027-Bhakti Lal-Commodity a Fundamental Research

8/8/2019 027-Bhakti Lal-Commodity a Fundamental Research

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EXECUTIVE SUMMARY

The title of the project is Commodity: A Fundamental Research its main objective is to

study the trading mechanism of the multi-commodity exchange and to describe the profile of

gold and silver as a commodity. It further delves into the fundamental research of a

commodity and to form the trading strategy for the future.

The whole project is divided into five parts where in the first part deals with the objective,

scope and approach of the project. The second part deals with mechanism of commodity

trading carried by the multi commodity exchange. Third part delves into the fundamentals

of bullions i.e. gold and silver. This part enables us to know the fundamental of gold and

silver that an analyst should know for research. Fourth part deals with the brief definition of

fundamental and technical analysis and a fundamental research is carried on the commodity

wheat. The conclusion is drawn as to what should be the trading strategy for trading in wheat

for the coming month futures. In the last section, the analysis is done related with the Indiancommodity market and the suggestions to improve it.

The information provided in the project would be useful to understand the fundamental

knowledge that is required in forming the strategy for trading.

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Chapter no. Name of the chapter Page no.1 Part 1 3-41.1 Objective1.2 Approach

1.3 Scope of the study1.4 Limitations2 Part-11 5-342.1 Theoretical framework 2.2 Derivatives2.3 Derivative market2.4 Commodity2.5 History of commodity trading2.6 Evolution of commodity market in India2.7 Commodity derivatives

2.8 Futures contract2.9 Hedging2.10 Speculation2.11 Arbitrage2.12 Operational mechanism of MCX

3 Part -III 35-563.1 Commodity profile

3.2 Silver

3.3 Gold4 Part -IV 57-86

4.1 Fundamental analysis4.2 Technical analysis (basic definition)

4.3 Analysis of wheat.

5 Part-V 87-90

5.1 Analysis of the Indian commodity market

5.2 Suggestions to improve it

References.

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PART-I

OBJECTIVE OF THE STUDY:

A basic purpose or valid reason is always required in order to carry out ant business

activity, and this purpose is nothing but the researchers must know the main objectives of the

study.

The main objectives:

I. Study of commodity trading and market.

II. Analysis of certain commodity

III. Comparison of returns on the various instruments.IV. A brief insight into fundamental and technical (candle sticks) analysis of the

commodity.

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APPROACH TO THE PROJECT :

The approach to the study would be:

Firstly to study the commodity market first in terms of its operational aspect with the help of

the terminal i.e. MCX.

Secondly , studying the nature of the various commodities like steel, gold, silver, cotton,

pepper, soybean seed, Soya oil

Thirdly , studying the comparative returns on the various commodity

Finally , suggestions as to how to improve the volume of commodity market

For the study we will require primary and secondary data:

PRIMARY DATA:

The first hand data has been collected by meeting people from mcx

SECONDARY DATA:

The secondary data has been collected from the website regarding the trend lines of the

commodities and it s nature.

SCOPE OF THE STUDY:

The present study includes the scope of the analysis of performance of the commodity

market. The scope is limited to some commodities only and to fundamental research only.

LIMITATION OF THE STUDY:

The study has certain limitation like:

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I. Time constraints

II. Confidential data

III. The detail analysis of the commodities in limited to certain commodities only

PART -II

THEORITICAL FRAME WORK:

A derivative is a product whose value is derived from the value of one or more underlying

variables or assets in a contractual manner. The underlying asset can be equity, forex, and

commodity.

For e.g.: wheat farmers may wish to sell their harvest at a future date to eliminate the risk of

a change in prices by that date. Such a transaction is an example of a derivative. The price of

this derivative is driven by the spot price of wheat, which is the underlying in this case.

Products, participants and functions:

Derivative contracts are of different types. The most common ones are forwards, futures,

options and swaps. Participants who trade in the derivatives market can be classified under

the following three broad categories hedgers, speculators, and arbitragers.

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1. Hedgers : The farmer's example that we discussed about was a case of hedging. Hedgers

face risk associated with the price of an asset. They use the futures or options markets to

reduce or eliminate this risk.

2. Speculators : Speculators are participants who wish to bet on future movements in the

price of an asset. Futures and options contracts can give them leverage; that is, by putting in

small amounts of money upfront, they can take large positions on the market. As a result of

this leveraged Speculative position, they increase the potential for large gains as well as large

losses.

3. Arbitragers : Arbitragers work at making profits by taking advantage of discrepancy between prices of the same product across different markets. If, for example, they see the

futures price of an asset getting out of line with the cash price, they would take offsetting

positions in the two markets to lock in the profit. Whether the underlying asset is a

commodity or a financial asset, derivative markets performs a number of economic functions.

Commodity markets give opportunity for all three kinds of participants.

o Prices in an organized derivatives market reacts the perception of market

participants about the future and lead the prices of underlying to the perceived future

level. The prices of derivatives converge with the prices of the underlying at the

expiration of the derivative contract. Thus derivatives help in discovery of future as well

as current prices.

o The derivatives market helps to transfer risks from those who have them but may

not like them to those who have an appetite for them.

o Derivatives, due to their inherent nature, are linked to the underlying cash

markets. With the introduction of derivatives, the underlying market witnesses higher

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trading volumes because of participation by more players who would not otherwise

participate for lack of an arrangement to transfer risk.

o Speculative traders shift to a more controlled environment of the derivatives

market. In the absence of an organized derivatives market, speculators trade in the

underlying cash markets. Margining,

o Monitoring and surveillance of the activities of various participants become

extremely difficult in these kind of mixed markets.

o Derivatives markets help increase savings and investment in the long run. The

transfer of risk enables market participants to expand their volume of activity.

Derivative market:

Derivative markets can broadly be classified as commodity derivative market and financial

derivatives markets. As the name suggest, commodity derivatives markets trade contracts for

which the underlying asset is a commodity. It can be an agricultural commodity like wheat,

Soybeans, rapeseed, cotton, etc or precious metals like gold, silver, etc.

The most commonly used derivatives contracts are forwards, futures and options

COMMODITY:

The commodity means any intermediate goods, which is useful for production and which has

constant and standard qualities. Commodity is derived from the Latin word Commodus

which means convenient.

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Characteristics of a commodity and commodity market:

1. They have standard and constant value

2. They are scarce

3. They are intermediate

4. They are controllable cost

5. Markets are liquid and competitive i.e. liquidity means the total supply equals total

demands or more or less same and fluctuation due to seasonal imbalance and

changing circumstances. Competitiveness is that large number of buyers and sellers

and perfect knowledge of market.6. There two types of market: centralized and decentralized

Centralized Markets Decentralized marketsAuction market

Centralized exchange

OTC

Posted price

History of commodity trading:

Derivatives as a tool for managing risk first originated in the commodities markets. They

were then found useful as a hedging tool in financial markets as well. In India, trading in

commodity futures has been in existence from the nineteenth century with organized trading

in cotton through the establishment of Cotton Trade Association in 1875. Over a period of

time, other commodities were permitted to be traded in futures exchanges. Regulatory

constraints in 1960s resulted in virtual dismantling of the commodities future markets. It is

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only in the last decade that Commodity future exchanges have been actively encouraged.

However, the markets have been thin with poor liquidity and have not grown to any

significant level.

Evolution of market in India:

Bombay cotton trade association ltd.set up in 1875 was the first organized futures market.

Bombay cotton exchange ltd.was established in1893 following the widespread discontent

among leading cotton mill owners and merchants over functioning at Bombay cotton trade

association. The future trading in oils seed started in 1900 with the establishment of the

Gujarat vyapari mandli, which carried on futures trading in groundnut, castor seed, and

cotton. Futures trading in wheat were existent at several places in Punjab and Uttar Pradesh.

