A SUMMER PROJECT

ON

“COMMODITIES GLOBAL PERSPECTIVE”

FOR KARVY STOCK BROKING LTD

BY

Savita Nathawat
FINANCE SPECIALIZATION

SADHANA CENTRE FOR MANAGEMENT AND LEADERSHIP

DEVELOPMENT
(2005-2007)

IN PARTIAL FULLFILLMENT
OF
MASTERS OF BUSINESS ADMINISTRATION

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by Savita Nathawat
 INDEX

Serial no. Particulars Page no.

1 Acknowledgement 3
2 Executive summary 4
3 Company profile 6
4 Need of study 8
5 Objective of study 9
6 Introduction 10
7 Derivatives 12
8 Commodity derivatives 14
9 Commodity market an overview 15
10 Convenience yield, term structure 23
&volatility across the market
11 Commodity as a distinct asset class 27
12 Commodity allocation from a private 30
client perspective
13 Commodity and financial market 33
instrument
14 Global commodity exchanges 35
15 Indian commodity market 42
16 Gold & Copper 46
17 Awareness 53
18 Conclusion 54
19 Recommendations 55
20 Bibliography 56

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 ACKNOWLEDGEMENT

IT gives me immense pleasure in completing this project and submitting the final project
report.
The last two months with KARVY STOCK BROKING LTD had been full of learning
and sense of contribution toward the organization. I would like to thank KARVY
STOCK BROKING LTD for giving me an opportunity for learning and contributing
through this project. I also take this opportunity to thank everybody who made this
experience a memorable one.
A successful project can never be done by an individual to whom the project is assigned,
it requires help and guardianship of some conversant person who helped the undersigned
actively or passively in the completion of successful project.
In this context as a student of SADHANA CENTRE FOR MANAGEMENT AND
LEADERSHIP DEVELOPMENT, Pune. I would first of all like to express my gratitude
to Mr. Ravi Gaikwad for assigning me such a worthwhile topic Commodities global
perspective.
The project couldn’t have been completed without timely and vital help of Anurag
Kataria (regional head, Karvy Comtrade Ltd), other office staff. Special thanks to
Mr. Shivraj , Mr Sushil, Mr Gaurav Lanjekar Mr Ninad Raghatate, Mr Kuldeep
bhorkar, Mr. Abhijeet singh, Mr.Vikrant Joshi, Ms.Sonal Chopra,Ms Shweta ,Mr
Viyay for there invaluable guidance, keen interest cooperation inspiration, and of course
moral support through my project session.

Savita
Nathawat

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 EXECUTIVE SUMMARY:-

The project titled “Commodities global perspective” being carried out for KARVY
STOCK BROKING LTD.

KARVY operates in various financial products and services like, Consultancy, Stock
Broking, Mutual Fund, Insurance, Registrar and Transfer Agent, Research, Commodity
etc.
The project is devoted to understand commodity futures market both Indian and global
and to find out the level of awareness about this market among investors.

Commodities, in simple words are any goods that are common and unbranded. Gold,
silver, rubber, pepper, jute, wheat, sugar, cotton etc., are some of the common
commodities. For e.g. apple juice can be a commodity whereas the ‘Real’ apple juice
cannot be called a commodity. Another feature of commodities is that they are
commonly available.
Commodity markets represent the formal system for the interplay of demand for and
supply of commodities. These markets can be broadly classified into spot market and
futures market.This market helps in fair price discovery.

Commodity market works basically on the function of demand and supplies any
imbalance in demand and supply result in the changes in commodity prices. If demand
override supply prices will go up, and if supply is more than demand prices falls.

During my study I realize hat global exchanges are very specialized for eg: LME trades
only in base metals and recently in plastics, NYMEX trades only in energy futures,
Whereas Indian exchanges are trading in all commodities, All these global exchanges
when compared to that of Indian having very high turnovers.
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Commodity market is negatively co related to stock markets, except the stocks of the
companies engaged in commodities business, and positively correlated to inflation.
As the consumption of commodities all over the word is increasing and no new sources
of natural resources are known, so prices of commodities in future can go only in one
direction that is up. So this is the right time to invest in commodities market.

It was also observed that globally commodities market shows negative correlation with
stock market but in India it is positively correlated. As seen that from 2004 when futures
trading in commodity market was permitted by government both stock markets and
commodity markets were in bull phase and recently as stock market came down
commodities also experience the fall in prices.

The survey conducted for finding out the awareness of commodity market among the
investors we found that less than 95% of them don’t know what is commodity market so
this market has immense opportunities to explore

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 COMPANY PROFILE
KARVY is founded by a group of Hyderabad based CHARTED ACCOUNTANTS in
1982 as a professional service firm. In the span of 25 years KARVY has entered into
capital market activity too.
KARVY is spread over 357 cities having about 532 offices. Over 500+ NSE and BSE
terminals spread across the country. Around 6000 active business associates are being
attached with KARVY across the country. It also comprises of 6000 employees and
professionals.
Principal activity of KARVY are-
KARVY CONSULTANTS LTD. Deals in Depository Participant services
and IT enabled services.
KARVY COMPUTERSHARE PRIVATE LIMITED performs transfer
agency services for corporate and mutual fund and also registrar for IPO’s.
KARVY INVESTOR SERVICE LIMITED includes Merchant Banking
and Corporate Finance.
KARVY SECURITIES LTD. is a big distributor of equity and other
financial product.
KARVY INSURANCE BROKING Ltd, it is an insurance distributor
which avails all insurance policies of all companies.
A KARVY COMTRADE Ltd. Where commodity trading is done.
In spite of all this KARVY has its RESEARCH CENTER in Hyderabad
and also a member of Hyderabad Stock exchange. It is also a member of
National Stock Exchange and Bombay Stock Exchange.
PRIVATE CLIENT GROUP is a special service offered to HNI clients for
portfolio management services. It is a paid service provided.

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ACHIEVEMENTS

 Largest independent distributor for financial products

 Amongst the top 5 stock brokers

 Amongst the top 3 Depository participants

 Largest network of branches and business associates

 Amongst top 10 investment Bankers.

 Ranking 1st in retail procurement in equity IPOs.

 Ranking 8th in Merchant banking services.

MISSION OF KARVY: -

Their mission is to be a leading, preferred service provider to our customer,

and they aim to achieve this leadership position by building an innovative,
enterprising, and technology driven organization which will set the highest
standards of service and business ethics.

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 Need of Study
Commodity market world’s best market but gets no respect in the eyes of investor. Too
many so-called smart investors consider themselves diversified if they have invested in
stocks, bonds, real estate, or may be in some currencies. But commodities rarely though
that have done quite well over a time , contrary to all myths about how risky, volatile
complex and dangerous putting money on commodities is supposed to be.

Commodity is the essential of not only our life but lives of the every one in this world.
Without the commodities “futures market” to set and regulate prices, the things we all
need for our lives would be scarce and often too costly. These essentials include oil,
natural gas, wheat, corn, cotton, soybeans, aluminum, copper, silver, gold, cattle, sugar
coffee, cocoa, rice, wool, rubber, lumber, and the 80 or so other things listed in CRB
(Commodity research bureau) yearbook.

Commodities are so pervasive that you can’t be a successful investor in stock, bonds, or
currencies without understanding them. One should understand commodities even if he
invests only in stocks and bonds. Commodities belong to every truly diversified
portfolio. Investing in commodities can be a hedge against the bear market in stocks,
high inflation, and even major downturn in economy.

Commodity markets work on the basis of demand and supply functions and today as all
the natural resources are depleting due to the heavy consumption by developed and
emerging economies and further investment in natural resources infrastructure is virtually
non existent and with this kind of imbalance of supply and demand, prices can go only in
one direction that is up So we can say that a bull market is on the way and it is an great
opportunity to make money

But does Indian markets are efficient when compared to global markets???
Does investors are aware of this market and its potential??????

