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S.NO Table of Contents Page
No
1 Executive Summary 1-4
2 Company Profile
History
Overview
About Karvy Group
Stock Broking Services
About Karvy Commodities Broking Limited
KARVY Advantage
Organization Chart
5-14
3 Introduction to commodity market 15-25
4 Research Methodology 26-29
5 Indian Commodity Futures Market
Introduction
Commodity trading contracts
Future market mechanisms
Participants in futures market & trading procedure
Limitations of commodity future market
30-46
6 Gold Commodity Future Market Introduction
Gold in Indian Scenario
World Markets
Gold an Independent Asset
Turning to demand
What makes Gold Special?
Fixing of spot gold prices
Sources Of Gold For The Goldsmiths
47-60
7 Investor Awareness And Their Perception 61-65
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Investment
Aware
Investment in commodity future
Future investment and services expectation
8 Impact of Spot Gold Market on Future Gold Market 66-69
9 Factors Affecting Future Gold Market 70-78
10 FINDINGS 79-80
11 SUGGESTIONS 81
12 CONCLUSION 82
13 BIBLIOGRAPHY 83
Executive Summary
Investing in various types of assets is an interesting activity that
attracts people from all walks of life. Investors who are having extra
cash could invest it in securities like shares or any other assets like gold,
which comes under commodity futures market. Commodity Futures are
contracts to buy specific quantity of a particular commodity at a future
date. It is similar to the index futures and stock futures but the
underlying happens to be commodities instead of stocks.
Now days, the commodity market is in growth stage and the
Karvy Finapolis Belgaum; working as a broking firm wants to expand
and for extensive reach thinking of establishing branches in various
cities of Karnataka.
I have taken thecommodity futures, to study and analyze, as it is the
emerging trend in the market, at Karvy Finapolis Belgaum, I have
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taken Gold as the commodity to study the Impact of present gold price
on future gold market and its trading mechanism.
Title: Study of Commodity Market with Special Reference to
Gold. at KARVY Finapolis Belgaum
Objectives:
To study the mechanism of commodity market.
To study the spot gold market.
To study whether the goldsmiths of Belgaum city aware of
commodity market and their perception.
To analyses the impact of spot gold market on future gold
market.
To study the factors such as economic factors of US, worldpolitical and other factors affect on future market.
Research methodology:
SAMPLE SIZE: 100 random sample size
SAMPLE TYPE: Simple random sampling
SAMPLE AREA: Belgaum city
TOOL USED FOR ANALYSES:1. Graphical Representation of Analysis:
Pie charts
Line Chart
2. SPSS
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3. Correlation
SOURCES OF DATA COLLECTION:
Primary Data- Questionnaire
Observation and personal discussion with gold traders.
Secondary data-
Information collected from different websites
likes Gold World, MCX etc.
From various text books, journals, magazines, newspapers and booklets from company.
LIMITATION OF THE STUDY:
Spot prices are varying from shop to shop.
Commission has not included spot prices of the
commodity. Study of awareness and perception of the
investor is only based on sample size.
The study of awareness is limited to Belgaum city.
Findings:
There is positive correlation between both market traders
can easily predict the future prices of the commodities and hedgetheir positions.
Most of the respondents are interested in investing in equity
(i.e. 49%) when compared to the other investment alternatives
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because they feel investing in equity will provide more returns to
them.
82% of Investors are aware about commodity future market.
67% of Investors have not invested as they have a
perception that it is risky and they even do not have much
knowledge about trading mechanism.
For gold price fluctuation main reasons are
Dollar depreciation / appreciation
World distress
Increase in money supply
Inflation
Suggestions:
Both the markets are positively correlated the traders have
knowledge about the commodity demand and supply and their
price fluctuations. So Karvy can approach these traders and they
can easily convince them so these people are the targeted
customers for Karvy.
More Awareness program has to be conducted by Karvy
consultants so that already aware investor takes the challenge to
invest in this commodity future market. Because since this was
new to the market and also risky but gives good return. so it can
be done through by giving advertisements in local channels, News
papers, by sending E-mail to present customers etc
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From survey it is found that most of the potential customers are
concerned about the genuine information and moderate
brokerage so Karvy can look upon this. If it can give good
information and charge moderate brokerage it will help to attract
more and more customers.
Conclusion
Capital market is already matured and reached at high level, every
investor interested to invest but not in commodity Future Market due to
lack of awareness. As per Data analysis most of the investors do not
have much idea of commodity market in Belgaum they are required to
be given awareness training and knowledge with the help of workshops
and seminars, as investors are willing to know more about commodity
market. There exists a high degree of positive correlation between Spot
Commodity Market and Commodity Future Market. If an amount of small
change in the spot gold market prices has the direct impact on the
future prices of gold in commodity market.