But the most notable futures exchange for wheat was chamber of commerce at hapur set up

in 1913.futures trading in bullion began in Mumbai in1920calcutta Hessian exchange ltd.was

established in 1919 for futures trading in raw jute and jute goods. But organized futures

trading in raw jute began only in 1945 to form the east India jute and Hessian ltd, to conduct

organized trading in both raw jute and jute goods. Forward contracts act was enacted in 1952

and the forward market commission was established in 1953 under the ministry of consumer

affair and public distribution.

Present scenario:

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Out of these 25 commodities the MCX, NCDEX and NMCE are large exchanges and MCX

is the biggest among them. Forward Markets Commission (FMC) headquartered at Mumbai

is a regulatory authority, which is overseen by the Ministry of Consumer Affairs and Public

Distribution, Govt. of India. It is a statutory body set up in 1953 under the Forward Contracts

(Regulation) Act, 1952.

Commodity derivative

The basic concept of a derivative contract remains the same whether the underlying happens

to be a commodity or a financial asset.

Characteristics of commodity derivatives:

o Due to the bulky nature of the underlying assets, physical settlement in commodity

derivatives creates the need for warehousing.

o In the case of commodities, the quality of the asset underlying a contract can vary largely.

This becomes an important issue to be managed.

Trading tools:

1. FORWARD CONTRACTS:

A forward contract is an agreement to buy or sell an asset on a 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.

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Other contract details like delivery date, the parties to the contract negotiate price and

quantity bilaterally. The forward contracts are normally traded outside the exchanges. The

salient features of forward contracts are:

They are bilateral contracts and hence exposed to counter party risk.

Each contract is custom designed, and hence is unique in terms of contract size,

expiration date and the asset type and quality.

The contract price is generally not available in public domain.

On the expiration date, the contract has to be settled by delivery of the asset.

If the party wishes to reverse the contract, it has to compulsorily go to the same

counter party, which often results in high prices being charged.

Example of forward contract is foreign exchange market .

Explanation with an example:

Forward contracts are very useful in hedging and speculation. The classic hedging

application would be that of an exporter who expects to receive payment in dollars three

months later. He is exposed to the risk of exchange rate fluctuations. By using the currency

forward market to sell Dollars forward, he can lock on to a rate today and reduce his

uncertainty.

If a speculator has information or analysis, which forecasts an upturn in a price, then he can

go long on the forward market instead of the cash market. The speculator would go long on

the forward, wait for the price to rise, and then take a reversing transaction to book profit

Speculators may well be required to deposit a margin upfront. However, this is generally a

relatively small proportion of the value of the assets underlying the forward contract. The use

of forward markets here supplies leverage to the speculator.

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The disadvantages of forward market are:

1. Lack of liquidity

2. No counter party guarantee

3. No standardization.

2. FUTURES CONTRACT:

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. But unlike forward contracts, the futures contracts are

standardized and exchange traded. To facilitate liquidity in the futures contracts, theexchange specifies certain standard features of the contract. It is a standardized contract with

standard underlying instrument, a standard quantity and quality of the underlying instrument

that can be delivered, (or which can be used for reference purposes in settlement) and a

standard timing of such settlement. 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.

The standardized item in the future is:

o Quantity of the underlying

o Quality of the underlying

o The date and the month of delivery

o The units of price quotation and

o minimum price change

o Location of settlement

Terminology used in futures:

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Spot price : The price at which an asset trades in the spot market.

Futures price : The price at which the futures contract trades in the futures

market.

Contract cycle : The period over which a contract trades. The commodity

futures contracts on the NCDEX have one-month, two-month and three-month expiry

cycles, which expire on the 20 th day of the delivery month. Thus a January expiration

contract expires on the 20th of January and a February expiration contract ceases trading

on the 20th of February. On the next trading day following the 20th, a new contract

having a three-month expiry is introduced for trading. Expiry date : It is the date specified in the futures contract. This is the last day

on which the contract will be traded, at the end of which it will cease to exist.

Delivery unit : The amount of asset that has to be delivered less than one

contract. For instance, the delivery unit for futures on Long Staple Cotton on the NCDEX

is 55 bales. The delivery unit for the Gold futures contract is 1 kg.

Basis : Basis can be defined as the futures price minus the spot price. There

will be a different basis for each delivery month for each contract. In a normal market,

basis will be positive. This rejects that futures prices normally exceed spot prices.

Cost of carry : The relationship between futures prices and spot prices can be

summarized in terms of what is known as the cost of carry. This measures the storage

cost plus the interest that is paid to finance the asset less the income earned on the asset.

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.

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Marking-to-market (MTM) : In the futures market, at the end of each trading

day, the margin account is adjusted to reflect the investor's gain or loss depending upon

the futures closing price. This is called marking to market.

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

Basic payoffs

A payoff is the likely profit/ loss that would accrue to a market participant with change in the

price of the underlying asset. This is generally depicted in the form of payoff diagrams,

which show the price of the underlying asset on the X-axis and the profits/ losses on the Y-

axis.

Payoff for futures

Futures contracts have linear payoff, just like the payoff of the underlying asset that we

looked at earlier. If the price of the underlying rises, the buyer makes profits. If the price of

the underlying falls, the buyer makes losses. The magnitude of profits or losses for a given

upward or downward movement is the same. The profits as well as losses for the buyer and

the seller of a futures contract are unlimited. These linear payoffs are fascinating as they can

be combined with options and the underlying to generate various complex payoffs.

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Payoff for buyer of futures: Long futures

The payoff for a person who buys a futures contract is similar to the payoff for a person who

holds an asset. He has a potentially unlimited upside as well as a potentially unlimited

downside.

Figure-1 Payoff for a buyer of gold

The figure shows the profits/ losses from a long position on gold. The investor bought gold at

Rs.6000 per 10 Gms. If the price of gold rises, he profits. If price of gold falls he looses.

Profit

+500

5500 6000 6500

0

-500

Loss

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Figure 2 Payoff for a seller of gold

The figure shows the profits/ losses from a short position on cotton. The investor sold long

staple cotton at Rs.6500 per Quintal. If the price of cotton falls, he profits. If the price of

cotton rises, he looses.

6000 6500 7000

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Figure 3 Payoff for a buyer of gold futures

The figure shows the profits/ losses for a long futures position. The investor bought futures

when gold futures were trading at Rs.6000 per 10 Gms. If the price of the underlying gold

goes up, the gold futures price too would go up and his futures position starts making profit.

If the price of gold falls, the futures price falls too and his futures position starts showing

losses.

Take the case of a speculator who buys a two-month gold futures contract on the NCDEXwhen it sells for Rs.6000 per 10 Gms. The underlying asset in this case is gold. When the

prices of gold in the spot market goes up, the futures price too moves up and the long futures

position start making profits. Similarly when the prices of gold in the spot market goes down,

the futures prices too move down and the long futures position starts making losses.

Profit

6000

Gold future price.

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Loss

Payoff for seller of futures: Short futures

The payoff for a person who sells a futures contract is similar to the payoff for a person who

shorts an asset. He has a potentially unlimited upside as well as a potentially unlimited

downside. Take the case of a speculator who sells a two-month cotton futures contract when

the contract sells Rs.6500 per Quintal. The underlying asset in this case is long staple cotton.

When the prices of long staple cotton move down, the cotton futures prices also move down

and the short futures position starts making profits. When the prices of long staple cottonmove up, the cotton futures price also moves up and the short futures position starts making

losses.

Figure 4 payoff for a seller of cotton futures

The figure shows the profits/ losses for a short futures position. The investor sold cotton

futures at Rs.6500 per Quintal. If the price of the underlying long staple cotton goes down,

the futures price also falls, and the short futures position starts making profit. If the price of

the underlying long staple cotton rises, the futures too rise, and the short futures position

starts showing losses.