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 Objectives of the study

To understand

1) What is commodity market ?

2) Indian scenario of commodity market?
3) Global scenario of commodity market?
4) Level of awareness about commodity market ?
5) Commodities market from personal client perspective?

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 Introduction

Commodities, in simple words are any goods that are common and unbranded. Gold,
silver, rubber, pepper, jute, wheat, sugar, cotton etc., are some of the common
commodities. For e.g. apple juice can be a commodity whereas the ‘Real’ apple juice
cannot be called a commodity. You may be surprised to know that in the US
commodities markets there are futures available even on cattle. Another feature of
commodities is that they are commonly available.

Commodity markets represent the formal system for the interplay of demand for and
supply of commodities. These markets can be broadly classified into spot market and
futures market. Commodities for immediate delivery are traded through the spot
market. The players in the spot market are the actual producers and the consumers of
the commodities.

The other type of market called the ‘Futures market’ is for facilitating contracts for
future delivery. (Please go through the material on ‘Futures and Options’ to
understand about futures) These markets make available for trading, the various
derivatives based on commodities. Usually traded ones are the futures and options.
However in India options on commodities are not available and are expected to be
introduced soon. The players in the futures markets are Hedgers, Arbitragers and
investors.

Hedgers are those who hold simultaneous positions in the spot market also. These are
generally the actual consumers or the producers of the commodities. For eg: A wheat
farmer who expects his harvest to be over in 3 months time may sell a futures
contract with an expiry of three months, so that even if the prices happen to fall after
three months, he can still manage to sell at the price at which the contract was struck.
The large scale consumers of the products can also make use of the futures to secure
their purchase. For eg: A cooldrinks can manufacturing company may buy tin futures,
so that even if the prices happen to rise later, thy can be assured of the supply of raw
materials at the pre-determined price.

The other major group of participants in the commodity futures market are the
importers and the exporters. Since they have confirmed obligations to export/import
fixed quantity of commodities at a particular period of time, they can take opposite
positions in the futures market.

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 Arbitrage is a process of making profits using the price differences between two
markets without exposing oneself to any risk. Arbitraging is a very profitable
business. It is possible to arbitrage between two different futures markets or between
the futures market and the spot market. However in an ‘efficient’ market arbitraging
is not possible, because any price gap is closed immediately as soon the arbitragers
enter the market.

Investors are those who participate in the market for profits and are ready to face the
risk involved in the market. An investor can be anyone from an individual who has a
small surplus income to the treasury desks of banks and corporate. Most commonly
traded derivatives around the world are futures, options and option futures. Some of
the most popular commodity exchanges in the world arelistedbelow:
London Metals Exchange, London
New York Mercantile Exchange, New York
Chicago Mercantile Exchange, Chicago
Chicago Board of Trade, Chicago
London International Financial Futures and Options Exchange (LIFFE), London
Tokyo Commodity Exchange, Tokyo
Winnipeg Commodity Exchange, Canada

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 Derivatives

Definition:- a derivative is a product whose value is derived from the value of one or
more underlying assets in a contractual manner. Underlying can be
Equity, forex ,Commodity, or any other asset.

---The forward contract (regulation) act, 1952, regulates the future/forward contract in
commodities in India.

----The Forward market commissions continues to have jurisdiction over commodities

forward /future contract

-----Derivatives are sec under SCRA (security contract regulation act and therefore
trading of derivative is governed by the regulatory framework under SCRA

Participants

1) Hedgers :- They use futures or option market to reduce risk

2) Speculators:-Futures and options market can give them leverage, that is by
putting small amount of money upfront, they can take large positions on the
market
3) Arbitragers:- Arbitragers work at making profit by taking advantage of difference
between the prices of two markets.

Economic functions performed by derivative markets

• Prices in an organized market reflects the perception of participants about

the future and lead prices of underlying to the perceived future level.
• It helps to transfer risk frm those who have them but don’t like them to
those who has appetite for them.
• Speculator traders shift to more controlled environment of derivative
markets
• Derivative markets help in increasing saving and investment in long run

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Derivative markets

• Spot v/s forward transactions

• Exchange traded v/s OTC derivatives

Difference between Otc and exchange traded derivatives

OTC derivatives Exchange traded derivatives

!)Forward contract 1) Futures contract
2)Customized contract terms 2) Standardized contract terms
3)Less liquid 3) More Liquid
4) No margin payment 4) Requires margin payment
5)Settlement happens at the end of the period 5) Follows daily settlement

Some commonly used derivatives

1) Forwards:- A forward contract is an agreement between two parties to buy and

sell the underlying asset at a future date, at todays pre-agreed price.
2) Futures:- A futures contract is an agreement between two parties to buy or sell the
underlying asset at a future date at a today’s future price. They iffer from forward
in the sense that they are standardized and exchange traded.
3) Options:-There are two type of option
a) Call---it gives the buyer right but not obligation to buy a given quantity of
underlying asset ,at a given price on or before a given future date
b) Put ---it gives buyer the right but not the obligation to sell a given
quantity of underlying asset ,at a given price on or before a given future
date
4)Warrants:- longer- dated options (more than one year) and generally traded OTC
5)Basket:-Basket options are options of underlying portfolio
6)Swaps:-Swaps are private agreement between two parties to exchange cash flows in
in the future acc. To pre arranged formula the two commonly used swaps are:
• Interest rate swaps:- swapping only the interest related cash flows between the
parties in the same currency
• Currency swaps:- Swapping both principal and interest between the parties, with
the cash flows in one direction being in a different currency than those in the
opposite direction.
7)Swaptions:- swaptions are options to buy or sell a swap that will become operative
at the expiry of the options .thus a swapton is an option on forward swaps.

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 Commodity Derivative

Derivative as a tool for managing risk first organized in commodities market . they were
then found useful as a hedging tool in financial markets.
--Trading in commodities future has been in existence with organized trading in cotton
through the establish ment of cotton trade association in 1875.

Difference between commodities and financial derivatives

1) Physical settlement:- Physical settlement involves the physical delivery of

commodity, typically at an accredited warehouse .
---- In case of physical settlement financial assets are not bulky and do not need
special storage facility.
----whereas due to the bulky nature of underlying asset settlement in commodities
creates the need for warehousing

Physical settlement in commodities

First step:- delivery notice period

Sec step:-assignment (done by clearing house)
Third step:-Delivery

2) Warehousing:- one of the main difference between the financial and commodity
derivatives is the need for ware housing
3) Quality of underling asset:-variance in quality is not an issue in financial
derivatives as the physical attribute is missing but when the underlying is
commodity , te quality of underline asset is of prime importance

-----currently there are various agencies that are responsible for specifying grades for
commodities
• Bureau of Indian Standards (BIS) under ministry of consumer affairs
specifies standards for processed agriculture commodities
• AGMARK under the department of rural development under ministry of
agriculture is responsible for promulgating standards for basic agriculture
• EIA specify std for export oriented commodities
---------CBOT and CME are two oldest derivative exchange in the world

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 Commodities Market An Overview

The History & Development of Commodity Exchanges

The origins of commodity exchanges are typically traced back to the 17th century and the trading of rice
futures in Osaka, Japan. However, well before then trading in commodity futures was being reported in
ancient Greece and China. The first commodity exchange to be established in the United States was the
Chicago Board of Trade in 1848 in response to the growth in agricultural production in the economy.
Today, the largest US exchange by volume is the Chicago Mercantile Exchange, which was founded in
1898 as the Chicago Butter and Egg Board. However, in terms of commodity futures alone, the New York
Mercantile Exchange (NYMEX) is the world’s largest.

