Commodity Analysis

Commodity Query

Rajalakshmi Nirmal | Updated on January 16, 2018 Published on October 09, 2016


I want to invest in commodities. How much of my portfolio should be in commodities? How do I decide this?

Prasant Mohanty, GurgaonBefore you make up your mind to invest in commodities, you need to be clear about the objective of investing in them. If it is to diversify the risk from equity investing, then gold may fit the bill well. About 10 per cent of your portfolio can be in gold. If you want an inflation hedge- you can choose to go long in a futures contract of a commodity that is in your shopping basket (in NCDEX futures contracts of sugar, oil seeds, spices and a few more agri commodities are traded) or buy the respective commodity stock if available. This can be 5-10 per cent of your portfolio.

For commodities other than gold, investment is possible only through the futures market where you have to keep rolling over the contract every month – this will involve costs as you have to first square-up your position and then buy the next month’s contract at whatever price it trades. Then, there is also margin risk. You have to keep paying the difference between the opening and closing contract price to the exchange (mark-to-market margin). If the contract sees a sharp price correction, you will be required to deposit additional volatility margin.

If you want to invest for the long term in commodities investing in commodity stocks is an option to consider. Sugar stocks (Balrampur Chini, EID Parry and others) follow price trends in sugar. Similar, is the case with tea (plantation) stocks (Mcleod Russel, Harrisons Malayalam) and metals- Zinc (Hindustan Zinc), Steel (Tata Steel) and aluminium (Hindalco). These can provide a hedge against inflation. For instance, in January, had you bought the stock of Balrampur Chini, you would have been protected against the rise in sugar prices. While sugar prices have rallied 48 per cent so far this year, the stock of Balrampur Chini has rallied 54 per cent.

Commodity price movement is cyclical, therefore this asset class is not suited for long-term investors who follow a buy and hold strategy. Only those who can track the price moves closely to enable timely entry and exits should consider investing in commodities.

How does the commodity market work? What is the difference between futures and option trading?

Diksha Srivastava, BiharIn India there are three national commodity exchanges- NCDEX, MCX and NMCE. As per 2015-16 numbers from SEBI, which is now the commodities market regulator, there are 38 commodities (28 of them being agri commodities) that are actively traded on these exchanges as futures contract. The regulator recently allowed these exchanges to offer trading in options on commodities.

Both futures and options are derivative instruments that derive their value from an underlying security (a commodity here). In a futures contract a buyer and a seller agree to buy or sell an asset at a certain time in the future at a certain price. However, there is a fundamental difference between the two instruments. In futures, while both the buyer and the seller have the obligation to fulfil the contract, in options, the buyer has the right but no obligation to fulfil it. So, for an option buyer, loss is limited (to the premium he pays for the contract) while profits are unlimited. This feature makes it an ideal hedging tool for small participants.

If you want to trade on commodity derivative contracts, you need to approach a commodity broker and open a trading and demat account. You can go for either cash settlement or take delivery when the commodity contract expires. A seller who intends to give delivery has to take his commodity to one of the designated warehouses. If it meets the contract specifications a warehouse receipt will be issued and the seller will get a credit for the commodities in his demat account.

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Published on October 09, 2016

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