Profit

6500

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Loss

How to use the trading tools:

The technique of HEDGING:

Many participants in the commodity futures market are hedgers. They use the futures market

to reduce a particular risk that they face. This risk might relate to the price of wheat or oil or

any other commodity that the person deals in. The classic hedging example is that of wheat

farmer who wants to hedge the risk of fluctuations in the price of wheat around the time that

his crop is ready for harvesting. By selling his crop forward, he obtains a hedge by locking in

to a predetermined price.

What hedging does however is, that it makes the outcome more certain. Hedgers could be

government institutions, private corporations like financial institutions, trading companies

and even other participants in the value chain, for instance farmers, extractors, ginners,

processors etc., who are influenced by the commodity prices.

Basic principles of hedging: When an individual or a company decides to use the futures

markets to hedge a risk, the objective is to take a position that neutralizes the risk as much as

possible. Take the case of a company that knows that it will gain Rs.1, 00,000 for each 1

rupee increase in the price of a commodity over the next three months and will lose Rs.1,

00,000 for each 1 rupee decrease in the price of a commodity over the same period. To

hedge, the company should take a short futures position that is designed to offset this risk.The futures position should lead to a loss of Rs.1, 00,000 for each 1-rupee increase in the

price of the commodity over the next three months and a gain of Rs.1, 00,000 for each 1-

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rupee decrease in the price during this period. If the price of the commodity goes down, the

gain on the futures position offsets the loss on the commodity.

Figure .1 Payoffs for buyer of a short hedge

The figure shows the payoff for a soy oil producer who takes a short hedge. Irrespective of

what the spot price of soy oil is three months later, by going in for a short hedge he locks on

to a price of Rs.450 per MT.

Price of Soya oil

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The price of the commodity goes up, the loss on the futures position is offset by the gain on

the commodity.

There are basically two kinds of hedges that can be taken. A company that wants to sell an

asset at a particular time in the future can hedge by taking short futures position. This is

called a short hedge . Similarly, a company that knows that it is due to buy an asset in the

future can hedge by taking long futures position. This is known as long hedge .

Short hedge

A short hedge is appropriate when the hedger already owns the asset, or is likely to own the

asset and expects to sell it at some time in the future. For example, a cotton farmer whoexpects the cotton crop to be ready for sale in the next two months could use a short hedge.

Example:

15th of January and that a refined soy oil producer has just negotiated a contract to sell

10,000 Kgs of soy oil. It has been agreed that the price that will apply in the contract is the

market price on the 15th April. The oil producer is therefore in a position where he will gain

Rs.10000 each 1 rupee increase in the price of oil over the next three months and lose

Rs.10000 for each one rupee decrease in the price of oil during this period. Suppose the spot

price for soy oil on January 15 is Rs.450 per 10 Kgs and the April soy oil futures price on the

NCDEX is Rs.465 per 10 Kgs. The producer can hedge his exposure by selling 10,000 Kgs

worth of April futures contracts (10 units). If the oil producers closes his position on April

15, the effect of the strategy would be to lock in a price close to Rs.465 per 10 Kgs. On April

15, the spot price can either be above Rs.465 or below Rs.465.

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Case 1 : The spot price is Rs.455 per 10 Kgs. The company realizes Rs.4, 55,000 under its

sales contract. Because April is the delivery month for the futures contract, the futures price

on April 15 should be very close to the spot price of Rs.455 on that date. The company closes

its short futures position at Rs.455, making a gain of Rs.465 - Rs.455 = Rs.10 per 10 Kgs, or

Rs.10, 000 on its short futures position. The total amount realized from both the futures

position and the sales contract is therefore about Rs.465 per 10 Kgs, Rs.4, 65,000 in total.

Case 2 : The spot price is Rs.475 per 10 Kgs. The company realizes Rs.4, 75,000 under its

sales contract. Because April is the delivery month for the futures contract, the futures price

on April 15 should be very close to the spot price of Rs.475 on that date. The company closesits short futures position at Rs.475, making a loss of Rs.475 - Rs.465 = Rs.10 per 10 Kgs, or

Rs.10, 000 on its short futures position. The total amount realized from both the futures

position and the sales contract is therefore about Rs.465 per 10 Kgs, Rs.4, 65,000 in total.

Long hedge:

A long hedge is appropriate when a company knows it will have to purchase a certain asset in

the future and wants to lock in a price now. Suppose that it is now January 15. A firm

involved in industrial fabrication knows that it will require 300 Kgs of silver on April 15 to

meet a certain contract. The spot price of silver is Rs.1680

The payoff for an industrial fabricator who takes a long hedge. Irrespective of what the spot

price of silver is three months later, by going in for a long hedge he locks on to a price of

Rs.1730 per kg.

The payoff for the buyer of a long hedge. Let us look at how this works. On April 15, the

spot price can either be above Rs.1730 or below Rs.1730.

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Case 1 : The spot price is Rs.1780 per kg. The fabricator pays rs.5, 34,000 to buy the silver

from the spot market. Because April is the delivery month for the futures contract, the futures

price on April 15 should be very close to the spot price of Rs.1780 on that date. The company

closes its long futures position at Rs.1780, making a gain of Rs.1780 - Rs.1730 = Rs.50 per

kg, or Rs.15, 000 on its long futures position. The effective cost of silver purchased works

out to be about Rs.1730 per MT, or Rs.5, 19,000 in total.

Case 2 : The spot price is Rs.1690 per MT. The fabricator pays Rs.5, 07,000 to buy the silver

from the spot market. Because April is the delivery month for the futures contract, the futures

price on April 15 should be very close to the spot price of Rs.1690 on that date. The companycloses its long futures position at Rs.1690, making a loss of Rs.1730 - Rs.1690 = Rs.40 per

kg, or Rs.12, 000 on its long futures position. The effective cost of silver purchased works

out to be about Rs.1730 per MT, or Rs.5, 19,000 in total. Note that the purpose of hedging is

not to make profits, but to lock on to a price to be paid in the future upfront. In the industrial

fabricator example, since prices of silver rose in three months, on hind sight it would seem

that the company would have been better off buying the silver in January and holding it. But

this would involve incurring interest cost and warehousing costs. Besides, if the prices of

silver fell in April, the company would have not only incurred interest and storage costs, but

would also have ended up buying silver at a much higher price. In the examples above we

assume that the futures position is closed out in the delivery month. The hedge has the same

basic effect if delivery is allowed to happen. However, making or taking delivery can be a

costly process. In most cases, delivery is not made even when the hedger keeps the futures

contract until the delivery month. Hedgers with long positions usually avoid any possibility

of having to take delivery by closing out their positions before the delivery period.

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Advantages of hedging:

Besides the basic advantage of risk management, hedging also has other advantages:

1. Hedging stretches the marketing period. For example, a livestock feeder does not have to

wait until his cattle are ready to market before he can sell them. The futures market permits

him to sell futures contracts to establish the approximate sale price at any time between the

time he buys his calves for feeding and the time the fed cattle are ready to market, some four

to six months later. He can take advantage of good prices even though the cattle are not ready

for market.2. Hedging protects inventory values. For example, a merchandiser with a large, unsold

inventory can sell futures contracts that will protect the value of the inventory, even if the

price of the commodity drops.

3. Hedging permits forward pricing of products. For example, a jewelry manufacturer can

determine the cost for gold, silver or platinum by buying a futures contract, translate that to a

price for the finished products, and make forward sales to stores at firm prices. Having made

the forward sales, the manufacturer can use his capital to acquire only as much gold, silver,

or platinum as may be needed to make the products that will fill its orders.