During the same period the development of commodity exchanges was being given an additional
push by Britain’s industrial revolution. Almost overnight the UK became an insatiable consumer of
industrial metals. To ensure a more organized market structure the London Metal Exchange (LME) was
established in 1877. However, the development of an international energy futures market only began in the
1980s following the listing of the gas oil futures contract on the International Petroleum Exchange (IPE) in
1981, the sweet crude oil contract on the New York Mercantile Exchange in 1983 and the Brent crude
futures in 1988.

Table 1 details the major commodity exchanges according to sector type and location.

Commodity Exchange Abbreviation

Energy New York Mercantile Exchange NYMEX
International Petroleum Exchange IPE
Tokyo Commodity Exchange TOCOM
Central Japan Commodity Exchange CJCE

Metals New York Mercantile Exchange COMEX

London Metal Exchange LME
Shanghai Futures Exchange SFE
Philadelphia Board of Trade PHLX
Tokyo Commodity Exchange TOCOM

Electricity New York Mercantile Exchange NYMEX

Nordic Power Exchange NORDPOOL
European Energy Exchange EEX
UK Power Exchange UKPX

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 Amsterdam Power Exchange APX
Paris Power Exchange POWERNEXT

Fibres Chicago Mercantile Exchange CME

New York Cotton Exchange NYCE

Grains & Oilseeds Chicago Board of Trade CBT

Dalian Commodity Exchange DCE
Kansas City Board of Trade KCBT
Minneapolis Grain Exchange MGE
Tokyo Grain Exchange TGE

Livestock Chicago Mercantile Exchange CME

Softs Coffee, Sugar and Cocoa Exchange CSCE
New York Board of Trade NYBOT
Tokyo Grain Exchange TGE
EURONEXT, UK EURONEXT
National Commodity & Derivatives Exchange Ltd., India NCDEX

In the current decade, the major growth in commodity futures trading is expected to
occur
in Asia and specifically China. In the early part of the 1990s, the number of commodity
exchanges in China totaled more than 40. However, in 1994 the Chinese Securities
Regulatory Committee embarked on a programme of consolidation which resulted in
three commodity exchanges emerging in the country:
1) The Shanghai Futures Exchange (SFE)
2) The Zhengzhou Commodity Exchange (ZCE)
3) The Dalian Commodity Exchange (DCE)
Following this rationalisation, there are more than thirty commodity exchanges
operational around the world. The proliferation of commodity exchanges has occurred as
more and more countries have deregulated their economies and removed price supports.
However, in terms of market turnover there remains a high degree of market
concentration with the lion’s share of commodity trading occurring in just four countries:
the US, Japan, China and the UK, Exhibit 1.

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Exhibit1:Commodity futures’ turnover by country/region

Market concentration
The number and composition of futures contracts traded in these four centres are detailed
in Exhibit 2. Not surprisingly, the US and Japan dominate not only in terms of turnover,
but, also in the number of commodity futures contracts listed on their exchanges at 82
and 52 respectively. China’s three exchanges currently offer eleven futures contracts
including aluminum, corn, copper, cotton, wheat, rubber, soybeans and fuel oil.

In terms of the composition of futures contracts listed, typically in the early stages of a
country’s development commodity futures have tended to be in agricultural products. For

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example, in China 80% of commodity futures’ volumes traded in 2004 were in
agricultural contracts. As a result, the Dalian Commodity Exchange is the country’s
largest exchange by turnover. It is expected that as the country industrialises and
deregulates its financial markets, metals and energy contracts will become more
prevalent. Indeed there are plans to launch new listed futures’ products for crude oil, gas
oil, natural gas, steel, coal, rice and soy oil.

In the US, the introduction of an energy futures market only occurred in the 1980s
following the launch of the sweet crude oil futures contract on the New York Mercantile
Exchange (NYMEX) in 1983. Today energy and agricultural futures trading constitute
the lion’s share of turnover on US commodity exchanges, with metals accounting for less
than 10% of total turnover with the bulk of this represented by the COMEX gold future.

In the UK, commodity futures trading is highly skewed to the metals sector, a reflection
of the London Metal Exchange’s dominance in trading non-ferrous metals. The next
phase of the LME’s development is launch of futures contracts for polypropylene (PP)
and linear low density polyethylene (LL) on 27 May 200

In 2004, many of these commodity excha nges reported traded volumes at or close to
record highs and although these individual exchanges offer a wide variety of futures
contracts, market activity tends to be concentrated in just one or two contracts. To
highlight this, take an example of market turnover in commodity futures contracts in the
top four exchanges, NYMEX, the Tokyo Commodity Exchange (TOCOM), the DCE and
the LME. On NYMEX, annual volumes hit 163.2 million contracts last year, up 17%
compared to 2003. However, market activity remained heavily concentrated in just one
commodity, the West Texas Intermediate light, sweet crude oil futures contract, which
represented 39.7% of total turnover on the exchange, or 52.9 million lots in 2004,

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Commodities in comparison
Despite the growth in financial futures trading over the past two decades, commodities
remain an important part of overall futures trading. Table 3 details the top 15 futures
contracts traded in the United States during 2003. We find that commodities occupy
seven of the top 15 products traded with crude oil, corn and natural gas the most widely
traded commodity futures contracts.

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New developments during this decade
The main developments to emerge relating to commodity exchanges this decade are:
· The listing of new commodity futures’ products.
· The increasing cooperation and competition between exchanges.
· The move from open outcry to electronic trading platforms.

Despite the launch of the LME’s polypropylene and linear low density polyethylene
futurescontracts next month as well as the NYBOT’s pulp future most of the
development of new commodity futures products is taking place in Asia and specifically
China. The Zhengzhou Commodity Exchange is preparing to launch a sugar and rapeseed
futures contract this year as well as develop new products for coal, natural gas and
power. On the Shanghai Futures Exchange a petroleum futures contract is being
considered while the Dalian Commodity Exchange is set to launch a soy oil futures
contract in the next few months.

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In terms of increasing cooperation between exchanges this year could see the merger of
NYMEX and NYBOT. This would further enhance NYMEX’s status as the world largest
physical commodity exchange by market turnover. Listed products would span across
both the energy and soft commodity sectors. Cooperation between exchanges is also
occurring on a global basis. For example, last month saw the signing of a Memorandus of
Undestanding between the Chicago Board Options Exchange (CBoE) and the Dalian
Commodity Exchange with the aim to enhance the development of options and other
derivative products on both exchanges. In addition, the plans to open the Dubai
Commodity Exchange is a joint venture with NYMEX and the government of Dubai.
Two aims are the listing of sour crude oil future and well as for Dubai to become the
centre of gold futures trading in the region. April 2005 An Investor Guide To
Commodities Deutsche Bank@17 NYMEX also plans to launch a London based
exchange to compete directly with the IPE and its Brent crude oil futures contract.
Regulatory approval for NYMEX’s plans are expected to be granted in the second half of
2005.
Trading on the exchange will be open-outcry in contrast to the IPE which switched to a
solely electronic platform on April 8. Since 1995, traded volumes of the IPE’s Brent
futures contract has risen by 160% compared to a 124% increase in trade volumes on the
sweet crude oil contract listed on NYMEX,
Another feature of this decade has been the move towards electronic trading platforms.
Last year, TOCOM began offering energy and metals futures trading on NYMEX’s
internet based trading platform. The IPE’s decision this month to end open-outcry is a
significant step since at the end of last year only 5% of IPE’s volume was accounted for
by electronic trades. The IPE’s decision also makes the LME the last exchange in
London to operate an open outcry system.

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 Convenience Yields, Term Structures & Volatility
Across Commodity Markets

The term structure for commodities

The forward curve for foreign exchange rates is simply calculated by the difference between
short and long-term interest rates. In commodity markets, the process is more complicated
since forward curves also have to contend with, among other things, changes to production
costs, weather and inventory levels.
In terms of market definitions, when the forward price of a commodity declines as tenor increases
the market is in backwardation. Conversely, contango is where the forward price rises as tenor
increases. These two types of term structures are represented by the WTI crude oil and gold price forward
curves in Exhibit 1.

