Chapter 1 INTRODUCTION OF COMMODITIES

Ever since the dawn of civilization commodities trading have become an integral part in the lives of mankind. The very reason for this lies in the fact that commodities represent the fundamental elements of utility for human beings. Over the years commodities markets have been experiencing tremendous progress, which is evident from the fact that the trade in this segment is standing as the boon for the global economy today. The promising nature of these markets has made them an attractive investment avenue for investors.

What is meant by the term Commodity?

One of the first forms of trade between individuals began by what is called the barter system where in goods were traded for goods. Any product that can be used for commerce or an article of commerce which is traded on an authorized commodity exchange is known as commodity. The article should be movable of value, something which is bought or sold and which is produced or used as the subject or barter or sale. In short commodity includes all kinds of goods. Indian Forward Contracts (Regulation) Act (FCRA), 1952 defines goods as every kind of movable property other than actionable claims, money and securities. Forward Contracts (Regulation) Act (FCRA), 1952 defines goods as every kind of movable property other than actionable claims, money and securities. In current situation, all goods and products of agricultural (including plantation), mineral and fossil origin are allowed for commodity trading recognized under the FCRA. The national commodity exchanges, recognized by the Central Government, permits commodities which include precious (gold and silver) and non-ferrous metals, cereals and pulses, ginned and unginned cotton, oilseeds, oils and oilcakes, raw jute and jute goods, sugar and gur, potatoes and onions, coffee and tea, rubber and spices, etc.
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1.1. Evolution of commodity markets in India:

Organized futures market evolved in India by the setting up of "Bombay Cotton Trade Association Ltd." in 1875. In 1893, following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association, a separate association by the name "Bombay Cotton Exchange Ltd." was constituted. Futures trading in oilseeds was organized in India for the first time with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures trading in groundnut , castor seed and cotton. Before the Second World War broke out in 1939 several futures markets in oilseeds were functioning in Gujarat and Punjab. Futures trading in Raw Jute and Jute Goods began in Calcutta with the establishment of the Calcutta Hessian Exchange Ltd., in 1919. Later East Indian Jute Association Ltd., was set up in 1927 for organizing futures trading in Raw Jute. These two associations amalgamated in 1945 to form the present East India Jute & Hessian Ltd., to conduct organized trading in both Raw Jute and Jute goods. In case of wheat, futures markets were in existence at several centers at Punjab and U.P. The most notable amongst them was the Chamber of Commerce at Hapur, which was established in 1913. Futures market in Bullion began at Mumbai in 1920 and later similar markets came up at Rajkot, Jaipur, Jamnagar, Kanpur, Delhi and Calcutta. In due course several other exchanges were also created in the country to trade in such diverse commodities as pepper, turmeric, potato, sugar and gur(jaggory). After independence, the Constitution of India brought the subject of "Stock Exchanges and futures markets" in the Union list. As a result, the responsibility for regulation of commodity futures markets devolved on Govt. of India. A Bill on forward contracts was referred to an expert committee headed by Prof. A.D.Shroff and Select Committees of two successive Parliaments and finally in December 1952 Forward Contracts (Regulation) Act, 1952, was enacted.

The Act provided for 3-tier regulatory system :(a) An association recognized by the Government of India on the recommendation of Forward Markets Commission,
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(b) The Forward Markets Commission (it was set up in September 1953) and (c) The Central Government. Forward Contracts (Regulation) Rules were notified by the Central Government in July, 1954

The Act divides the commodities into 3 categories :(a) The commodities in which futures trading can be organized under the auspices of recognized association. (b) (c) The Commodities in which futures trading is prohibited. Those commodities which have neither been regulated for being traded under the

recognized association nor prohibited are referred as Free Commodities and the association organized in such free commodities is required to obtain the Certificate of Registration from the Forward Markets Commission. In the seventies, most of the registered associations became inactive, as futures as well as forward trading in the commodities for which they were registered came to be either suspended or prohibited altogether. The Khusro Committee (June 1980) had recommended reintroduction of futures trading in most of the major commodities , including cotton, kapas, raw jute and jute goods and suggested that steps may be taken for introducing futures trading in commodities, like potatoes, onions, etc. at appropriate time. The government, accordingly initiated futures trading in Potato during the latter half of 1980 in quite a few markets in Punjab and Uttar Pradesh. After the introduction of economic reforms since June 1991 and the consequent gradual trade and industry liberalization in both the domestic and external sectors, the Govt. of India appointed in June 1993 one more committee on Forward Markets under Chairmanship of Prof. K.N. Kabra. The Committee submitted its report in September 1994. The majority report of the Committee recommended that futures trading be introduced in:

Basmati Rice Cotton Kapas Raw

Rice bran oil Linseed Silver Onions

The committee also recommended that some of the existing commodity exchanges particularly the ones in pepper and castor seed may be upgraded to the level of international futures markets. The liberalized policy being followed by the Government of India and the gradual withdrawal of the procurement and distribution channel necessitated setting in place a market mechanism to perform the economic functions of price discovery and risk management. The National Agriculture Policy announced in July 2000 and the announcements of Hon'ble Finance Minister in the Budget Speech for 2002-2003 were indicative of the Governments resolve to put in place a mechanism of futures trade/market. As a follow up the Government issued notifications on 1.4.2003 permitting futures trading in the commodities, with the issue of these notifications futures trading is not prohibited in any commodity. Options trading in commodity is, however presently prohibited.

1.2 OBJECTIVE OF STUDY:

1) To study Commodity market 2) To study perception of investors towards Commodity market. 3) To understand what are investment and why one invest. 4) To understand whether Commodity market is profitable source of investment 5) To find out market position of Company 6) To know the market share on daily basis 7) To know the behavior of the customer 8) To know the competitors strategy 1.3 RESEARCH METHODOLOGY: A. PRIMARY DATA Primary data is a type of information that is obtained directly from first-hand sources by means of surveys, questionnaire, observation or experimentation. It is data that has not been previously published and is derived from a new or original research study and collected at the source such as in marketing. B. SECONDARY DATA Secondary data is any information collected by someone else other than it's user. It is data that has already been collected and is readily available for use. Secondary data saves on time as compared to primary data which has to be collected and analyzed before use C. RESEACH LIMITATION : 1. The suggestion is based on the study on Fundamental and Technical Analysis such as price movement, relationship of gold with others factors, Volumes and Open 2. This analysis will be holding good for a limited time period that is based on pressing scenario and study conducted, future movement on gold may or may not be similar 3. Some people are not aware about commodity markets in details

Chapter 2

COMMODITY MARKETS

Commodity market is a place where trading in commodities takes place. Markets where raw or primary products are exchanged. These raw commodities are traded on regulated commoditiesexchanges, in which they are bought and sold in standardized Contracts. It is similar to an Equity market, but instead of buying or selling shares one buys or sells commodities.