COMPAN PROFILE
The birth of Karvy was on a modest scale in 1981. It began with
the vision and enterprise of a small group of practicing Chartered
Accountants who founded the flagship company Karvy Consultants
Limited. We started with consulting and financial accounting
automation, and carved inroads into the field of registry and share
accounting by 1985. Since then, we have utilized our experience and
superlative expertise to go from strength to strengthto better ourservices, to provide new ones, to innovate, diversify and in the process,
evolved Karvy as one of Indias premier integrated financial service
enterprise.
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Thus over the last 20 years Karvy has traveled the success route,
towards building a reputation as an integrated financial services
provider, offering a wide spectrum of services. And we have made this
journey by taking the route of quality service, path breaking innovations
in service, versatility in service and finallytotality in service.
Our highly qualified manpower, cutting-edge technology, comprehensive
infrastructure and total customer-focus has secured for us the position
of an emerging financial services giant enjoying the confidence and
support of an enviable clientele across diverse fields in the financial
world.
Our values and vision of attaining total competence in our
servicing has served as the building block for creating a great financial
enterprise, which stands solid on our fortresses of financial strength -
our various companies.
With the experience of years of holistic financial servicing behind
us and years of complete expertise in the industry to look forward to, we
have now emerged as a premier integrated financial services provider.And today, we can look with pride at the fruits of our mastery and
experience comprehensive financial services that are competently
segregated to service and manage a diverse range of customer
requirements.
Overview:
KARVY, is a premier integrated financial services provider, and ranked
among the top five in the country in all its business segments, services
over 16 million individual investors in various capacities, and provides
investor services to over 300 corporate, comprising the who is who of
Corporate India. KARVY covers the entire spectrum of financial services
such as Stock broking, Depository Participants, Distribution of financial
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products - mutual funds, bonds, fixed deposit, equities, Insurance
Broking, Commodities Broking, Personal Finance Advisory Services,
Merchant Banking & Corporate Finance, placement of equity, IPO,
among others. Karvy has a professional management team and ranks
among the best in technology, operations and research of various
industrial segments.
Value and Vision of Karvy Stock Broking Ltd:
Our values and vision of attaining total competence in our servicing has
served as the building block for creating a great financial enterprise,
which stands solid on our fortress of financial strength our various
companies.
About KARVY Group
Karvy has traveled the success route, towards building a
reputation as an integrated financial services provider, offering a wide
spectrum of services for over 20 years.
Karvy, a name long committed to service at its best. A fame
acquired through the range of corporate and retail services including
mutual funds, fixed income, equity investments, insurance to
name a few. Our values and vision of attaining total competence in our
servicing has served as a building block for creating a great financial
enterprise.
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The birth of Karvy was on a modest scale in the year 1982. It
began with the vision and enterprise of a small group of practicing
Chartered Accountants based in Hyderabad, who founded Karvy. We
started with consulting and financial accounting automation, and then
carved inroads into the field of Registry and Share Transfers.
Since then, we have utilized our quality experience and
superlative expertise to go from strength to strength to provide better
and new services to the investors. And today, we can look with pride at
the fruits of our experience into comprehensive financial services
provider in the Country.
KARVY Group companies are:
Karvy Consultants Limited
Karvy Stock Broking Limited
Karvy Investor Services Limited
Karvy Computershare Private Limited
Karvy Global Services Limited
Karvy Comtrade Limited
Karvy Insurance Broking Private Limited
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Karvy Mutual Fund Services
Karvy Securities Limited
Stock Broking Services:
It is an undisputed fact that the stock market is unpredictable and
yet enjoys a high success rate as a wealth management and wealth
accumulation option. The difference between unpredictability and a
safety anchor in the market is provided by in-depth knowledge of
market functioning and changing trends, planning with foresight and
choosing one & rescues options with care. This is what we provide in
our Stock Broking services.
We offer services that are beyond just a medium for buying and
selling stocks and shares. Instead we provide services, which are multi
dimensional and multi-focused in their scope. There are several
advantages in utilizing our Stock Broking services, which are the reasons
why it is one of the best in the country.