What drives term structure?

While energy markets are typically characterised by backwardated markets, this is not the
case for the precious and industrial metals’ markets. In normal market conditions , the
forward price for industrial metals tedns to rise as tneor increases, that is, the market is in
contango. These differing term structures between the energy and metals complexes can
be explained by the Theory of Storage and the existence of convenience yield.

The relationship between the forward and spot price is defined as:

Formula 2:
Forward Price = Spot Price + Interest Rate - (Convenience Yield – Storage)

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Formula 2 relies on the fact that by storing rather than selling the commodity, one
surrenders the spot price but incurs interest rate and warehousing costs. However,
offsetting these costs, are the benefits accruing from holding inventory, or what is called
the convenience yield1.

The convenience yield

A holder of inventories in a particular commodity generates a convenience yield. This is

the flow of services and benefits that accrues to an owner of a physical commodity but
not to an owner of a contract for future delivery of the commodity 2. This can come in
the form of having a secure supply of raw materials and hence eliminating the costs
associated with a supply disruption. Rearranging Formula 2 above implies that:
Forward – Spot = -Roll Yield = (Interest Rate – [Convenience Yield – Storage Cost]) or,

Formula 3:
Convenience Yield = Roll Return + Storage Cost + Interest Cost

To solve for the convenience yield one only has left to estimate the fixed costs of storage
for each commodity. For this we use industry estimates, Table 2. Since storage costs are
fixed, the share of costs accounted for by storage will be a function of the spot price. For
example, in 1989 the average WTI spot price was USD19.60/barrel. Fixed costs for
storing a barrel of oil amount to approximately USD0.40/barrel per month and
consequently for that year fixed costs were USD4.80 (0.40x12) or 24.49%. Over the
1989-2004 period, storage costs have amounted to an average of 22% per annum.

These results show that convenience yields trend higher the lower the level of
inventories. Put another way, the convenience yield rises as the market’s precariousness
increases. This makes intuitive sense since in tightening market conditions consumers
attach a greater benefit to the physical ownership of a commodity. Oil is the most
obvious example since if world oil production ceased today the economic consequences
would be felt within a matter of days, if not hours. Hence a higher convenience yield or
premium is built into the spot price.
The gold market is at the other extreme. It would take many years for the world to
exhaust available gold reserves on current demand trends if every gold mine in the world
were to close tomorrow. This reflects the fact that annual gold consumption amounts to
approximately 3,200 tonnes per annum while total above ground stocks (private plus
public sector holdings) exceed 145,000 tonnes. In the absence of additional new mine
supply the world would consequently only run out of gold after 16,500 days or sometime
in 2050. As a result, any disruptions to gold mine production would have only a marginal
effect on the convenience yield. Hence the larger the amount of daily consumption of a
particular commodity compared to available inventories the greater the convenience
yield. This positive relationship between convenience yield and consumption of stock per
day across a number of commodity markets is highlighted in Exhibit 3.

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It is worth remembering that the convenience yield will vary over time as and when there
is an increase in stocks above or below ‘requirements’. Indeed the convenience yield is
likely to rise very sharply when there is a reduction of stocks below requirements3.
Commodities subject to sudden changes in inventory levels due to supply or demand
shocks are particularly vulnerable in this regard. Such inventory shocks help to explain
why certain markets are more prone to move from contango to backwardation in a very
short space of time. One can therefore consider the slope of the forward price term
structure as an indication of the current supply of storage such that a continuing decline
in inventory levels implies an even steeper backwardation and vice versa.

Interestingly over the past two years, term structures in the six industrial metals’ markets
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have changed dramatically. This reflects strong global demand for commodities, most
notably from China, which has led to a dramatic decline in inventory levels across the
industrial metals complex. As the physical availability of metal inventories has declined
so the convenience yield has risen. This has led term structures to flip from contango to
backwardation in all six non-ferrous metal markets. This decline in inventory is also
having an effect on commodity volatility.

Commodity volatility & the convenience yield

Since convenience yield is an indication of market precariousness, it is also positively

correlated with the level of volatility across various commodity markets, Exhibit 5. Not
surprisingly those markets which have the lowest level of available inventory compared
to consumption and hence the highest convenience yields typically have the highest
levels of volatility, for example crude oil and heating oil. Where inventories are plentiful
and the convenience yield is low so too is the volatility, for example gold..

Conclusion
The benefits to a consumer of a holding a particular commodity is directly related to the
level of available inventories. This benefit, or convenience yield, consequently drives not
only the term structure but also the level of volatility across the main commodity
markets. Since energy markets have high convenience yields and traditionally
backwardated term structures it helps to explain why within any commodity index, the
energy sector is typically the engine room of performance.

26 Presented
by Savita Nathawat
 Commodities as a distinct asset class

Commodities are fundamentally different from stocks and bonds. While they are
investable assets, they are not capital assets. Commodities do not generate a stream of
dividends, interest payments, or other income that can be discounted in order to calculate
a net present value. The Capital Asset Pricing Model does not apply to a bushel of corn.
Rather, commodities are valued because they can be consumed or transformed into
something else which can be consumed. Their value at any time is determined by basic
laws of supply and demand. Analytically, it’s the intersection of supply and demand
curves that determines their price. And it’s the expected intersection of those supply and
demand curves in the future that will affect (but not totally determine) the price of a
commodity futures contract. This is the unifying feature of commodities that
distinguishes them as an asset class different from the other investable assets in a
portfolio. These commodities include energy products, livestock, food, fiber, and
industrial and precious metals. Unlike financial assets, commodities are real assets, also
known as “stuff.” Stuff which can be used, touched, seen, consumed. Hard assets as
opposed to paper assets. Not only are commodities a distinct asset class, but they are an
important asset class in the world economy. The commodities included in some of the
most popular investable indexes represent about US$1.5 trillion of annual global
production. It’s important stuff.

27 Presented
by Savita Nathawat
The first and easiest component of return is the return on your collateral, since your
futures positions are fully collateralized. Published futures indexes typically assume that
this collateral is invested in T-Bills, which over a long period of time have returned an
expected rate of inflation plus a real rate of return. [True, as this is written in early 2005,
T-Bills are yielding less than inflation. But both economic theory and longer term history
demonstrate that TBills might be expected to provide a positive real yield.]

The next component of return is insurance.

Historical results

To see what actual returns might have been in that wide range of economic
environments from 1970 to the present. From 1970 through 2004, the GSCI
actually had higher returns than the S&P 500, with only slightly higher volatility
—and with that diversifying aspect of negative correlation. An examination of
returns of the various commodity indexes over shorter periods of time would also

28 Presented
by Savita Nathawat
show higher returns in the last few years, while returns in the ‘80s and ‘90s
weren’t much better than just the return on T-Bills (a time period when paper
assets were benefiting a portfolio). It wasn’t just in the 1970’s that they did
| lc;dfs[]well. Over the most recent five years ending in 2004 this asset class
performed well also. It looks like commodities might indeed shelter a portfolio
from inflation, and also provide useful diversification in a wide range of economic
environments. Meanwhile, you still have positive exposure to some unexpected
events that might affect individual markets.

Risk averse investors prefer higher commodity allocations

Commodities are volatile, which may explain why investors historically have not
allocated to this asset class. Prices respond almost immediately to unexpected changes in
the weather, sudden supply and demand shocks, changes in regulation, climate,
geopolitical risks and a host of transitory affects arriving randomly (e.g., a refinery fire).
These volatile asset prices can be harnessed into a commodity index, such that the index
itself has relatively low, equity-like volatility, even though its components are highly
volatile in isolation. This is due to the low to negative correlations among the individual
commodities’ returns.