2.1. Myths about commodity exchanges

2.2. World Commodity Markets

A commodities exchange is an exchange where various commodities and derivatives products are traded. Most commodity markets across the world trade in agricultural products and other raw materials (like wheat, barley, sugar, maize, cotton, cocoa, coffee, milkproducts, pork

bellies, oil, metals, etc.) and contracts based on them. These contracts can include spot prices, forwards, futures and options on futures. Other sophisticated products may

include interest rates, environmental instruments, swaps, or ocean freight contracts. Some of the leading Commodity Exchanges are follows:

I.

New York Mercantile Exchange, Inc.,

It is the world's largest physical commodity futures exchange and the prominent trading forum for energy and precious metals. The Exchange has stood for market integrity and price transparency for more than 135 years. Transactions executed on the Exchange avoid the risk of counterparty default because the NYMEX clearinghouse acts as the counterparty to every trade. Trading is conducted in energy, metals, softs, and environmental commodity futures and options via the CME electronic trading system, open outcry, and NYMEX. NYMEX pioneered the development of energy futures and options contracts in 1978 as means of bringing price transparency and risk management to this vital market. NYMEX provides markets for the trading and clearing of crude oil, gasoline, heating oil, natural gas, electricity, propane, coal, uranium, environmental commodities, softs, gold, silver, copper, aluminum, platinum, and palladium. Many different types of options are also available for most of these products, including options on the price differentials between crude oil and its products (crack spreads), various futures contract months (calendar spreads), and European- and Asianstyle options.

II.

The Chicago Board of Trade (CBOT)

It was established in 1848, is the world's oldest futures and options exchange. More than 50 different options and futures contracts are traded by over 3,600 CBOT members through open outcry and E-Trading. Volumes at the exchange in 2003 were a record breaking 454 million contracts. On 12 July 2007, the CBOT merged with the CME under the CME Group holding company and ceased to exist as an independent entity.

In 1864, the CBOT listed the first ever standardized "exchange traded" forward contracts, which were called futures contracts. In 1919, its name changed to Chicago Mercantile Exchange (CME).

III.

Dubai Gold Commodity Exchange

Dubai has historically been an international hub for the physical trade of not only gold, but also many other commodities and so the establishment of the Dubai Gold & Commodities Exchange (DGCX) was the next logical step for the region and the local economy. DGCX commenced trading in November 2005 as the regions first commodity derivatives exchange and has become today, the leading derivatives exchange in the Middle East , providing the right products, at the right price and the right time. DGCX is an initiative of the Dubai Multi Commodities Centre (DMCC), Financial Technologies (India) Limited and the Multi Commodity Exchange of India Limited (MCX). The Management team of DGCX comprises senior personnel from the commodities, securities and financial services industries bringing a wealth of experience and expertise to ensure the success of DGCX. DGCX offers the unique advantage of being located in the Middle East, one of the worlds largest areas of financial liquidity. Dubai is one of the worlds fastest growing business centres, with over 400 international institutions from around the globe and US $160 billion high net worth investment business. It is

also the worlds third largest re-exporter and grew on average by over 13.4% per year between 2000 and 2005. Dubai offers a strong, stable government and a balanced, world class regulatory framework. With a zero tax environment and free trade zones offering 100% ownership, it has become the entry point for much of the Middle Easts liquidity and trade activity.

IV.

London Metal Exchange

Established for over 130 years and located in the heart of The City of London, the London Metal Exchange is the worlds premier non-ferrous metals market. It offers futures and options contracts for aluminum, copper, nickel, tin, zinc and lead plus two regional aluminum alloy contracts. In 2005 the Exchange launched the worlds first futures contracts for plastics; for polypropylene and linear low density polyethylene, with the introduction of regional plastics contracts in 2007. In addition, it offers LMEminis, which are smaller-sized contracts for copper, aluminum and zinc plus an index contract (LMEX). The Exchange provides a transparent forum for all trading activity and as a result helps to discover what the price of material will be months and years ahead. This helps the physical industry to plan forward in a world subject to often severe and rapid price movements. Such is the liquidity at the Exchange that the prices discovered at the LME are recognized and relied upon by industry throughout the world. The LME is a highly liquid market and in 2007 achieved volumes of 93 million lots, equivalent to $9,500 billion annually and between $35-45 billion on an average business day. Despite its London location the LME is a global market with an international membership and with more than 95% of its business coming from overseas. Being a principal-to-principal market, the only organizations able to trade are its member firms, of which there are various categories. LME members provide the physical industry with access to the market, to the risk management tools and to the delivery mechanism. Trading takes place across three trading platforms: through open-outcry trading in the Ring, through an inter-office telephone market and through LME Select, the Exchanges electronic trading platform
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Chapter 3
COMMODITY EXCHANGES IN INDIA In India there are 21 regional exchanges and three national level multi-commodity exchanges. After a gap of almost three decades, Government of India has allowed forward transactions in commodities through Online Commodity Exchanges, a modification of traditional business known as Adhat and VaydaVyapar to facilitate better risk coverage and delivery of commodities. The three exchanges are:

3.1. National Commodity & Derivatives Exchange Limited (NCDEX)

National Commodity & Derivatives Exchange Limited (NCDEX) located in Mumbai is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956 and had commenced its operations on December 15, 2003.This is the only commodity exchange in the country promoted by national level institutions. It is promoted by ICICI Bank Limited, Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India Limited (NSE). It is a professionally managed online multi commodity exchange. NCDEX is a nation-level, technology driven demutualised on-line commodity exchange with an independent Board of Directors and professional management - both not having any vested interest in commodity markets. It is committed to provide a world-class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency. NCDEX is regulated by Forward Market Commission and is subjected to various laws of the land like the Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various other legislations.

