a lean season in September and sees more action in October, November and December when the cane comes to market and crushing happens. That’s when people trade or hedge using sugar contracts.

Third, I also need to understand my risk appetite and the capital I can infuse. Since these contracts are traded on the margin concept, exchanges decide the margin based on the volatility.

How is the spot and future convergence on commodity exchanges currently in agri-commodities?

We need to understand this a little critically here. Earlier, we had FMC and now SEBI is in control. There is doubt being raised by SEBI on the polling mechanism followed by exchanges to arrive at the spot price. As I understand, they are re-thinking the way it is being done now. What steps will be taken in the future, I do not know. The objective of this exercise, as I understand, is to streamline the process.

Today, there is convergence taking place, but it is not ideal. For instance, the contracts that are traded are based on certain quality and specification associated with some designated spot-market assigned at the beginning of the contract. Sugar future might be converged to Kolhapur spot market and not to the Andhra Pradesh spot market.

How is the settlement of contracts that are suspended from trading done?

These contracts are settled based on the average spot prices of the previous few days. So those holding the contracts could either gain or lose. It will, however, be good if the exchanges notify the participants a couple of days prior to the banning of contract so that retail participants can exit it.

Published on September 25, 2016

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