Commodities versus traditional asset classes

Commodity index investments were not well understood among portfolio managers in
the
past, and certainly were not widely held. This despite the fact commodities produce
consistent returns that are competitive with equities, which are uncorrelated with
financial-asset returns.
As economists turn their attention to commodity index products, this is changing. In a
recent working paper published by the National Bureau of Economic Research, Gorton
and Rouwenhorst (2005) found that over the 43-year period from 1959 – 2002
commodities produced:
· Returns comparable to the return on the S+P 500
· Lower standard deviation of returns than stocks
· Negative correlation with the return on the S+P 500 and long-term bonds
· Opposite exposure to inflation compared to stocks and bonds
- Stocks and bonds are negatively correlated with inflation
- The correlation of commodity futures with inflation is positive at all horizons.

29 Presented
by Savita Nathawat
Commodity Allocation From A Private Client Perspective

Supply
Since the oil price shock in the eighties, commodity prices had, by and large, been on a
long-term downtrend ever since. An indication of this long-term trend is highlighted by
the Commodity Research Bureau (CRB) index in Exhibit 1. This fell 45% from its
November 1980 high of 337.60 to a low of 182.9 in February 1999. Although this trend
was interrupted by large swings, which sometimes persisted for several years, these were
not strong enough to break the downtrend. Since economic sectors with declining prices
are not particularly attractive to invest in, companies as well as individual investors were
increasingly
hesitant with capital spending in the commodity complex.

30 Presented
by Savita Nathawat
This is confirmed by examining average annual returns of the major economic sectors in
the S&P 500 throughout the 1990s. This shows a significant underperformance of
commodity related sectors compared to other sectors of the economy, Exhibit 2. Since
relative price performance is a major driver of the allocation of capital, investments
tended to flow towards those sectors with higher returns on capital while investments in
commodity related sectors were curtailed. Capital withdrawal forced companies to cut
costs. Over time, this lack of investment resulted in a deterioration of the materials
handling equipment and a reduction of production which has led to supply-side capacity
constraints, which we are now experiencing today.

Demand

The demand for commodities has changed significantly since the entry of China to the
World Trade Organisation (WTO) in 2001. Extraordinary strong growth initiated a
demand shock for many basic resources as structural changes began to get under way in
China (urbanisation, expansion of infrastructure). This led to an insatiable appetite for
building materials, which are not always available domestically – at least not at the
required quantities. As a result, China became one of the principal global consumers in
many commodity sectors. No reversal of this process is to be expected as economic
catch-up continues. In 2004 World GDP is estimated to hit USD35trillion. About one
quarter of this is produced in developing economies with the growth rates in these

31 Presented
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economies expected to be roughly twice as fast as economic activity in industrialised
countries. Due to the range of products fabricated by developing countries and the fact
that they often use less expensive and less efficient technologies, the raw material
consumption per USD of GDP is roughly twice as much as in the industrialised
countries. As most of the future growth dynamics is expected from developing countries,
the increase in commodity demand is not a one time effect but will persist and be largely
driven by these countries.

Price development and investor interest

The increase in raw material demand has occurred at a time of strong global growth and
limited spare capacity to expand commodity production. As producers have not been able
to quickly adjust their output, commodity prices have soared. While price increases are
not only starting to induce increases in exploration spending of commodity producers, it
is also stimulating the interest of financial investors. The rising interest of non-
commercial market participants can be seen by the increasing number of commodity
futures contracts traded on global com modity exchanges. In the US, the Commodity
Futures Trading Commission publishes detailed weekly data on the trading volume of
commodity futures, which differentiate between commercial and non-commercial market
participants. Data on the oil market, for example, show a clear upward trend of the
contract volume traded by non-commercial market participants along with the increase in
oil prices since 2002.

Commodity allocation in security portfolios

After the distress of the extended equity bear market, risk aspects in investment policy
and asset allocation have attracted more attention. As commodities offer attractive
diversification benefits when added to portfolios with traditional securities such as
equities and bonds, commodity investments have received more interest from this
perspective as well. However, given that commodity prices tend to move in a volatile
fashion with a high degree of uncertainty of future returns, they should be treated more
like growth assets in the portfolio context. The high volatility and the cyclicality of
commodity returns would argue for low allocation weights. On the other hand, in order to
achieve a material effect on overall risk-return of the portfolio, the allocation should not
be too low. Commodity allocation recommendations depend on the risk attitude of the
investor as well as the allocation of the main part of the portfolio. As a rule of thumb
commodity allocations of 3% to 10% are recommended for conservative portfolios. In
order to implement such diversification strategies, adequate investment vehicles must be
chosen.

32 Presented
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Commodities and financial market instruments

Traditionally, private investors often gained exposure to commodities via investing in

equities operating in one way or another in the commodity sector. The problem with this
proc edure is, that the companies, although operating in the commodity sector, are still
linked to influences and developments of the overall equity market. Moreover, company
specific policies and procedures can lead to significant deviations, time lags, etc. with
respect to the price developm ents in the respective commodity sectors. The original
investment aim of adding assets with low correlation to equities could thus be diluted.
In order to get exposure, which is directly linked to price developments in commodities,
one could choose direct inves tments in commodity futures traded on commodity
exchanges such as e.g. in Chicago or London. For private investors, however, investing
in commodities via commodity futures is, in general, costly and difficult to handle. To
avoid such difficulties, indirect investment vehicles seem to be a better way to implement
such strategies. The financial services industry has reacted to these needs and has created
a variety of new commodity investment vehicles, which are more suitable for the
investment needs of private clients. Such indirect vehicles are, as a rule, wrapped into
structures such as funds, exchange traded funds, warrants or certificates, which are either
directly linked to the price of specific commodities or to an index of several commodities
.
Financial market activity in the commodity sector has therefore increased. Data on the
dynamics of market developments across asset classes are difficult to obtain. The Bank
for International Settlements (BIS) publishes data on the OTC market. Although the OTC
market is only a limited part of overall financial market activity and consequently one
must be careful in interpreting these data, they can provide an indication of the relocation
of interest in the respective asset classes. According to the BIS data, the outstanding
amount of OTC derivatives in June 2004 was USD 6395bn. With 2.6% of the overall
amount, commodity contracts were the smallest group, but showed by far the strongest
growth momentum in year on year terms rising 66% compared to an overall decline of
19% for total outstanding OTC derivatives.

33 Presented
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 34 Presented
by Savita Nathawat
 Global Commodity Exchanges

The New York Mercantile Exchange

The New York Mercantile Exchange, Inc., is the world's largest physical commodity
futures exchange and the preeminent trading forum for energy and precious metals
throughout its 132-year history.Trading is conducted through two divisions, the
NYMEX Division, home to the energy, platinum, and palladium markets; and the
COMEX Division, on which all other metals are traded.

The Exchange pioneered the development of energy futures and options contracts 26
years ago as means of bringing price transparency and risk management to this vital
market

The wide array of trading markets provided by the Exchange include futures and options
contracts for crude oil, gasoline, heating oil, natural gas, electricity, gold, silver, copper,
aluminum, and platinum; futures contracts for coal, propane, and palladium; and options
contracts on the price differentials between crude oil and gasoline, crude oil and heating
oil, Brent and West Texas Intermediate crude oil, and various futures contract months
(calendar spreads) for light, sweet crude; Brent crude; gasoline; heating oil; and natural
gas.

The Exchange also lists NYMEX miNY™ energy futures, fractional light, sweet crude
oil and natural gas futures contracts that offer smaller investors and traders the
opportunity for an efficient means of participating in energy markets. The contracts trade
via the NYMEX ClearPort® electronic trading system and clear through the New York
Mercantile Exchange clearinghouse. NYMEX miNY™ Futures

The Exchange also clears off-exchange trades for market participants who wish to avoid
counterparty credit risk by using standardized contracts for natural gas, crude oil,
refined products, and electricity.