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Products Dealt Agro products Precious metals Base metals Ferrous Metals Energy products Polymers

Carbon credit

3.2. Multi Commodity Exchange of India Limited (MCX)

Headquartered Exchange of in Mumbai Multi Commodity is an

India

Limited

(MCX),

independent and de-mutulised exchange with a permanent recognition from Government of India. Key shareholders of MCX are Financial

Technologies (India) Ltd., State Bank of India, Union Bank of India, Corporation Bank, Bank of India and Canara Bank. MCX facilitates online trading, clearing and settlement operations for commodity futures markets across the country. MCX started offering trade in November 2003 and has built strategic alliances with Bombay Bullion Association, Bombay Metal Exchange, Solvent Extractors Association of India, Pulses Importers Association and ShetkariSanghatana. Apart from being accredited with ISO 9001:2000 for quality standards, MCX offers futures trading in 59 commodities as on January 31,2009, 2008, defined in terms of the type of contracts offered, from various market segments including bullion, energy, ferrous and non-ferrous metals, oils and oil seeds, cereals, pulses, plantations, spices, plastics and fibres. The exchange strives to be at the forefront of developments in the commodities futures industry and has forged ten strategic alliances across the world, including with Tokyo Commodity Exchange, Chicago Climate Exchange, London Metal Exchange, New York Mercantile Exchange, New York Board of Trade and Bursa Malaysia Derivatives, Berhad.
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Products Dealt: Bullion Oil & oil seeds Spices Metal Fiber Pulses Cereals Energy Plantations Petrochemicals Weather Others

3.3. National Multi-Commodity Exchange of India Limited(NMCE)

National Multi Commodity Exchange of India Limited (NMCE) is the first de mutualized, Electronic MultiCommodity Exchange in India. On 25th July, 2001, it was granted approval by the Government to organize trading in the edible oil complex. It has

operationalized from November 26th, 2002. It is being supported by Central Warehousing Corporation Ltd., Gujarat State Agricultural Marketing Board and Neptune Overseas Limited. It got its recognition in October 2002. Commodity exchange in India plays an important role where the prices of any commodity are not fixed, in an organized way. Earlier only the buyer of produce and its seller in the market judged upon the prices. Others never had a say. Today, commodity exchanges are purely speculative in nature. Before discovering the price, they reach to the producers, end-users, and even the retail investors, at a grassroots level. It brings a price transparency and risk management in the vital market.
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A big difference between a typical auction, where a single auctioneer announces the bids and the Exchange is that people are not only competing to buy but also to sell. By Exchange rules and by law, no one can bid under a higher bid, and no one can offer to sell higher than someone elses lower offer. That keeps the market as efficient as possible, and keeps the traders on their toes to make sure no one gets the purchase or sale before they do.

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Chapter 4
MARKET SHARE OF INDIAN COMMODITY EXCHANGE

From the following table we can see that MCX share in the commodity market is more as compared with other Commodity Markets. But MCXs share has decreased as compared to year ago in April 2008 was 82.8% which has decreased to 82.5%, NCDEXs share has also decreased from 14% to 13.3%, NMCEs share has increased from 1.1% to 2.7%, Others has also decreased from 1.8% to 1.3%. From all this we can say that there is overall increase in the turnover of Commodity Market from 337814 in April, 2008 to 489988 in April, 2009.

4.1 Monthly Turnover of Commodity Exchanges

(Amt in Rs. Crores) 2008-09 Turnover April-08 Turnover March-09 Turnover April-09 Turnover

Commodity Exchanges

Multi Commodity Exchange of India (MCX)

4588094 (87.54)

279581 (82.8)

528138 (87.4)

404352 (82.5)

National multi-commodity exchange of India limited, Ahmadabad (NMCE) National Commodity & Derivatives Exchange Ltd. Mumbai (NCDEX)

61457 (1.2) 535707 (10.2)

3858 (1.1)

21820 (3.6)

13250 (2.7)

47351 (14.0)

42937 (7.1)

65202 (13.3)

Others

43156 (0.9) 5248957 (100)

6012 (1.8)

8776 (1.4)

6087 (1.3)

Total

337814 (100)

604459 (100)

489988 (100)

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Precious Metals Prices

4.2. Turnover of Various Commodity Markets

Turnover of Various Commodity Markets

1% 13% 3% MCX NMCE NCDEX others

83%

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4.3. List of Commodities Traded in India

FIBRES Kapas Cotton Yarn Cotton Raw Jute SPICES Pepper Cardamon Red Chilly Jeera Termeric Coriander

PULSES Masoor Chana Yellow Peas

METALS Aluminium Nickel Copper Zinc Lead Tin Iron Steel Gold Silver

ENERGY PRODUCTS Crude Oil Furnace Oil Natural Gas Electricity Heating Oil

EDIBLE OILSEEDS & OIL RBD Pamolein Groundnut Oil Sunflower Oil Rapeseed/Mustardseed Oil Soy bean and Oil

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Sesame Oil Refine soya Oil Castor Oil Castor Seeds Coconut Oil Cotton Seeds Mustard Oil Soy Bean Soy Seeds CEREALS Maize Wheat PLANTATIONS Coffee Cashewnut Rubber WEATHER Carbon Credits OTHERS Potato Guar Gum Sugar

Almond Mentha Oil Guar seed

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Chapter 5 COMMODITY MARKETS PARTICIPANTS

The structure of commodity markets dictates that there are several types of participants active in the trading of commodities and commodity derivatives. The structure of the participants and the nature of their activities/motivations are more complex than in other asset classes. The major participants in commodity markets include:

Commodity Producers/Consumers: These participants have natural underlying outright long (producers) and short (consumers) positions in the relevant commodity. The inherent risk-exposure drives the use of commodity derivatives by producers and users. The application of commodity derivatives in frequently driven by the pattern of cash flows. Producers must generally make significant capital investments (sometime significant in scale) to undertake the production of the commodity. This investment must generally be made in advance of production and sale of the commodity. This means that the producer is exposed to the price fluctuations in the commodity. If prices decline sharply, then revenues may be insufficient to cover the cost of servicing the capital investment (including debt service). This means that there is a natural tendency for producers to hedge at levels that ensure adequate returns without seeking to optimize the potential returns from higher returns. This may also be necessitated by the need to secure financing for the project. Consumer hedging behavior is more complex. Consumer desire to undertake hedges is influenced by availability of substitute products and the ability to pass on higher input costs in its own product market. In many commodities, producer and consumer deal directly with each other. The form of arrangement may include negotiated bilateral longterm supply or purchase contracts between the producers and consumers. The contracts may include fixed price arrangements to reduce the price risk for both parties.