Limitation of hedging: basis Risk

Hedging can only minimize the risk but cannot fully eliminate it. The loss made during

selling of an asset may not always be equal to the profits made by taking a short futures

position. This is because the value of the asset sold in the spot market and the value of the

asset underlying the future contract may not be the same. This is called the basis risk. In our

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examples, the hedger was able to identify the precise date in the future when an asset would

be bought or sold. The hedger was then able to use the perfect futures contract to remove

almost all the risk arising out of price of the asset on that date. In reality, this may not always

be possible for a various reasons.

The asset whose price is to be hedged may not be exactly the same as the asset

underlying the futures contract. For example, in India we have a large number of varieties

of cotton being cultivated. It is impractical for an exchange to have futures contracts with

all these varieties of cotton as an underlying.

The hedger may be uncertain as to the exact date when the asset will be bought or sold. Often the hedge may require the futures contract to be closed out well before its

expiration date. This could result in an imperfect hedge.

The expiration date of the hedge may be later than the delivery date of the futures

contract. When this happens, the hedger would be required to close out the futures

contracts entered into and take the same position in futures contracts with a later delivery

date.

The technique of SPECULATION:

An entity having an opinion on the price movements of a given commodity can speculate

using the commodity market. Commodities are bulky products and come with all the costs

and procedures of handling these products. The commodities futures markets provide

speculators with an easy mechanism to speculate on the price of underlying commodities.

To trade commodity futures on the mcx, a customer must open a futures trading account with

a commodity derivatives broker. Buying futures simply involves putting in the margin

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money. This enables futures traders to take a position in the underlying commodity without

having to actually hold that commodity. With the purchase of futures contract on a

commodity, the holder essentially makes a legally binding promise or obligation to buy the

underlying security at some point in the future (the expiration date of the contract)

Speculation: Bullish commodity, buy futures

Take the case of a speculator who has a view on the direction of the price movements of

gold. Perhaps he knows that towards the end of the year due to festivals and the upcoming

wedding season, the prices of gold are likely to rise. He would like to trade based on this

view. Gold trades for Rs.6000 per 10 Gms in the spot market and he expects its price to go

up in the next two three months. How can he trade based on this belief? In the absence of a

deferral product, he would have to buy gold and hold on to it. Suppose he buys a 1 kg of

gold, which costs him Rs.6, 00,000. Suppose further that his hunch proves correct and three

months later gold trades at Rs.6400 per 10 Gms. He makes a profit of Rs.40, 000 on an

investment of Rs.6, 00,000 for a period of three months. This works out to an annual return

of about 26 percent. Today a speculator can take exactly the same position on gold by using

gold futures contracts. Let us see how this works. Gold trades at Rs.6000 per 10 Gms and

three-month gold futures trades at Rs.6150. The unit of trading is 100 Gms and the delivery

unit for the gold futures contract on the NCDEX is 1 kg. He buys One kg of gold futures,

which have a value of Rs.6, 15,000. Buying an asset in the futures market only requiresmaking margin payments. To take this position, he pays a margin of Rs.1, 20,000. Three

months later gold trades at Rs.6400 per 10 Gms. As we know, on the day of expiration, the

futures price converges to the spot price (else there would be a risk free arbitrage

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opportunity). He closes his long futures position at Rs.6400 in the process making a profit of

Rs.25, 000 on an initial margin investment of Rs.1, 20,000. This works out to an annual

return of 83 percent. Because of the leverage they provide, commodity futures form an

attractive tool for speculators.

Bearish commodity, sell futures

A speculator who believes that there is likely to be excess supply of a particular commodity

in the near future and hence the prices are likely to see a fall can also use commodity futures.

How can he trade based on this opinion? In the absence of a deferral product, there wasn'tmuch he could do to profit from his opinion. Today all he needs to do is sell commodity

futures. Let us understand how this works. Simple arbitrage ensures that the price of a futures

contract on a commodity moves correspondingly with the price of the underlying

commodity. If the commodity price rises, so will the futures price. If the commodity price

falls, so will the futures price. Now take the case of the trader who expects to see a fall in the

price of cotton. He sells ten two month cotton futures contract, which is for delivery of 550

bales of cotton. The value of the contract is Rs.4, 00,000. He pays a small margin on the

same. Three months later, if his hunch were correct the price of cotton falls. So does the price

of cotton futures. He close out his short futures position at Rs.3, 50,000, making a profit of

Rs.50, 000.

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The technique of ARBITRAGE:

A central idea in modern economics is the law of one price . This states that in a competitive

market, if two assets are equivalent from the point of view of risk and return, they should sell

at the same price. If the price of the same asset is different in two markets, there will be

operators who will buy in the market where the asset sells cheap and sell in the market where

it is costly. This activity termed as arbitrage , involves the simultaneous purchase and sale of

the same or essentially similar security in two different markets for advantageously different

prices. The buying cheap and selling expensive continues till prices in the two markets reach

equilibrium. Hence, arbitrage helps to equalize prices and restore market efficiency.

Whenever the futures price deviates substantially from its fair value, arbitrage opportunities

arise. To capture mispricing that result in overpriced futures, the arbitrager must sell futures

and buy spot, whereas to capture mispricing that result in under priced futures, the arbitrager

must sell spot and buy futures. In the case of investment commodities, mispricing wouldresult in both, buying the spot and holding it or selling the spot and investing the proceeds.

However, in the case of consumption assets, which are held primarily for reasons of usage,

even if there exists a mispricing, a person who holds the underlying may

not want to sell it to profit from the arbitrage.

Overpriced commodity futures: buy spot, sell futures

An arbitrager notices that gold futures seem overpriced. How can he cash in on this

opportunity to earn risk less profits? Say for instance, gold trades for Rs.600 per gram in the

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spot market. Three month gold futures on the NCDEX trade at Rs.625 and seem overpriced.

He could make risk less profit by entering into the following set of transactions.

1. On day one, borrow Rs.60, 07,460 at 6% per annum to cover the cost of buying and

holding gold.

Buy 10 Kgs of gold on the cash/ spot market at Rs.60, 00,000. Pay (310 + 7150) as

warehouse costs.

(We assume that fixed charge is Rs.310 per deposit up to 500 Kgs. and the variable storage

costs are Rs.55 per kg per week for 13 weeks).

2. Simultaneously, sell 10 gold futures contract at Rs.62, 50,000.3. Take delivery of the gold purchased and hold it for three months.

4. On the futures expiration date, the spot and the futures price converge. Now unwind the

position.

5. Say gold closes at Rs.615 in the spot market. Sell the gold for Rs.61, 50,000.

6. Futures position expires with profit of Rs.1, 00,000.

7. From the Rs.62, 50,000 held in hand, return the borrowed amount plus interest of

Rs.60, 98,251.

8. The result is a risk less profit of Rs.1, 51,749.

When does it make sense to enter into this arbitrage? If the cost of borrowing funds to buy

the commodity is less than the arbitrage profit possible, it makes sense to arbitrage. This is

termed as cash and carry arbitrage. Remember however, that exploiting an arbitrage

opportunity involves trading on the spot and futures market. In the real world, one has to

build in the transactions costs into the arbitrage strategy.

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Under priced commodity futures: buy futures, sell spot

An arbitrager notices that gold futures seem under priced. How can he cash in on this

opportunity to earn risk less profits say for instance, gold trades for Rs.600 per gram in the

spot market Three month gold futures on the NCDEX trade at Rs.605 and seem under priced.

If he happens to hold gold, he could make risk less profit by entering into the following set of

transactions.

1. On day one, sell 10 Kgs of gold in the spot market at Rs.60, 00,000.

2. Invest the Rs.60, 00,000 plus the Rs.7150 saved by way of warehouse costs for three

months 6%.

3. Simultaneously, buy three-month gold futures on NCDEX at Rs.60, 50,000.

4. Suppose the price of gold is Rs.615 per gram. On the futures expiration date, the spot and

the futures price of gold converge. Now unwind the position.