It is governed by CFTC (commodity futures trading commission)

35 Presented
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 London Metal Exchange
History of the LME
The origins of the London Metal Exchange can be traced as far back as the opening of
the Royal Exchange in 1571. This is where metal traders first began to meet on a regular
basis. However, it was in 1877 that the London Metal Market and Exchange Company
was formed as a direct result of Britain's industrial revolution of the 19th century. This
led to a massive increase in the UK’s consumption of metal, which required the import of
enormous tonnages from abroad. Merchant venturers were investing large sums of
money in this activity and were exposed to great risk, not only because the voyages were
hazardous but also because the cargoes could lose value if there was a fall in price during
the time it took for the metal to reach Britain.

Merchants began meeting in coffee houses where they traded with each other in order to
protect themselves against this latter risk by selling the cargoes as forward contracts. The
LME was formed to bring order to this activity with the establishment of a single
marketplace, recognised times of trading and standardised specifications for the
contracts. As the Exchange developed, its forward contracts were utilised by all aspects
of industry in order to protect against price risk. This activity is referred to as hedging.

Trading on the LME

There are currently three ways to trade on the LME.

Open outcry market (ring trading) - this market is attended by representatives of the
LME ring dealing firms.

Inter-office telephone market - a 24 hour global market place transacted between

member companies over the telephone.

LME Select - the LME's electronic trading platform.

The Exchange has a membership of around 80 major firms, 11 of which take part in ring
dealing (open outcry). Another thirty-one broker members join them in the trading of
futures and options through the telephone market and LME Select.

Regulation & compliance

The Financial Services Authority (FSA) is responsible for regulating the financial
soundness and conduct of LME members' business. Approved as a recognised investment
exchange (RIE) and conforming with British and other international regulatory
requirements, the LME offers, through price and volume transparency and audit trails, a
legally safe forum for metal and plastics trading. As an RIE, the exchange comes under

36 Presented
by Savita Nathawat
the direct jurisdiction of the FSA. LME members also operate in a strict regulatory
environment policed by the FSA..

Beyond this, both the exchange and its members are subject to regulatory controls and
input from various UK bodies and government offices, as well as directives from the EU
Commission in Brussels. In international trading, rules applied by overseas regulatory
bodies such as the CFTC in the USA also have to be taken into account.

LME contracts
The LME's forward contracts allow producers, fabricators, merchants and consumers to
insure against price risk. Today the Exchange trades in eight metals, two plastics and one
index comprising the six primary base metals. The LME's eight metals contracts are:
copper grade A, primary aluminium, standard lead, primary nickel, tin, special
high grade zinc, aluminium alloy and North American Special Aluminium Alloy
(NASAAC). The LME's plastics contracts are polypropylene (PP) and linear low
density polyethylene (LL).

.The LME also offers traded options contracts based on each of these futures contracts,
together with traded average price options contracts (TAPOs) based on the monthly
average settlement price (MASP) for all metals futures contracts.

The LME's plastics contracts are based on monthly prompt dates out to 15 months
forward. All LME prices are quoted in US Dollars, but the LME permits contracts in
sterling, Japanese yen, and Euros and provides official exchange rates from US Dollars
for each of them. Trade is conducted in lots rather than tonnes, with each lot of
aluminium, copper, lead and zinc amounting to 25 tonnes. Nickel is traded in 6 tonne
lots, tin in 5 tonnes and aluminium alloy and NASAAC in 20 tonne lots. PP and LL are
traded in 24.75 tonne lots.

What is a TAPO?
London Metal Exchange Traded Average Price Options (TAPOs) for copper grade A,
high grade primary aluminium, standard lead, primary nickel, special high grade zinc,
aluminium alloy, NASAAC and tin are Exchange cleared contracts based on the LME
Monthly Average Settlement Price (MASP).

Because many users in the industry price their physical material on the basis of the LME
MASP, brokers developed off-Exchange average price option products, known as
'Asians' which quickly became popular, particularly with large producers. To meet this
growing demand, the LME developed the TAPO contracts.

TAPO contracts complement existing LME futures and traded options contracts. Users of
the market who trade basis the MASP will tend to use TAPO contracts. However,

37 Presented
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hedgers who trade using the LME's flexible daily prompt system will find futures or
traded options more suitable hedging tools.

Chicago Board of Trade (CBOT® )

The Chicago Board of Trade (CBOT® ), established in 1848, is a leading futures and
futures-options exchange. More than 3,600 CBOT member/stockholders trade 50
different futures and options products at the CBOT by open auction and electronically.
Volume at the Exchange in 2005 surpassed 674 million contracts, the highest yearly total
recorded in its history.

In its early history, the CBOT traded only agricultural commodities such as corn,
wheat, oats and soybeans. Futures contracts at the Exchange evolved over the years
to include non-storable agricultural commodities and non-agricultural products. In
October 2005, the CBOT marked the 30th anniversary of the the Exchange's first
financial futures contract, based on Government National Mortgage Association
mortgage-backed certificates. Since that introduction, futures trading has been initiated
in many financial instruments, including U.S. Treasury bonds and notes, 30-Day Federal
Funds, stock indexes, and swaps, to name but a few. Another market innovation, options
on futures, was introduced in 1982. The CBOT added a new category to its diverse
product mix in 2001 with the launch of 100 percent electronic Gold and Silver futures
contracts. CBOT South American Soybean futures and Ethanol futures, the
Exchange’s newest products, were introduced in 2005 in response to shifting trends
in the global agricultural economy.

For decades, the primary method of trading at the CBOT was open auction, which
involved traders meeting face-to-face in trading pits to buy and sell futures contracts. But
to better meet the needs of a growing global economy, the CBOT successfully launched
its first electronic trading system in 1994. During the last decade, as the use of electronic
trading has become more prevalent, the Exchange has upgraded its electronic trading
system several times. Most recently, on October 12, 2005, the CBOT successfully
launched its newly enhanced electronic trading platform, e-cbot, powered by LIFFE
CONNECT®, by introducing a major API upgrade.

Whether trading futures and options on futures through an electronic platform or open
auction, the CBOT’s primary role is to provide transparent and liquid contract markets
for its member/stockholders and customers to use for price discovery, risk management
and investment purposes. These futures markets also allow speculators throughout the
world to interpret economic data, news and other information and use that information to
make decisions about price and enter the futures markets as investors. Speculators bridge
the gap between hedgers’ bids and offers, thereby making the market more liquid and
cost effective

38 Presented
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Chicago Mercantile Exchange
CME is the largest futures exchange in the United States and also owns and operates the largest futures Clearing House
in the world. CME products fall into five major areas: interest rates, equities, foreign exchange, agricultural
commodities and alternative investments. Two forums are available for trading CME products: the long-standing open
outcry trading floors and the CME® Globex® electronic trading platform. The CME Clearing House guarantees, clears
and settles every contract traded through the Exchange. Founded as a not-for-profit corporation in 1898, CME
became the first publicly traded U.S. financial exchange in December 2002 when the Class A shares of its
common stock began trading on the New York Stock Exchange under the ticker symbol CME.