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 Commodity Processors: These participants have limited outright price exposure. This reflects the fact the processors have a spread exposure to the price differential between the cost of the input and the cost of the output. For example, oil refiners are exposed to the differential between the price of the crude oil and the price of the refined oil products (diesel, gasoline, heating oil, aviation fuel, etc.). The nature of the exposure drives the types of hedging activity and the instruments used. Commodity Traders: Commodity markets have complex trading arrangements. This may include the involvement of trading companies (such as the Japanese trading companies and specialized commodity traders). Where involved, the traders act as an agent or principal to secure the sale/purchase of the commodity. Traders increasingly seek to add value to pure trading relationship by providing derivative/risk management expertise. Traders also occasionally provide financing and other services. Commodity traders have complex hedging requirements, depending on the nature of their activities. A trader as a pure agent will generally have no price exposure. Where a trader acts as a principal, it will generally have outright commodity price risk that requires hedging. Financial Institution/Dealers: Dealer participation in commodity markets is primarily as a provider of finance or provider of risk management products. The dealers' role is similar to that in the derivative market in other asset classes. The dealers provide credit enhancement, speed, immediacy of execution and structural flexibility. Dealers frequently bundle risk management products with other financial services such as provision of finance. Investors: This covers financial investors seeking to invest in commodities as a distinct and a separate asset class of financial investment. The gradual recognition of commodities as a specific class of investment assets is an important factor that has influenced the structure of commodity derivatives markets.

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PRODUCERS

PROCESSORS

CONSUMERS

COMMODITYMARKET

COMMODITY TRADERS

BANKS/DEALERS

INVESTORS

COMMODITY MARKETS PARTICIPANTS

ANCILLARY SERVICES Commodity Trading Transportation/Transmission Unprocessed Commodity Processed Commodity

PRODUCER Cash

PROCESSOR Cash FINANCIAL SERVICES Finance Insurance Hedging/Risk Management

CONSUMER

COMMODITY MARKETS VALUE / PROCESS CHAIN

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Chapter 6 TYPES OF TRADERS

The following three broad categories of type of players:

6.1. TYPE OF PLAYERS IN COMMODITY MARKET

HEDGERS
1. Hedgers: -

SPECULATORS

ARBITRATORS

Hedgers face risk associated with the price of an asset. They use futures or options markets to reduce or eliminate this risk. Example: If I am a textile manufacturer and I have to buy cotton at Rs. 100 after 3 months. I am located in Mumbai but the delivery centre is Ahmedabad. Suppose after 3 months the futures price is Rs. 120, as is the spot price. I would not like to go to Ahmedabad and pick up the cotton because of the transport cost, tax payments, insurance etc. I therefore, sell the futures contract on the Exchange for Rs, 120 and make a profit of Rs.20/-. But, the price in the spot market is also Rs.120/-. I buy cotton at Rs. 120/- in Mumbai spot market and the implicit loss is Rs.20/- now as I had a price of Rs.100/- in mind. But, this loss is offset by the gain thus providing the perfect hedge for me. 2. Speculators: Speculators wish to bet on future movements in the price of an asset. Futures and options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture.

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Example:Here the Speculator believes that Commodity Market will go to appreciate while Diwali Season. Current Market price of Gold = 15,000 per 10 grams. Strategy = Buy Gold futures contract at Rs. 15,000 per 10 grams. Lot Size = 1 Kg (1000 grams) Contract value = Rs.15,00,000 (8,000*1,000/10) Margin = Rs. 1,50,000 (10% of 15,00,000) Market action = Rise to 15,100 Future Gain = 10,000 [(15,100-15000)*1000/10] So, her Speculator gained the profit of Rs.10,000. But it is not always true that the speculator will gain the profits every time. Thus the Speculator has a view on the market and accepts the risk in anticipating of profiting from the view. He studies the market and plays the game with the Commodity market. 3. Arbitrators: Arbitrators are the people who take the advantage of a discrepancy between prices in two different markets. Example:Spot price of Gold in Mumbai = Rs. 15,000 per 10 grams. And at the same time The Gold futures contract on MCX = Rs. 15,200 per 10 grams. Then the trader buys a kg of gold in cash market and simultaneously takes a Short position in the futures market. On the expiry of the contract he opts to deliver the physical gold and gains at the rate of Rs.200 per 10 grams.
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Chapter 7 INSTRUMENTS AVAILABLE FOR TRADING

In recent year, derivatives have become increasingly popular due to their applications for hedging, speculation and arbitrage. Before we study about the applications of commodity derivatives, we will have a look at some basic derivative products. While futures and options are now actively traded on many exchanges, forward contracts are popular on the OTC market.

7.1. FORWARD CONTRACTS: Forwards are oldest and simplest mode of a derivative transaction. A forward contract refers to an agreement to buy or sell an asset on specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchange. The salient features of forward contracts are :1. They are bilateral contracts and hence exposed to counterparty risk. 2. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. 3. The contract price is generally not available in public domain. 4. On the expiration date, the contract has to be settled by delivery of the asset. 5. If the party wishes to reverse the contract, it has to compulsorily go to the same Counterparty, which often results in high prices being charged.