5. The gold sales proceeds grow to Rs.60, 97,936.

6. The futures position expires with a profit of Rs.1, 00,000.

7. Buy back gold at Rs.61, 50,000 on the spot market.

8. The result is a risk less profit of Rs.47, 936.

If the returns you get by investing in risk less instruments is more than the return from the

Arbitrage trades; it makes sense for you to arbitrage. This is termed as reverse cash and carry

arbitrage. It is this arbitrage activity that ensures that the spot and futures prices stay in linewith the cost carry. As we can see, exploiting arbitrage involves trading on the spot market.

As more and more players in the market develop the knowledge and skills to do cash-and-

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carry and reverse cash-and-carry, we will see increased volumes and lower spreads in both

the cash as well as the derivatives market.

Operational mechanism with respect to the trading of commodities at MCX:

MCX is designed in a manner to ensure that it broad bases the market participation by

making its operations inclusive and expansive, but at the same time building in sufficient

measures that would ensure the safety and integrity of the market is maintained at all times.

Moreover, in order to provide a strong correlation between the Physicals and Futures

markets, and based on Indias long history of trade practice continuing since over 100 years,MCX provides for settlement of all open positions at the end of the contract through delivery.

The salient features of the MCX market framework include the following:

Matching System - Order Driven system of matching based on the logic of price-time priority

Margins Initial margins are computed and adjusted online whereas the Mark to Market

margins are collected by the next day. The business is based on the deposit contribution

made by the Members to MCX that is earmarked online with every trade. Thus, Members

are able to take only such positions as their deposit entitles them, based on the commodity

specific margin utilization.

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Guarantee MCX, through its Settlement Guarantee Fund, guarantees the net settlement

liability of futures contract executed in the Exchange as per its Rules, Byelaws, Business

Rules and Regulations.

Settlement - All net outstanding futures contracts during the delivery period may be settled

by delivery of the underlying commodity. The objective is to ensure that MCX is able to

maintain close association between the Futures Market and the Physical Market.

Delivery - To start with the trade practice, which has been in existence in the country for

over 100 years that delivery will be sellers option and the Buyers obligation, has beenadopted. However, going forward, should the market desire so, suitable amendments can be

done to make the delivery rules, inclined to the market requirements.

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PART-III

COMMODITY PROFILE

SILVER:

Silvers unique properties make its a very useful Industrial Commodity, despite it being

classed as a precious metal.

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

1. In terms of fabrication demand, silver possesses many physical characteristics, which

make it a key component in numerous products used on a daily basis. The main uses for

silver are in:

2. Jewelry and silverware,3. Photographic films and papers, and

4. Electrical contacts and connectors.

5. Mirror, medical instruments, dental alloys, brazing alloys, silver-bearing batteries,

and bearings.

Briefing of demand:

Together, industrial and decorative uses, photography and jewelry and silverware

represent more than 95% of annual silver consumption.

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Industrial use of silver is the largest component of silver fabrication demand, with

silver being used in a wide range of products. Electrical and electronics applications

account for the largest area of industrial silver off take, (roughly 85% of the silver

demand)

Jewelry and silverware fabrication demand represents second largest component of

the silver demand.

World demand of silver:

Demand Drivers 2002 (in tons) 2003 (in tons)Fabrication- Industrial Application 341.4 351.2- Photography 205.7 196.1- Jewelry & Silverware 265.9 276.7- Coins & Medals 32.8 35.3Total Fabrication 845.8 859.2

Net Government Purchases - -Producer De- hedging 24.8 21.0

Implied Net Investment - -

Total Demand 870.7 880.2.

Supply:

The supply of silver is based on two facts: mine production and recycled silver scraps. Mine

production is surprisingly the largest components of silver supply. It normally accounts for a

little less than two third of the total

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Silver is often mined as by product of other base metal production, which accounts

for r-fifth of the total supply.

Other sources of supply are scrap: it is the silver that returns to the market when

recovered from the existing manufactured goods and wastes. it makes fifth of the supply.

Disinvestments

Government sales.

Producers hedging

Recycling

PRODUCTION:

In many instances, silver occurs in ores along with gold, copper, lead, zinc and other metals.

In many mines, the primary product is one of these metals, with silver being a by-product. At

some mines, silver is the sole product or main co-product.

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.

Silver occurs in the metallic state, commonly associated with gold, copper, lead, and

zinc. It is also found in some 60 minerals including: argentite (a sulfide), cerargyrite (a

chloride), many other sulfides and telluride.

Relative abundance in solar system: -0.313 log

Abundance earth's crust: -1.2 log

The amount of silver extracted from primary silver mines fell, while silver mined as a

co-product of copper, lead, zinc, gold, or poly-metallic deposits rose.

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Growth in silver bearing products worldwide has also led to increases in the amount

of silver recovered from scrap recycling. Most scrap comes from photographic materials,

jewelry, and silverware.

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2002 World Mine Production of Silver by Source

World Silver Supply from Aboveground Stocks

World Silver Supply and Demand (million ounces)

(Totals may not add due to rounding)

Supply 2002 2003

Mine Production 596.4 595.6 Net government Sales 61.2 82.6Oil Silver Scrap 186.8 199.6Producer hedging - -Implied net disinvestments 26.2 10.4Total Supply 870.7 880.2

Indian Scenario

Silver imports into India for domestic consumption in 2002 was 3,400 tons down 25 % from

record 4,540 tons in 2001.

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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-

on-year to 150 tons.

Around 50% of Indias 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 those Industrial giants, Japan and the United States.

By contrast with United States and Japan, Indian industrial off take 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 jewelry and

silverware and jari.

In India silver price volatility is also an important determinant of silver demand as it is for

gold.

India Industrial Fabrication, 2002:

PercentagePharmacy & Chemicals 22.4Foil 9.0Plating 13.7

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Solders & Brazing 5.4Electrical 13.5Photography 0.85Jari 17.1

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.

Frequency Distribution of Silver London Fixing Volatility from 1995 till date

Percentage Change

>7 % 5-7% 3-5%


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Less than one third of golds total accumulated holdings are 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.

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.

Demand:

Industrial uses:

Gold possesses a unique combination of properties that have resulted in its use in a wide

range of industrial applications. These applications in total account for a current

consumption of approximately 450 tonnes of gold per annum..

Gold and its alloys have been used for decorative purposes .

The most significant uses of gold in electronics

A number of gold products are used in dentistry.

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Gold is not a liability of any government or corporation it does not, unlike currencies, bonds

and equities, run any risk of becoming worthless through the default of the issuer. In more

recent times its role as an excellent portfolio diversifier. Since, unlike jeweler and industrial

demand, investment is measured on a net basis this makes it appear more volatile. However

interest in gold also rises and falls as a result of the political and economic situation; its role

as a safe haven often prompts buying during time of worry or uncertainty.

Investment holdings (institutional and retail) account for 16% of the total stocks of gold .

Over the last five years net retail investment has accounted for 13% of total demand. Its

share of gold stocks is greater than its share of demand, due to the greater importanceinvestment had as a share of demand in earlier years.

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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 that the flow equilibrium

SUPPLY:

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The main suppliers of gold are Grasberg, Australia, Russia, Switzerland, Netherlands,

Germany and Greece. Gold is produced in every continent except for Antarctica.