Regulatory Authority

Commodity Futures Trading Commission (CFTC)

Futures Industry Association (FIA) and Futures Industry Institute (FII)
National Futures Association (NFA)

The Bursa Malaysia Derivatives

As the 21st century dawns and the capital market in Malaysia evolves further with more
varied and customised investment instruments, the futures industry will play a significant
role in the transformation towards a more dynamic capital market and financial industry.
In catering for increasing risk management needs, the diversity of products traded on
Exchanges throughout Asia has expended tremendously and this is ably supported by
sophisticated trading and clearing systems equal to the best available in developed
countries. In Malaysia, the Bursa Malaysia Derivatives Berhad exemplifies this type of
Futures Exchange, offering both futures and options contracts on a sound trading
platform

The Bursa Malaysia Derivatives operates under the supervision of the

Securities Commission and is governed by the Futures Industry Act
(FIA) 1993. The Exchange also falls under the jurisdiction of the Ministry of Finance
of Malaysia, thus offering investors the security of trading on a regulated Exchange with
similar rules and regulation as the more established markets worldwide.
Bursa Malaysia Derivatives was established pursuant to the provisions of the Futures
Industry Act 1993 (amended in 1995)("FIA"). The Ministry of Finance is responsible
under the FIA to regulate the trading of futures contracts and to provide for matters
connected or incidental to trading in futures. The Malaysian Securities Commission
("SC") is empowered by the Ministry of Finance to regulate all matters relating to the
derivatives industry. It is mainly responsible for providing regulatory protection and
39 Presented
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licensing of participants in the Exchange namely

Tokyo Commodity Exchange

Juridical Character
TOCOM is a non-profit membership organization as defined under the Commodity
Exchange Law (1950), which regulates all commodities futures and options trading in
Japan.

Regulatory Authority
Ministry of Economy, Trade and Industry

Administration
Responsible for the activities of TOCOM is the Board of Directors, under which stand
the following committtees:
• General Affairs Committee
• Membership Committee
• Market Management Committee
• Delivery Quality Committee
• Market Trading Monitoring Committee

Singapore Commodity Exchange

Singapore Commodity Exchange provides a centralised and regulated marketplace for

commodity futures to be traded in Singapore. This paves the way for Singapore to
become a commodity futures trading centre complementing its international trading
activities.

The Exchange is governed by statutory acts. Integrity of its trading and financial
practices is assured. The financial integrity of the marketplace is safeguarded by the
Exchange through its membership criteria and trading rules.

While buyers and sellers do not meet in a trading pit, the Exchange's computerised
trading network linking the market-makers/brokers provides them with an efficient price
discovery system. The system ensures the best bid and offer for all the market's
participants. Of pivotal importance, however, is the role of the Exchange's Clearing
House. All futures contracts transacted between buyers and sellers are cleared through
the clearing House.

40 Presented
by Savita Nathawat
It is regulated by The International Enterprise Singapore Board

Commodity trading act 2001(CTA) authorise the International

Enterprise Singapore Board (formerly known as the Singapore Trade
Development Board) to regulate futures trading in commodities.

Products:- Rubber ,Robusta Coffee

Indian Commodities Market

In India commodity markets have been in existence for decades. However in 1975 the Government banned forward contracts
on commodities. Later in 2003 the Government of India again allowed forward contracts in commodities. There have been

41 Presented
by Savita Nathawat
over 20 exchanges existing for commodities all over the country. However these exchanges are commodity specific and have
a strong regional focus. The Government, in order to make the commodities market more transparent and efficient, accorded
approval for setting up of national level multi commodity exchanges. Accordingly three exchanges are there which deal in a
wide variety of commodities and which allow nation-wide trading. They are

1. Multi Commodity Exchange (MCX)

2. National Commodities Derivatives Exchange (NCDEX)
3. National Multi Commodity Exchange (NMCE)

The MCX is Mumbai-based and is promoted by Financial Technologies Pvt Ltd. MCX allows trading on a host of
commodities ranging from bullion to grains. Please check the ‘Commodities traded’ menu’. MCX has become the first
exchange in the world to launch futures on steel. Recently on 11th August 2004, MCX crossed a peak daily turnover of
Rs.950 Crores.

NCDEX is promoted by an elite group of financial institutions including NSE, LIC, SBI, UBI etc., NCDEX also allows
trading of futures on a host of commodities.

Evolution of commodity market in India

---Bombay cotton trade association ltd.. set up in 1875
---The future trading in oilseeds started in 1900 with establishment of Gujarati Vyapari
Mandali.
----Future exchange for wheat was chamber of commerce at Hapur set up in 1913
----Future trading in bullion began in Mumbai in 1920
-----Calcutta Hessian exchange Ltd was established in 1919 for future trading in raw jute
and jute goods
----East Indian Jute Association set up in 1927
----these two associations amalgamated in 1945 to form the east India Jute and
Hassian Ltd
------Forward contract regulation act was enacted in 1952
------Forward market commission was established in 1953 under ministry of consumer
affairs and public distribution

THE KABRA COMMITTEE REPORT

The govt of India appointed in June 1993 a committee on forward market under
chairmanship of Prof. K.N. kabra.

OBJECTIVES
1)To asses the working of commodities exchanges and their trading practices and to
make recommend with a view to making them compatible with those of other countries
2) To asses the role of forward market commission and to make recommendations with a
view to make it compatible with similar regulatory agencies in other countries
3) To examine the extent to which forward trading has special role to play in promoting
exports
4) To suggest amendments to the Forward contract regulation act ,with a view to
effective enforcement of act.

42 Presented
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5) To suggest measure to ensure that forward trading in the commodities in which it is
allowed to be operative remains constructive and helps in maintaining prices within
reasonable limit

Recommendations

1)The forward market commission and forward regulation act need to be strengthened .
2)Due to in adequate facility such as space and telecomm the comm. Exchange were not
be able to function effectively
3)Enforce capital adequacy norms
4)In built devices in comm. Such as vigilance committee and the panels of surveyors and
arbitrators be strengthened further
5)FMC should continue to act as watch dog . Amendments to the rules and regulations
and by laws of the commodities exchange should require the approval of FMC only
6)In the context of globalization ,comm. Market in India could not function effectively in
an isolated manner . Therefore, some of the comm. Exchanges be upgraded to the level
of international markets.

LATEST DEVELOPMENTS

• National Board of Trade

• Multi commodity exchange
• National Commodity & Derivative Exchange of India Ltd

NCDEX PLATFORM
• It is a tech driven commodity exchange
• It is a public Ltd co registered under the companies act 1956 with the registrar of
companies , Maharashtra in Mumbai on April 23,2003
• It has an in dependent board of directors and professionals not having vested
interest in commodity market
• It is regulated by Forward market commission in respect of futures trading in
comm.
• It is subjected to various laws of the land like companies act ,contract act, stamp
act, FCRA

OBJECTIVE
To provide world class comm. Ex platform for market participants to trade in a wide
spectrum of comm. Derivatives driven by best global practices , Professionalism and
transparency.
To include best international practices like de-modularization ,tech platform,low cost
solutions and information dissemination without noise
To provide nation wide reach and consistent offering
To bring together the entities that the market can trust

43 Presented
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PROMOTERS
• ICICI
• NABARD
• LIC
• NSE

GOVERNANCE
It is run by an independent board of directors , promoters do not participate in day to day
activities. The board is responsible for all operations of the exchange .Board appoints an
executive committee and other committee for the purpose of managing activities of
exchange for eg:- member committee, Audit committee, Risk committee

EXCHANGE MEMBERSHIP
The members of NCDEX falls into two categories
1) Trading cum clearing members (TCM)
2) Professional clearing members (PCM)

CAPITAL REQUIREMENT
The members has to deposit Base Min Capital (BMC)
Base min capital comprises of following
1) Interest free cash security deposit
2) Collateral security deposit

TCM = 30,00,000
PCM = 50,00,000

The NCDEX trading system

• Trading
• Clearing
• Settlement

Multi Commodity Exchange of India Ltd. (MCX)

Multi Commodity Exchange of India Ltd. (MCX), with the permanent recognition from
Forward Markets Commission, Government of India has established a demutualised
Nation-wide Multi Commodity Online Exchange for Futures Trading in all the important
and essential commodities.