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Example:Mr. A is the Farmer who produces Wheat and wants to sell his crop after harvesting on the other hand Mr. B is the Grain Merchant who wants to purchase the Wheat when the new crop will come in the market. Here, both parties are worried about the future price fluctuation of wheat. Mr. A & Mr. B comes together and makes the Forward Contract and decides to sell the Wheat at Rs.10/Kg. After Harvesting, Case I reflect Favorable Monsoon & Case II reflect Unfavorable Monsoon Case I: In the Case I there is good monsoon, so therefore the production and supply of wheat in the market increases and it automatically results Decrease In Price of the Wheat to Rs.9/-. Here, Mr. A gain Rs.1/- and Mr. B lose Rs.1/Case II: In the Case II there is Bad Monsoon, so therefore the production and supply of Wheat in the market decreased and it automatically results Increases in Price of the Wheat to Rs. 11/-. Here, Mr. A loses Rs.1/- and Mr. B gains Rs.1/-. A farmer risks the cost of production a product ready for market at sometime in the future because he doesnt know what the selling price will be, for reducing such kind of risks he make the Forward Contract to reduce the risks.

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7.2. FUTURE CONTRACTS

A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. There is a multilateral contract between the buyer and seller for an underlying asset. But unlike forward contracts the future contracts are standardized and exchange traded. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way. A futures contract is a type of "forward contract". Forward Contract (Regulation) Act, 1952 (FCRA) defines forward contract as "a contract for the delivery of goods and which is not a ready delivery contract". Under the Act, a ready delivery contract is one, which provides for the delivery of goods and the payment of price therefore, either immediately or within such period not exceeding 11 days after the date of the contract, subject to such conditions as may be prescribed by the Central Government. A ready delivery contract is required by law to be fulfilled by giving and taking the physical delivery of goods. In market parlance, the ready delivery contracts are commonly known as "spot" or "cash" contracts. All contracts in commodities providing for delivery of goods and/or payment of price after 11 days from the date of the contract are "forward" contracts. Forward contracts are of two types - "Specific Delivery contracts" and "Futures Contracts". Specific delivery contracts provide for the actual delivery of specific quantities and types of goods during a specified future period, and in which the names of both the buyer and the seller are mentioned. The term 'Futures contract' is nowhere defined in the FCRA. But the Act implies that it is a forward contract, which is not a specific delivery contract. However, being a forward contract, it is necessarily "a contract for the delivery of goods". A futures contract in which delivery is not intended is void (i.e., not enforceable by law), and is, therefore, not permitted for trading at any commodity exchange.

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The standardized items in a futures contract are : Quantity of the underlying. Quality of the underlying. The date and the month of delivery. The units of price quotation and minimum price change. Location of settlement. 7.3. COMMODITY FUTURES CONTRACTS A commodity futures contract is a tradable standardized contract, the terms of which are set in advance by the commodity exchange organizing trading in it. The futures contract is for a specified variety of a commodity, known as the "basis", though quite a few other similar varieties, both inferior and superior, are allowed to be deliverable or tenderable for delivery against the specified futures contract. The quality parameters of the "basis" and the permissible tenderable varieties; the delivery months and schedules; the places of delivery; the "on" and "off" allowances for the quality differences and the transport costs; the tradable lots; the modes of price quotes; the procedures for regular periodical (mostly daily) clearings; the payment of prescribed clearing and margin monies; the transaction, clearing and other fees; the arbitration, survey and other dispute redressing methods; the manner of settlement of outstanding transactions after the last trading day, the penalties for non-issuance or non-acceptance of deliveries, etc., are all predetermined by the rules and regulations of the commodity exchange. Consequently, the parties to the contract are required to negotiate only the quantity to be bought and sold, and the price. The Exchange prescribes everything else. Because of the standardized nature of the futures contract, it can be traded with ease at a moment's notice PURPOSE The primary purpose of futures market is to provide an efficient and effective mechanism for management of inherent risks, without counter-party risk. It is a derivative instrument and a type of forward contract. The future contracts are affected mainly by the prices of the underlying asset. As it is a future contract the buyer and seller has to pay the margin to trade in the futures market.

26

It is essential that both the parties compulsorily discharge their respective obligations on the settlement day only, even though the payoffs are on a daily marking to market basis to avoid default risk. Hence, the gains or losses are netted off on a daily basis and each morning starts with a fresh opening value. Here both the parties face an equal amount of risk and are also required to pay upfront margins to the exchange irrespective of whether they are buyers or sellers.

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7.4. APEX BODY

MINISTRY OF CONSUMER AFFAIRS

FMC

COMMODITY EXCHANGES

NATIONAL EXCHANGESS

REGIONAL EXCHANGES

NCDEX

NMCE

MCX

NBOT

20 OTHERS REGIONAL EXCHANGES

At present, there are three tiers of regulations for contracts of commodities in India namely, GOVERNMENT [Ministry Of Consumer Affairs], FORWARD MARKET COMMISSION [FMC] and COMMODITIES EXCHANGES. The need for regulation arises on account of the fact that the benefits of future markets accrue in competitive conditions. Proper regulation is needed to create competitive conditions. In the absence of regulation, unscrupulous participants could use these leveraged contracts for manipulating prices. This could have undesirable influence on the spot prices; thereby affecting interests of society at large. Regulation is also needed to ensure that the market has appropriate risk management system. In the absence of such a system, a major default could create systematic risk. Finally regulation is also needed to ensure fairness and transparency in Trading,
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Clearing, Settlement and Management of the exchange so as to protect and promote the interest of various stakeholders.

GOVERNMENT OF INDIA
FORWARD MARKET COMMISSION Ministry Of Consumer Affairs, Food & Public Distribution

FORWARD MARKETS COMMISSION {FMC} headquartered at Mumbai, is a regulatory authority, which is overseen by the Ministry of Consumer Affairs & Public Distribution, Government Of India. It is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952. "The Act provides that the Commission shall consist of not less than two but not exceeding four members appointed by the Central Government out of them being nominated by the Central Government to be the Chairman thereof. Currently Commission comprises four members among whom Shri S. Sundareshan, IAS, is the Chairman and Dr. Kewal Ram, IES, Dr. (Smt) Jayashree Gupta, CSS, and Shri Rajeev kumarAgarwal, IRS, are the Members of the Commission."