The main sources of supply are:

1. Mining

2. Scrap

3. Hedging activity

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Mine Production by major region, 2003(total, 2,593 tonnes)

PRODUCTION: The grade of ore refers to the proportion of gold contained in the ore of a

particular mine and is quoted in grams per tonnes (g/t). The type of mine depends on the

depth and grade of the ore. At a rough estimate, the larger, better quality South African

South Africa 14% 376 tonnes

USA 11% 285 tonnes

Australia 11% 284 tonnes

China 8%

Russia 7%

Peru 7% 172 tonnes

Indonesia 6% 163 tonnes

Canada 5%

Other Latin America 9%

Other Asia 6%

Other Africa 9%

Other CIS 5%

Rest of World 1%

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underground operations are around 8-10g/t (Anglogold), while the marginal South African

underground mines run at around 4-6g/t. Many of the operations elsewhere in the world are

open pit mines, which run at lower grades, from as little as 1g/t up to around 3-4g/t. A more

significant piece of information than average gold mining grade is cost per ounce, which is a

combination of grade (grams/tonnes) and operating costs (USD/tonnes).

COST OF PRODUCTION:

Production costs vary widely, according to the nature of the mine, be it open pit or

underground and at what depth, the nature and distribution of the ore-body (and byimplication the metallurgy which affects processing techniques) and the grade. Average

quoted cash costs for 2003 were estimated by GFMS at US$222/ounce with total cash costs

(including depreciation, amortization, reclamation and mine closure costs) at US$278/ounce.

ABOVE THE GROUND GOLD:

RECYCLED GOLD:

In the statistics, scrap is defined as being gold that has been sourced from old fabricated

products that have been recovered and refined back into bars. It does not include jewellery

that has simply been traded in and resold without being re-refined, or resold investment bars

and coins.

Most recycled gold generated originates from jewellery. Smaller amounts come from

recuperated electronics components and, at times, from investment bars and coins.

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The supply of scrap depends largely on economic circumstances and on the behavior sof the

gold price. It is common practice in the Middle East and Asia for customers to trade in one

piece of jewellery in exchange for another, and the piece traded in may be melted down

rather than simply being resold. But gold can also be sold for cash either if the owner has

need of money or if the owner wants to cash in a profit following a rise in the gold price. It

follows that scrap supply typically rises in times of economic distress or following a price

rise.

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JEWELLERY:

JEWELLERY is not a homogenous market globally. Its use, the type of jewellery acquired

and the conditions under which it is bought and sold are determined by custom and usage

which vary both from country to country and also within countries according to social

factors. A broad - although somewhat oversimplified - distinction can be made between two

types of jewellery: that which is primarily for adornment; and that which is also bought as a

means of saving.

World scenario:

In recent years retail investment in gold has been largely concentrated in a few countries.

These are

The USA, Turkey where the official gold coin is widely used for savings and is also

used as currency

Vietnam due to the use of gold for the purchase of property

India due to the high propensity to use gold for savings

Japan where saving plans encourage regular purchases and where banking crises and

other economic fears often encourage surges in buying.

Indonesia, Thailand, South Korea, Saudi Arabia and the Gulf States are also

normally net investors although at a lower rate.

In China latent demand has been heavily restrained due to regulations largely

prohibiting investment.

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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

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India in world gold industry

(Rounded Figures)

India

(In Tons)

World

(In Tons)% Share

Total Stocks 13000 145000 9Central Bank holding 400 28000 1.4Annual Production 2 2600 0.08Annual Recycling 100-300 1100-1200 13Annual Demand 800 3700 22Annual 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.

India is the worlds 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 jewelers 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 off take 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.

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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.

Frequency Dist. of Gold London Fixing Volatility from 1995 till date

Percentage

Change

> 5% 2 - 5 % < 2%

Daily Number of times 4 54 2147Percentage times 0.2 2.4 97.4Weekly

Number of times 3 62 376Percentage times 0.7 14.1 85.3

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.

GOLD SCENARIO IN OTHER MKTS:

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In the Middle and Far East , where financial and banking are not fully developed or

available, universally takes the form of high carat, heavy jewelry. Sold at a low markup it

can easily be turned into bullion.

In the more affluent Western countries , it is more often-low carat, high design and

high margin fashion jewelry. For this type of jewelry the demand is more income related

than it is price sensitive

Most of the increase in for gold comes from extremely price sensitive markets, such

as the Middle East and the Indian Sub Continent. The typical investor there, unlike his

counterpart in the West, is far more rational and invests for the long haul. They tend to

buy when prices are low and sell when prices are high, which is the reverse of many

Western short-term momentum traders.

As developing countries prosper and urbanize, they tend to switch towards Western

style fashion jewelry. In rural India, it is regarded as the property of women; a haven

against divorce or widowhood. Two-thirds of Indian gold is held in rural India.

Eleven years ago, when India deregulated the gold trade, consumption began to climb

from 200 tons per annum to 900 tons in 2003. Today, China consumes an average 0.02

grams per capita, the same as India before gold was deregulated. Over 90% of Chinese

gold purchases go towards jewelry, for which is growing at over 15% per annum.

Goldfields Minerals Services estimates that private investors own 15% of the above-

ground stock of gold (exclusive of jewelry), with the fastest growth occurring in the

Eastern Asian developing countries. GMS also estimates that from 1993 to 2000 retail

investment accounted for a mere 7% of total

OTHER FACTS:

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1. The gold price is usually quoted in US dollars per troy ounce. To calculate the cost of

one gram of gold, divide the US dollar price for one troy ounce by 31.1035 (one fine troy

ounce is equal to 31.1035 grams).

2. The price movements of the gold and of sensex has been in opposite or near opposite

direction.

3. Price movement of gold in relation with the dollar is also negatively related.

4. While it is true that bullion responds to adversity in the short run, its trend in the long

run is a function of widened world prosperity, which in turn leads to an enlarged market

for jewery.over half of the ever mined currently resides in the form of jewelry. As eachyear passes, this percentage increases.

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FACTORS AFFECTING GOLD PRICES:

1. Dollars

2. Interest rates

3. Political situation

4. Comparative returns on stock markets

5. Prices in the other market

6. Income of the people.

7. Business economic cycle.

8. Above ground supply from sales by central banks, reclaimed scrap and official gold

loans

9. Producer / miner hedging interest

9. Domestic demand based on monsoon and agricultural output

The peak year for scrap sales occurred during the 1997 / 1998 Asian financial crisis, whereas

the 2001 / 2002 increase was mostly due to profit taking as the price increased.

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PART-IV

FUNDAMANTAL AND TECHNICAL ANALYSIS:

FUNDAMANTAL ANALYSIS:

FUNDAMENTAL ANALYSIS is based on the study of factors external to the trading

markets, which affect the supply and demand of a particular market. It is in stark contrast to

technical ANALYSIS since it focuses, not on price but on factors like weather, government

policies, domestic and foreign political and economic events and changing trade prospects

fundamental analysis theorizes that by monitoring relevant supply and demand factors for a

particular market, a state of current or potential disequilibria of market conditions may be

identified before the state has been reflected in the price level of that market. Fundamental

analysis assumes that markets are imperfect that information is not instantaneouslyassimilated or disseminated and that econometric models can be constructed to generate

equilibrium prices, which may indicate that current prices are inconsistent with underlying

economic conditions, and will, accordingly, change in the future.

Another definition:

It is an approach to analyzing market behavior that stresses the study of underlying factors of

supply and demand. It is done in the belief that such analysis will enable one to profit by

being able to anticipate price trends. A Fundamentalist is a market observer-and/or

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participant who relies principally on Supply/demand considerations in price forecasting.

Components of fundamental analysis

Supply:

Weather

Acres planted to a crop

Government Programs

USDA Reports

Demand:

USDA Reports

Domestic usage - Feed & processing

Value of the Dollar

Actions of Other Countries

Exports

Transportation

TECHNICAL ANALAYSIS:

Technical analysis operates on the theory that market prices at any given point in time reflect

all known factors affecting supply and demand for a particular market. Consequently,

technical analysis focuses, not on evaluating those factors directly, but on an analysis of

market prices themselves. This approach theorize that a detailed analysis of, among other

things, actual daily, weekly and monthly price fluctuations is the most effective means of

attempting to capitalize on the future course of price movements. Technical strategies

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generally utilize a series of mathematical measurements and calculations designed to monitor

market activity. Trading decisions are based on signals generated by charts, manual

calculations, computers or their combinations.