44 Presented
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Key Shareholders:
1. Financial Technologies (India) Ltd.
2. State Bank of India
3. Union Bank of India
4. State Bank of Indore
5. Bank of India
6. State Bank of Hyderabad
7. Canara Bank
8. Bank of Baroda
9. Corporation Bank
10. Bank of Saurashtra
11. SBI Life Insurance Co.

International Alliances :

MCX has signed MOUs with world’s leading commodity exchanges like The Tokyo
Commodity Exchange (TOCOM) and The Baltic Exchange, London MCX &
Financial Technologies (India) Ltd. (FTIL) in association with DMCC, a strategic
initiative of Government. of Dubai has entered into a 50:50 Joint Venture to set up the
Dubai Gold & Commodity Exchange (DGCX).

(Commodities traded on MCX is given in annexure)

45 Presented
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 Gold
• Gold is primarily a monetary asset and partly a commodity.
• More than two thirds of gold's total accumulated holdings relate to 'value for
investment' with central bank reserves, private players and high-carat jewelry.
• Less than one third of gold's total accumulated holdings is as a 'commodity' for
jewelry in Western markets and usage in industry.
• Gold market is highly liquid and gold held by central banks, other major
institutions and retail jewelry 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
• Zurich 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

India in World Gold Industry

World (In
(Rounded Figures) India (In Tons) % Share
Tons)
Total Stocks 13000 145000 9
Central Bank holding 400 28000 1.4
Annual Production 208 2600 0.08
Annual Recycling 100-300 1100-1200 13
Annual Demand 800 3700 22
Annual Imports 600 --- ---
Annual Exports 60 --- ---

Indian Gold Market

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

46 Presented
by Savita Nathawat
 • 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 jewellery offtake 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

Market Moving Factors

• Above ground supply from sales by central banks, reclaimed scrap and official
gold loans
• Producer / miner hedging interest
• World macro-economic factors - US Dollar, Interest rate
• Comparative returns on stock markets
• Domestic demand based on monsoon and agricultural output

Biggest Price Movement since 1995

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.

47 Presented
by Savita Nathawat
Contract Specifications of gold

48 Presented
by Savita Nathawat
 49 Presented
by Savita Nathawat
 Copper
Characteristics of Copper
• Copper ranks third in world metal consumption after steel and aluminum. It is a
product whose fortunes directly reflect the state of the world's economy
• Copper is the best non-precious metal conductor of electricity. The metal's
exceptional strength, ductility, and resistance to creeping and corrosion, makes it
the preferred and safest conductor for building wiring. Copper is also used in
power cables, either insulated or uninsulated, for high, medium and low voltage
applications. Copper is an essential component of energy efficient motors and
transformers and automobiles.

Supply and Demand :

Global Scenario
• Economic, technological and societal factors influence the supply and demand of
copper. As society's need for copper increases, new mines and plants are
introduced and existing ones expanded.
• Land-based resources are estimated at 1.6 billion tons of copper, and resources in
deep-sea nodules are estimated at 0.7 billion tons.
• The global production of refined copper is around 15 million tons
• The major copper-consuming nations are Western Europe (28.5%), the United
States (19.1%), Japan (14%), and China (5.3%).
• Copper and copper alloy scrap composes a significant share of the world's supply.
• The largest international sources for scrap are the United States and Europe.
Chile, Indonesia, Canada and Australia are the major exporters and Japan, Spain
China, Germany and Philippines are the major importers.

Indian Scenario
• The size of Indian Copper Industry is around 4 lakh tons, which as percentage of
world copper market is 3 %.
• Birla Copper, Sterilite Industries are two major private producers and Hindustan
Copper Ltd the public sector producers.
• India is emerging as net exporter of copper from the status of net importer on
account of rise in production by three companies.
• Copper goes into various usage such as Building, Cabling for power and
telecommunications, Automobiles etc. Two major states owned
telecommunications service providers; BSNL and MTNL consume 10% of
country's copper production. Growth in the building construction and automobile
sector would keep demand of copper high.

World Copper Markets

• LME and NYMEX are the two international markets, which provide direction to
the copper prices.

50 Presented
by Savita Nathawat
 The eight leading refining nations, viz., United States,Japan, Chile, Canada, Zambia,
Belgium, and the Federal Republic of Germany account for 67% of total refined
metal production.

Factors Influencing Copper Markets

• Copper prices in India are fixed on the basis of the rates that rule on LME the
preceding day.
• new mine and expansion of existing mine
• Economic growth of the major consuming countries such as China, Japan,
Germany etc.
• Growth and development in the Building, electronics and electrical industry

51 Presented
by Savita Nathawat
 450
400
350
300
250
Series1
200
150
100
50
0
-0 06

5/ 6

06
-0 006
-0 06

6/ 6

-0 006
8/ 00 6
-0 0 6

8/ 00 6

-0 0 6

/6 6
-0 06
1/ 00

5/ 00
12 200
24 - 20

20
29 - 20
17 20

15 20

19 /20
2

22 - 2

26 - 2
2

2
4-

6-
5-
5/
4/
4/
4

5
5

6
1/

Movement of copper prices in last 3 months

As the inflation all over the world is increasing and it will keep on increasing as the
demand is more than supply the interest rates will also keep on increasing so dollar will
depreciate and gold will appreciate more and more investors will use it as hedging tool
against inflation .so prices of gold will definitely rise.

Copper is the largest used industrial metal but with the introduction of wireless phones
the demand its demand fall down as it was used in telephone wires. But again as
computers require copper the demand for copper is increasing so the prices of copper will
also increase.

52 Presented
by Savita Nathawat
 Awareness
We conducted a survey to find out the level of awareness about commodities market
among the investors
Sample= IT professionals and bank employees
Sample size = 2000

Out of 2000 only 100 were aware of what is commodities market.

Survey was conducted through a questionnaire in which we asked them if they want to
invest in which instrument they will invest and we gave them option of mutual fund,
LIC, Stocks, Commodities, Bonds & FD, Foreign Exchange. Only 25 People said that
they want to invest in commodities market.

53 Presented
by Savita Nathawat
 Conclusion
Commodities market will be the market of future as this market is under a bull way
because all over the world commodity resources are scarce and demand is increasing so
the commodity prices will go only in one direction that is up. So this is the right time to
invest in the commodities market.

Commodities market if compared to stock market will give better return in long run.
Commodities are also less risky than stocks as the commodity prices can never become
zero they will have some value at ant point of time.

Commodities also provide better hedge against inflation as they have positive correlation,
and inflation is increasing all over the world that is why it is advisable to invest in
commodities.

Commodities Exchanges in India is not efficient as compared to global exchanges they

are very specialized for eg: LME trades only in metals NYMEX trades only in energy
futures. The economic data in US and UK are updated very fast whereas in India we
don’t get updated data when it is required.

People are not aware of this market in India and those who are aware has a myth that it is
a highly risky to invest in commodities. So this a market untapped market having great
potential.

54 Presented
by Savita Nathawat
 Recommendations

1) Karvy should launch a campaign for the awareness of

investors .
2) Personal advisory department of Karvy should also help in
Creating awareness about commodities market and try to
educate people about this market
3) Launch some broacher having all required information about
commodity market.
4) Provide updated data and information to the clients.
5) Provide details of commodity requirement, supply, and
demand.

55 Presented
by Savita Nathawat
 BIBLIOGRAPHY

1) www.lme.co.uk
2) www.nymex.com
3) www.mcxindia.com
4) www.ncdex.com
5) www.brusaderivative.com
6) Hot commodities
7) CRB yearbook
8) www.Karvycomtrade.com
9) www.Agriwatch.com
10) www.Lbma.com
11) www.Sicom.com.SG
12) www.Cme.com
13) www.Cbot.com
14) www.dce.com.cn
15) www.Tocom.or.jp
16) www.Crbtrader.com

…………………………...Thank you…………………………………

56 Presented
by Savita Nathawat