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The functions of the Forward Markets Commission are as follows: 1. To advise the Central Government in respect of the recognition or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of the Forward Contracts (Regulation) Act 1952. 2. To keep forward markets under observation and to take such action in relation to them, as it may consider necessary, in exercise of the powers assigned to it by or under the Act. 3. To collect and whenever the Commission thinks it necessary, to publish information regarding the trading conditions in respect of goods to which any of the provisions of the act is made applicable, including information regarding supply, demand and prices, and to submit to the Central Government, periodical reports on the working of forward markets relating to such goods; 4. To make recommendations generally with a view to improving the organization and working of forward markets; 5. To undertake the inspection of the accounts and other documents of any recognized association or registered association or any member of such association whenever it considerers it necessary.

7.5 The Scope of commodities

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Chapter 8 HOW COMMODITY MARKET WORKS

When you buy Futures, you do not have to pay the entire amount, just a fixed percentage of the cost. This is known as the margin. Let's say you are buying a Gold Futures contract. The minimum contract size for a gold future is 100 gms. 100 gms of gold may be worth Rs 72,000. The margin for gold set by MCX is 3.5%. Therefore, you only end up paying Rs 2,520.The low margin means that you can buy futures representing a large amount of gold by paying only a fraction of the price. So you bought the Gold Futures contract when it was Rs 72,000 per 100 gms. The next day, the price of gold rose to Rs. 73,000 per 100 gms. Rs.1,000 (Rs 73,000 Rs 72,000) will be credited to your account. The following day, the price dips to Rs 72,500. Rs 500 will be debited from your account (Rs 73,000 - Rs 72,500).

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In the above diagram it is seen how the commodity market works. It starts with the farmer producing the food grain and pulses, then he sells his produce in the mandi or he directly deposits it in the warehouse of the depository link. Then the trade is executed then the time of the settlement of trade comes i.e. on 20th of every month the buyer who wants the physical delivery of the commodity fills the form for delivery and the depository participant of the buyer informs the exchange about this and the same thing is done by the depository participant of the seller, if the delivery is possible then the buyer is given the delivery, otherwise the trade is cash settled. So this is how the commodity market works but there are some loopholes. The farmer is not able to provide the goods to the mandi or warehouse because the middlemen exploits the farmer and they purchase the goods from them at cheaper rates and sold them at higher rates. Another problem was the uniformity of the prices, the prices of the goods tend to fluctuate and the farmers were not getting their share of profit. So the exchanges were formed to help the farmers and to provide them with proper prices and eliminated the middlemen from the trade. So the exchanges like MCX, NCDEX, and NMCE are the best exchanges that are helping all the people to trade, hedge their risks and to make profits from commodity trading.

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Chapter 9 TYPES OF MARGINS

Although the value of a contract at time of trading should be zero, its price constantly fluctuates. This renders the owner liable to adverse changes in value, and creates a credit risk to the exchange, who always acts as counterparty. To minimize this risk, the exchange demands that contract owners post a form of collateral, in the US formally called performance bond, but commonly known as margin. Margin requirements are waived or reduced in some cases for hedgers who have physical ownership of the covered commodity or spread traders who have offsetting contracts balancing the position. 1. Initial margin: - The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin. The initial margin approximately equals the maximum daily price fluctuation permitted for the contract being traded.

2. Maintenance margin :- This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day. Till now the concept of maintenance margin is not used in India. 3. Mark-to-Market margin :- Mark-to-market margins (MTM or M2M) are payable based on closing prices at the end of each trading day. These margins will be paid by the buyer if the price declines and by the seller if the price rises. This margin is worked out on difference between the closing/clearing rate and the rate of the contract (if it is entered into on that day) or the previous day's clearing rate. The Exchange collects these margins from buyers if the prices decline and pays to the sellers and vice versa.

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4. Additional margin :- In case of sudden higher than expected volatility, additional margin may be called for by the exchange. This is generally imposed when the exchange fears that the markets have become too volatile and may result in some crisis, like payments crisis, etc. This is a preemptive move by exchange to prevent breakdown.

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9.1. BULLION

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9.2. Gold
Gold is the oldest precious metal known to man. Therefore, it is a timely subject for several reasons. It is the opinion of the more objective market experts that the traditional investment vehicles of stocks and bonds are in the areas of their all-time highs and may be due for a severe correction.

Gold is primarily a monetary asset and partly a commodity. More than two thirds of gold's total accumulated holdings account as 'value for investment' with central bank reserves, private players and high-carat Jewellery.

Less than one third of gold's total accumulated holdings are as a 'commodity' for Jewellery in Western markets and usage in industry.

The Gold market is highly liquid and gold held by central banks, other major institutions and retail Jewellery keep coming back to the market.

Due to large stocks of Gold as against its demand, it is argued that the core driver of the real price of gold is stock equilibrium rather than flow equilibrium.

Economic forces that determine the price of gold are different from, and in many cases opposed to the forces that influence most financial assets.

South Africa is the world's largest gold producer with 394 tons in 2001, followed by US and Australia. India is the world's largest gold consumer with an annual demand of 800 tons.

World Gold Markets

London as the great clearing house New York as the home of futures trading urich as a physical turntable Istanbul, Dubai, Singapore and Hong Kong as doorways to important consuming regions Tokyo where TOCOM sets the mood of Japan Mumbai under India's liberalized gold regime.

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India in world gold Industry

(Rounded Figures) Total Stocks Central Bank holding Annual Production Annual Recycling Annual Demand Annual Imports Annual Exports India (In Tons) 13000 400 2 100-300 800 600 60 World (In Tons) 145000 28000 2600 1100-1200 3700 ----% Share 9 1.4 0.08 13 22 -----

Indian Gold Market

Gold is valued in India as a savings and investment vehicle and is the second preferred investment after bank deposits.

India is the world's largest consumer of gold in jewellery as investment. In July 1997 the RBI authorized the commercial banks to import gold for sale or loan to jewellers and exporters. At present, 13 banks are active in the import of gold.

This reduced the disparity between international and domestic prices of gold from 57 percent during 1986 to 1991 to 8.5 percent in 2001.

The gold hoarding tendency is well ingrained in Indian society. Domestic consumption is dictated by monsoon, harvest and marriage season. Indian jewelleryofftake is sensitive to price increases and even more so to volatility.