ANALYSIS OF COMMODITY WHEAT:

BRIEF HISTORY OF FUTURES IN WHEAT IN INDIA:

India has a very long tradition of commodity futures. It was having sporadic of futures

markets almost all over the country in not only such diverse cash crops as Cotton, Oilseeds,

and Raw jute and their products but also food grains. Futures trading started with the setting

up of Bombay Cotton Trade Association in 1875. The organized futures trading started in

1922 by the East India Cotton Organization. More and more commodities were added

between 20s and 40s, for futures trading like Groundnut, Groundnut oil, Raw jute, Jute

goods, Castor seed, Wheat, Rice, Sugar, Gold and Silver. This was indicative of a very long

tradition of commodity futures in our country. This is on the basis of recorded regulation in

various provinces in pre-independence time. But sporadic futures trading are heard even prior

to that. Teji, mandi, gali, phataks are the derivatives of futures heard happening centuries

ago.

Wheat markets were in existence in several centers of Punjab and UP. The prominent and

active was the Chamber Of Commerce of Hapur, which was established in 1913. Other

markets were located at Amritsar, Moga, Ludhiana, Jalandhar, Bhatinda, in Punjab and at

Meerut, Hathras, Saharan and Barreily in UP.

Futures trading in wheat have been taking place since long back at various renowned

commodity exchanges of world like Chicago Board of Trade (CBOT) in Chicago; USA,

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Winnipeg Commodity Exchange in Canada, Kansas City Board of Trade in Kansas, USA,

Minneapolis Grains in Missouri, USA and many other exchanges located in Japan, Australia,

and East European countries.

This bears testimony to the fact that the food grains are suitable for futures trading. With

evolution of scientific grades and standards, scientific warehousing systems and practices,

advances in transportation and communication, trading, clearing and settlement systems

provides the necessary environment of competitive futures market.

WHEAT SCENARIO IN INDIA:

Wheat is one of the most important staple food grains of human race. India produces about

70 million tones of wheat per year or about 12 per cent of world production. It is now the

second largest producer of wheat in the world. Being the second largest in population, it is

also the second largest in wheat consumption after China, with a huge and growing wheat

demand.

GEOGRAPHICAL AREA UNDER WHEAT CULTIVATION:

It is cultivated from a sea level up to even 10,000 feet. More than 95 percent of the wheat

area in India is situated north of a line drawn from Bombay to Calcutta and also in Mysore

and Madras in small amounts.

The Major Wheat producing states in India is placed in the Northern hemisphere of the

country with UP, Punjab and Haryana contributing to nearly 80% of the total wheat

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production (Chart

Sh are of Major Wh eat Produ cing States in Ind iaaverage-in % )

Uttar Prad es41 %

Punjab24 %

Haryan13 %

Madhya Prades12 %

Rajastha10 %

TYPES OF WHEAT SIMILARITY BETWEEN INDIA & INTERNATIONAL:

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Types

Regions

Uses

Seasons

Indian varieties*

Soft Red Winter Wheat

Eastern US

(Great Lakes

Area)

Cakes, Cookies,

Snacks

Winter

Dara, Kalyan,

Mexican, Sharbati,

147-Avg. Lok-1

Hard Red Winter

Wheat(predominant)

Southern &

Central Plains

of US

Bread

Winter

Dara, Kalyan,

Mexican, Sharbati,

147-Avg. Lok-1Hard Red Spring Wheat Northern Plains Bread

Spring

None

Durum Wheat Northern Plains Spaghetti,

macaroni, pasta

Spring

Desi (Durum)

White Wheat Pacific and

Northwest

Cakes, Cookies,

snacks

Spring

&Winter

Dara, Kalyan,

Mexican, Sharbati,

147-Avg, Lok-1

NOTE: Dara variety produced all over in India (Maximum production), Desi (Durum)

produced all over in India, Lok-1 in Gujarat and part of MP& Rajsthan,

Kalyan in U.P., 147 Average produced in Sahajanpur (U.P.), Sharbati in

M.P., Mexican produced in Kota (Rajasthan)

TRENDS IN AREA, PRODUCTION AND PRODUCTIVITY OF WHEAT IN INDIA :

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Production of Wheat in India as can be seen from Chart 2 has shown a rising trend in the past

5 decades. However, there was a steep jump in production of wheat during 1960-70 to 1970-

1980 by nearly 109%. The Green Revolution in the 1960s contributed to this phenomenal

rise in wheat production in the country over the decade. However, following 1980s, there

has been a consistent declining trend in production of Wheat in India. For instance, the

production of Wheat rose by just 61% from 1970-1980 to 1980-1990. In recent years, there

has been a worsening trend with wheat production actually growing by just 7% from 2000-01

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to 2001-02. (Please refer to Table 1)

Production of Wheat (MMT) over the past 5 decades

8.36

13.3

27.78

44.76

63.91

0

10

20

30

40

50

60

70

1950-51 to 1960 1960-61 to 1970 1970-71 to 1980 1980-81 to 1990 1990-99 to 2000

Years

P r o d u c

t i o n o f

W h e a

t ( i n M M T )

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Production of Wheat (MMT) over the past 5 decades

8.36

13.3

27.78

44.76

63.91

0

10

20

30

40

50

60

70

1950-51 to 1960 1960-61 to 1970 1970-71 to 1980 1980-81 to 1990 1990-99 to 2000

Years

P r o

d u c

t i o n o f

W h e a

t ( i n M M T )

For nearly a decade, i.e. upto mid 70s agricultural production had stagnated. The spectacular yield growth recorded in the post-Green Revolution years in Punjab and Haryana has receded

into history. Food grain production in the frontline agricultural states of Punjab, Haryana and

western Uttar Pradesh, comprising the country's food bowl, has decelerated. The miracle that

began with wheat was replicated in rice.The area under production of Wheat has increased

from a mere 12.93 million hectares in 1960-61 to 27.49 million hectares in 1999-2000, an

increase of more than 100% over the past 5 decades. The production of Wheat at the same

time, increased from 11 million tones in 1960-61 to 76.37 million tones in 1999-2000. The

yield (kg/hectare) on the other hand, increased from 851 in 1960-61 to 2778 in 1999-2000, an

increase of around 3.56 times. This indicates that although wheat production over the past 5

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decades increased by 6.87 times but the yield of wheat has actually increased by only half of

this figure.

SUPPLY-DEMAND BALANCE OF WHEAT IN INDIA:

As can be seen from Chart 3, the demand of wheat has increased by 2% (approximately) over

the past 7 years while the supply of wheat has increased by 3% over the same time period.

This indicates that the supply of wheat is more than needed for domestic use leading to stock

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surpluses.

Deman d & Sup ply of Wheat ( in

626466

68707274767880

94/95 95/96 96/97 97/98 98/99 99/00 00/01

Year

S u p p

l y

54

56

58

60

62

64

66

D e m a n

d

Total Suppl

Demand

Since 1998 Indias share in world wheat production is around 12% to 13%, at the same time.