In the cities gold is facing competition from the stock market and a wide range of consumer goods.

Facilities for refining, assaying, making them into standard bars in India, as compared to the rest of the world, are insignificant, both qualitatively and quantitatively.

Biggest Price Movement in Gold prices

Between September 24 and October 5, 1999, daily prices witnessed a rally of more than 21 %, based on surprised announcement by 15 European central banks of a five-year suspension on all new sales of gold from their reserves.

Contract Specification
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Contracts available in gold are of February, April, June, August, October and December
Trading Mondays through Saturdays Mondays to Friday: 10.00 a.m. to 11.30 p.m. Saturday: 10.00 a.m. to 2.00 p.m. 1 kg 10 grams Ex-Ahmedabad (inclusive of all taxes and levies relating to import duty, customs but excluding sales tax and VAT, any other additional tax or surcharge on sales tax, local taxes and octroi) 10 kg Re. 1 per 10 grams Delivery 1 kg 25% of the value of the open position during the delivery period Ahmedabad and Mumbai at designated Clearing House facilities of Group 4 Securitas at these centers and at additional delivery centers at Chennai, New Delhi and Hyderabad (for procedure please refer circular no. MCX/198/2005).

Trading period Trading session Trading unit Quotation / Base value Price quote

Maximum order size Tick size (minimum price movement)

Delivery unit Delivery period margin Delivery center(s)

Delivery and Settlement Procedure of Gold Contracts Settlement period Tender period Delivery period 1 to 6 day of the contract expiry month.
st th st th

1 to 6 day of the contract expiry month. Pay-in of commodities (delivery by seller On any tender days by 6.00 p.m. except Saturdays, Sundays and Trading Holidays. member) Marking of delivery will be done on the tender days based on the intentions received from the sellers after the trading hours. On expiry all the open positions shall be marked for delivery. Delivery pay-in will be on E + 1 basis. By 11.00 a.m. on Tender day +1 basis Pay-in of funds Pay-out of funds and commodities By 05.00 p.m. on Tender day +1 basis. (delivery to buyer member)

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9.3. Silver General Characteristics

Silver's unique properties make it a very useful 'Industrial Commodity', despite it being classed as a precious metal.

Demand for silver is built on three main pillars; industrial uses, photography and Jewellery& silverware accounting for 342, 205 and 259 million ounces respectively in 2002.

Just over half of mined silver comes from Mexico, Peru and United States, respectively, the first, second and fourth largest producing countries. The third largest is Australia.

Primary mines produce about 27 percent of world silver, while around 73 percent comes as a by-product of gold, copper, lead, and zinc mining.

The price of silver is not only a function of its primary output but more a function of the price of other metals also, as world mine production is more a function of the prices of other metals.

The tie between silver and economic activity is strong, given that around two-thirds of total silver fabrication is in the industrial and photographic sectors.

Often a faster growth in demand against supply leads to drop in stocks with government and investors. Economically viable primary silver mine is a function of the world silver price level.

World Silver Supply from Above-ground Stocks

Million Ounces 2001 Implied Net Disinvestment Producer Hedging Net Government Sales Sub-total Bullion Scrap Total -9.5 18.9 87.2 96.6 182.7 279.3 2002 20.9 -24.8 71.3 67.4 184.9 252.3

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Indian Scenario

Silver imports into India for domestic consumption in 2002 was 3,400 tons down 25 % from record 4,540 tons in 2001.

Open General License (OGL) imports are the only significant source of supply to the Indian market.

Non-duty paid silver for the export sector rose sharply in 2002, up by close to 200% year-onyear to 150 tons.

Around 50% of India's silver requirements last year were met through imports of Chinese silver and other important sources of supply being UK, CIS, Australia and Dubai.

Indian industrial demand in 2002 is estimated at 1375 tons down by 13 % from 1,579 tons in 2001. In spite of this fall, India is still one of the largest users of silver in the world, ranking alongside Industrial giants like Japan and the United States.

By contrast with United States and Japan, Indian industrial offtake for fabrication in hardcore industrial applications like electronics and brazing alloys accounts for only 15 % and the rest being for foils for use in the decorative covering of food, plating of Jewellery and silverware and jari. In India silver price volatility is also an important determinant of silver demand as it is for gold.

World Markets
London Bullion Market is the global hub of OTC (Over-The-Counter) trading in silver. Comex futures in New York is where most fund activity is focused

Biggest Price Movement since 1995

Between February 4 - 6, 1998, daily prices rocketed by 22.3%, as on a noted US financier had accumulated nearly 130 ounces of physical silver. Note: Post September 1999 daily silver prices have not shown more than 5% movement once and weekly silver prices only once.

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Contract Specification
Contracts available in Silver are March, May, July, September, and December
Trading Trading period Trading session Mondays through Saturdays Mondays to Friday: 10.00 a.m. to 11.30 p.m. Saturday: 10.00 a.m. to 2.00 p.m. 30 kg 1 kg Ex-Ahmedabad (inclusive of all taxes and levies relating to import duty, customs , if applicable but excluding Sales Tax / VAT, any other additional tax or surcharge on sales tax, local taxes and octroi. 600 kg Re. 1 per kg

Trading unit Quotation/Base Value Price Quote

Maximum order size Tick size (minimum price movement)

Delivery Delivery unit Delivery period margin Delivery center(s) 30 kg 25% Ahmedabad at designated Clearing House facilities of Group 4 securitas

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Tick Size:
Tick size is a basic concept in Financial Markets. It represents the

minimum price difference between two levels in the order book; in other words, between two possible prices for orders.This implies that the difference between two orders in the order book can never be less than the tick size. Because the tick size represents the difference between two orders, it also represents the minimum bid-ask spread in a Commodity. The tick size is determined by the exchange. Different products may have different tick sizes. The tick size may be important, because it determines the minimum bid-ask spread of the underlying. This may impact the liquidity and the costs associated with trading, especially when the tick size is a significant fraction of the price of the asset, say more than 1%. Commodity Gold Silver Lot Size 1 kg 30 kg Quotation Value 10 gms 10 kg Tick Size 1 1 Multiplier 100 30

Multiplier is if the commodity moves by 1 tick size how much will be price change in the commodity. Multiplier also remains fixed. Multiplier is calculated as follows: Multiplier = Lot Size/quotation value e.g. Gold = 1000/10 = 100

Commodity-Wise Turnover of Gold-Silver:

Commodity-Wise Turnover Apr-08 Apr-09 Trading on all Trading on all Exchanges (Rs. % to Total Exchanges (Rs. % to Total Commodity Crore) Turnover Crore) Turnover Gold 104509 30.9 160598 32.8 Silver 64540 19.1 54947 11.2 169049 50 215545 44 Total Source : FMC (www.fmc.gov.in)

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From this table we can see that Trading of Gold has increased from Rs. 104509 to Rs. 160598 i.e. increase by Rs. 56089, but turnover of Silver has decreased from Rs.64540 to Rs. 54947 i.e. decreased by Rs. 9593.