Indias share in world wheat consumption is around 10% to 11%. It proves that some sort of

extra stock (around 1% to 2%) arises every year. The demand-supply gap which is open at a

rate of about 1 to 2 per cent per year is equivalent to 0.7 to 1.4 million tones of wheat,

growing larger over the years. Resultantly the ending stocks of wheat have been increasing

and the same thing can be visualized from the following chart

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Indian Wheat Consumption and Stock variables

ANALYSIS OF PRICE TREND OF WHEAT IN INDIA & DEMAND ELASTICITY

OF WHEAT:

Since the Green Revolution, Indian production of cereals including Wheat has been on the

rise with the production of wheat rising from a mere 8.6 million tones in 1960-61 to 73.53

million tones in 1999-2000 [1]. A study of the supply and demand trends over the past decade

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MSP, PROCUREMENT AND STOCKS WHEAT

Year MSP Rs./quintal WPI all commodities

1993-94 base

What MSP would be if

it had grown at same

rate as WPI1996-97 380 127.2 380.01997-98 475 132.8 396.71998-99 510 140.7 420.31999-00 550 145.3 434.12000-01 580 155.7 465.12001-02 610 161.3 481.9

The distortions in prices are evident from the above table also. If consider Wholesale Price

Index 127.2 as base during 96-97 when MSP was Rs. 380/- per quintal for both wheat and

rice then MSP in 2001 should have been Rs. 481.90 as against Rs.610/- per quintal.

The demand of Wheat in the country is pretty stable over the past few years with the average

demand of Wheat staying at around 63 MMT over the past 4 years. (Please see table 4) On

the other hand, the supply of Wheat has also remained steady at 77 MMT (approximately)

over the same time period. This condition is highly conducive to commencement of futures

trading in wheat with better chances of price discovery. The reason being that stable demand

and supply would help in correct future forecasting and future spot price fixation. This in turn

would lead to convergence between futures price and future spot price and hence correct risk

management mechanism.

Year Total Supply Demand

94/95 68.37 57.6695/96 75.20 61.3296/97 75.61 62.02

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97/98 75.32 61.6998/99 76.29 62.5699/00 77.41 63.5300/01 78.66 64.60

Indian Wheat Whoes ale Prices (Rs/qntl)

0

100

200

300

400

500

600

700

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Months (2002)

P r i c e s

( R s .

/ q n

t l . )

HARVESTING--

SUP P LY of WINTER

WHEAT

SOWING OFWINTER

Wheat

SLACK SEASON--MAY-AUG

MSP Prices (Rs 620/qntl.)

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As can be seen from Chart 4A, the MSP is always higher than the Mandi Prices in

entire year of 2002 indicating that the MSP prices are not reflecting actual demand-

supply of Wheat in country.

INDIAS POSITION IN WORLD WHEAT MARKET

% Share of Country

Italy4%

Turkey4%

Pakistan3%

Canada5%

Australia4%

Russian Federation

6% Romania6% France

7%

USA13%

India13%

China22%

Others13%

Wheat production in India has increased by over ten times in the past five decades

and India has become the second largest wheat producer in the world. Today wheat

plays an increasingly important role in the management of Indias food economy.

Since 1998-99 Indias share in world Wheat production hovers around 11%

to13%.

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INDIAS POSITION IN THE WORLD WHEAT MARKET

India's share in World Wheat Production

Year Production share (%)1998/99 11.251999/00 12.072000-01 13.07001/02(12-June) 11.862002/03(12- June) 12.54

Starting from 1998-99 till date Indias share in world wheat export shows a rising trend. Not

only share, Indias physical export also sharply rising. Indias percentage share in both world

total export during 2001-02-July was 2.79 (i.e. around 3%).

INDIAS WHEAT EXPORT

Year India's Export figure

(In Thousand Metric Tons)1998/99 01999/00 2002000/01 23572001/02(12-June) 30002002/03(11-July) 4000

GOVERNMENT POLICY REGARDING WHEAT:

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Since wheat prices at procurement level and at disposal level are placed under controlled

mechanism with defined objectivity, scope of general price trend analysis also becomes govt.

policies centric. The related price in the open market has got a substantial relationship with

the prices of wheat traded in the open market. Therefore our presentation on this aspect has a

notion that the price elasticity of demand has got direct relationship on prices of wheat of

other varieties (whatsoever be the size of share in total production). However, availability of

targeted variety (Mexican/Dara) wheat shall increase, if Govt. withdraws gradually from

procurement at MSP; in the open market, which shall concede volatility.

PURCHASES:

The policy of Minimum Support Price (MSP) supports economic growth. MSP is a critical

policy component of the Indian Economy. It generates broadly different purchasing power,

health and wealth. Governments works out the MSP giving due consideration to all the

economic factors like cost of input, power, capital; and labor with reasonable going margins.

With the certainty about the support price, farmers expend better effort and resources provide

confidence and motivation to the growers. MSP and commodity options are consistent with

the requirements of the produced economy.

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PROCUREMENT OF WHEAT (CENTRAL POOL ACCOUNT)

(Figs. In Lac Tonnes)

Marketing

Year

1994-

95

1995-

96

1996-

97

1997-

98

1998-

99

1999-

2000

2000-

01

2001-

02

2002-03

Wheat 119 123 82 93 126 141 163 206 #190.2

STATEWISE PROCUREMENT OF WHEAT BY FCI

(In Lac Tons)

State 1999-2000 2000-01 2001-02

Punjab 78.31 94.24 105.60Uttar Pradesh 12.61 15.45 24.46Haryana 48.70 44.98 64.07Rajasthan 6.37 5.39 6.76Other 5.44 3.50 5.41All India 141.43 163.56 206.30

SALES/LIQUIDATION OF INVENTORIES:

The prime objective of MSP of providing assured market to the growers achieved and

production kept on upward swing which culminated into comfort level of food security and

paused much more serious issues. One of them was the slower pace of replenishing the

inventories. Pricing policies of disposal of stocks thrusted at the social commitment of the

Government. Government kept on pumping wheat stocks at the issue price, which need to be

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lower than MSP through States machinery of Public Distribution channels throughout the

country that has helped to sustain the high growth rate and maintain regular, supply of Wheat

and Rice.

Government of India introduced a new scheme called Targeted Public Distribution Scheme

(TPDS) in 1997 where in ultimate consumers were segmented in two categories i.e., Below

Poverty Line and Above Poverty Line as per the recommendation of Planning Commission.

The issue price of Wheat during 2001 and 2002 were as under:-

(Rs./Quintal)

Commodities As on BPL APLWheat 1.04.2002 415 510

12.07.2001 415 610

Besides above stocks were earmarked for various other welfare schemes by the Government

like Jawahar Rojgar Yojona, Mid Day Mill Scheme etc.

OPEN MARKET SALES SCHEME:

When the impact of Government policies on pricing started showing little effect on the wheat

market; it was more or less stabilized, but at the same time off take by states in PDS either

steady or slightly showing downswing, resulting into burgeoning and inventories with the

Govt. agency (FCI). Therefore Govt. for minimizing subsidies decided release first old grain

or below quality grain and then superior quality grain in Open market at the best available

market rate on commercial terms.

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EXPORTS:

When saturation of domestic demand was observed and further compulsion of sustaining the

present market condition, the only avenue of liquidation of inventories was Exports. But

disparity of domestic and international prices were dealt with subsidized issue price which

served prime objective of quick and faster replacement, reducing carrying cost which

ultimately form the major share of subsidy and ultimately earn the foreign exchange which

shall provide India a dependable supplier in the Wheat world market.

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ADMINISTERED PRICES BY INDIAN GOVERNMENT AND FUTURES

TRADING:

Futures as well as MSP and OMSS (Open Market Sales Scheme) are price risk management

mechanisms with the same objective to help remove uncertainties arising due to price

volatility in Wheat. However, in light of administered price regime, futures trading in Wheat

cannot kick off. Futures trading in Wheat would help in proper price discovery only if the

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ISSUE PRICE

PDS (PublicDistribution

System)

APL BPL

OMSS (pricedeclared ontender basis)

Export IssuePrice (declaredfor each crop

year)


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CORRELATION BETWEEN INDIAN AND US WHEAT PRICES:

Indian and US Wheat Prices (in qntl)

0

027-Bhakti Lal-Commodity a Fundamental Research

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