Gold-Silver Ratio
What is meant by Gold-Silver Ratio? An Ounce of Gold is X times expensive than Silver. Say Gold is $650/OZ Silver is 13/OZ Than Gold-Silver Ratio (GSR) = 50 Meaning Gold is 50 times expensive then Silver Or 50kg of Silver is equivalent to 1Kg gold

85 80 75 70 65 60 55 50 45 40
98 M ar -9 9 Se p99 M ar -0 0 Se p00 M ar -0 1 Se p01 M ar -0 2 Se p02 M ar -0 3 Se p03 M ar -0 4 Se p04 M ar -0 5 Se p05 M ar -0 6 Se p06 Se p-

Base of the Ratio

Base of the Ratio Historical Barter System Reserves in Base Reserve/Usage Ratio The Ratio of Annual Production (tons) Gold & Silver already Mined (m/OZ) Above Ground Stock (in Tons)
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Gold 1 90,000 25 2500 4.98 155000

Silver 15 5,70,000 19 20000 45.556 532859

Ratio 15.00 6.33 1.32 8.00 9.15 3.44

Production Cost (in $/OZ)

330

66.00

How does this Ratio Works?

Indicator

Action Buy Silver Sell Gold

Swap Ratio Gold Silver Ratio

Buy Gold Sell Silver

Gold Silver Ratio

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Gold & Crude Relationship

1200 1000 800 600 400 200 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 gold crude

From the above chart we can see that there is direct relation between gold and crude. As there is upward movement in Gold there is also upward movement in Crude also. We can see that there is not much movement in Crude as compared to Gold. This may be because gold is more volatile as compared to Crude. There are various events affecting the prices of Gold & Crude, they are explained below.

International Events Affecting Bullion Prices

There are various international events which affect the prices in Bullion market. Basic of them are as follows: Dollar Movement Euro Movement

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Gold-Dollar Movement
As there is Rise in the price of Dollar there is fall in the prices of Bullion and vice versa. So, we can say that there is inverse relation between Bullion & Dollar Movement.

Gold-Euro Movement
Euro and gold are directly related as there is appreciation in Euro, Gold also increases and vice versa. There are various factors that determine the rate of these Dollar & Euro. Some of important factors are as follows: USD pending home sales Euro Zone Retail Sales Crude Oil Inventories
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 USD initial Jobless claims USD Continuing Claims Euro German Industrial Production USD change in Non-farm pay rolls USD Unemployment Rate

USD pending home sales The Pending Home Sales report is an advanced read on trends in the US housing market. Housing is typically correlated to the overall state of the economy. This data comes on Tuesdayon Month-On-Month basis. Euro Zone Retail Sales The total value of goods and services sold each month at retail outlets. An increasing number of sales signal consumer confidence and economic growth, which would fuel the Euro-zone economy. This data comes on Wednesday on Month-On-Month basis. Crude Oil Inventories This data comes on every Wednesday. This gives information regarding crude oil production. This data affects directly the prices of gold. USD initial Jobless claims New unemployment claims are compiled weekly to show the number of individuals who filed for unemployment insurance for the first time. This data comes on every Thursday.

USD Continuing Claims This data states that till August 1st how many persons have filled unemployment insurance. This data comes on Every Thursday. Euro German Industrial Production Measures the per volume change in output from mining, quarrying, manufacturing, energy and construction sectors in Germany. Industrial production is significant as a short term

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indicator of the strength of German industrial activity. This data comes on Friday on MonthOn-Month basis.

USD change in Non-farm pay rolls One of the most widely anticipated reports on the US economic calendar, the Employment Situation is a timely report that gives a picture of job creation, loss, wages and working hours in the US. Monthly change in employment excluding the farming sector. A non-farm payroll is the most closely watched indicator in the Employment Situation. Data Comes on Friday on Month-On-Month basis. USD Unemployment Rate It reflects the percentage of people considered unemployed in the United States. Unemployment is the single most popularly used figure to give a snapshot of US labor market conditions. This Data comes on Friday on Month-On-Month basis.

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Chapter 10 CONCLUSION& RECOMMENDATION

Commodities offer exciting opportunities for investors to diversify their investment portfolios beyond stocks, bonds and mutual funds. Like any other investment, commodities carry some risk. However, what makes them particularly attractive is leverage. You can trade them on very low margin. There are more than a dozen major commodity exchanges around the world, reflecting the globalization of the markets. Grains include wheat, oats, corn, rice, soybeans and other agricultural products. Softs include coffee, cocoa, sugar, oats, cotton and similar products. Frozen concentrated orange juice (FCOJ) has been actively traded since the creation and widespread use of inexpensive refrigeration (post World War II). Energies cover a range of products used to provide energy to heat and power homes and businesses. The most common are petroleum and its byproducts: crude oil, heating oil, natural gas and others. Meats like live cattle, pork bellies and feeder cattle are traded on various exchanges. Pork belly prices can be dependent on the price of grain, since the pigs are fed mostly corn. Each commodity has its own tick and standard contract size, which is the amount covered by a standard futures contract. Some prices, like soybean meal, are listed in dollars per ton, where the standard contract size is 100 tons. By contrast, the amount for wheat is 5,000 bushels. In the case of crude oil, the amount is 1,000 barrels.

Commodities trading has become an increasingly popular way for active investors to profit from global demand.

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