We offer trading on a vast platform; National Stock Exchange,
Bombay Stock Exchange and Hyderabad Stock Exchange. More
importantly, we make trading safe to the maximum possible extent, by
accounting for several risk factors and planning accordingly. We are
assisted in this task by our in-depth research, constant feedback and
sound advisory facilities. Our highly skilled research team, comprising of
technical analysts as well as fundamental specialists, secure result-
oriented information on market trends, market analysis and market
predictions. This crucial information is given as a constant feedback to
our customers, through daily reports delivered thrice daily ; The Pre-
session Report, where market scenario for the day is predicted, The Mid-
session Report, timed to arrive during lunch break , where the market
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forecast for the rest of the day is given and The Post-session Report, the
final report for the day, where the market and the report itself is
reviewed. To add to this repository of information, we publish a monthly
magazine. The Finapolis, which analyzes the latest stock market trends
and takes a close look at the various investment options, and products
available in the market, while a weekly report, called Karvy Bazaar
Baatein keeps you more informed on the immediate trends in the stock
market. In addition, our specific industry reports give comprehensive
information on various industries. Besides this, we also offer special
portfolio analysis packages that provide daily technical advice on scripts
for successful portfolio management and provide customized advisory
services to help you make the right financial moves that are specifically
suited to your portfolio.
Our Stock Broking services are widely networked across India,
with the number of our trading terminals providing retail stock broking
facilities. Our services have increasingly offered customer oriented
convenience, which we provide to a spectrum of investors, high-net
worth or otherwise, with equal dedication and competence.
About Karvy Commodities Broking Limited:
Commodities market, contrary to the beliefs of many people, has
been in existence in India through the ages. However the recent attempt
by the Government to permit Multi-commodity National levels
exchanges has indeed given it, a shot in the arm. As a result two
exchanges Multi Commodity Exchange (MCX) and National Commodity
and derivatives Exchange (NCDEX) have come into being. These
exchanges, by virtue of their high profile promoters and stakeholders,
bundle in themselves, online trading facilities, robust surveillance
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measures and a hassle-free settlement system. The futures contracts
available on a wide spectrum of commodities like Gold, Silver, Cotton,
Steel, Soya oil, Soya beans, Wheat, Sugar, Channa etc., provide
excellent opportunities for hedging the risks of the farmers, importers,
exporters, traders and large scale consumers. They also make open an
avenue for quality investments in precious metals. The commodities
market, as the movements of the stock market or debt market do not
affect it provides tremendous opportunities for better diversification of
risk. Realizing this fact, even mutual funds are contemplating of entering
into this market.
Karvy Commodities Broking Limited is another venture of the
prestigious Karvy group. With our well established presence in the
multifarious facets of the modern Financial services industry from stock
broking to registry services, it is indeed a pleasure for us to make foray
into the commodities derivatives market which opens yet another door
for us to deliver our service to our beloved customers and the investor
public at large.
With the high quality infrastructure already in place and a committed
Government providing continuous impetus, it is the responsibility of us,the intermediaries to deliver these benefits at the doorsteps of our
esteemed customers. With our expertise in financial services, existence
across the lengths and breadths of the country and an enviable
technological edge, we are all set to bring to you, the pleasure of
investing in this burgeoning market, which can touch upon the lives of a
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vast majority of the population from the farmer to the corporate alike.
We are confident that the commodity futures can be a good value
addition to your portfolio.
The company provides investment, advisory and brokerageservices in Indian Commodities Markets. And most importantly, we offer
a wide reach through our branch network of over 225 branches located
across 180 cities.
KARVY Advantage:
Trade from anywhere in India Karvy, with its network of branches across
the length and breadth of the country, is always within your reach, no
matter where you are. This gives you the facility to trade from anywhere
in India.
Reliable research
Karvy has a dedicated team of research analysts who work round the
clock to provide the best research newsletters and advices. We reach
your desk daily, weekly and monthly.
Personalized Services
Karvy, with its wide array of personalized services from registry to stock
broking takes the pleasure of adding one more service, commodities
broking with the same personal touch
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State of Infrastructure
The strong IT backbone of Karvy helps us to provide customized direct
services through our back office system, nation-wide connectivity and
website.
Round the clock operations in commodities trading
Indian commodities market, unlike stock market keeps awake till 11 in
the night and Karvy is all poised to offer round the clock services
through its dedicated team of professionals.
The account opening forms are available at our branch offices and
with our business associates. You are requested to kindly contact a
branch nearby your area and complete the account opening formalities
for commodities trading at the branches.
Also you can take a print out and fill out a simple account opening
form from our website and complete the necessary documentation as
per the checklist enclosed in the form. The form after duly filled up may
be deposited at the nearest Karvy Branch or Associate along with a
cheque/DD favoring Karvy Commodities Broking Private Limitedpayable at Hyderabad towards initial margin. Please remember the
Member-Client agreement has to be executed on a non-judicial stamp
paper, as per the applicable by the Stamp Duty Act of the relevant
state.
Deposit Initial Margin:
You need to deposit an initial upfront margin as specified by the
exchange (usually between 5-10% of the contract value).The cheque/DD
should be in favour of Karvy Commodities Broking Private Limited
Mark to Market Margin:
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In addition to initial margin, you also need to keep a mark to
market margin for taking care of the adverse price movements, if any.
Achievements
Among the top 5 stock brokers in India (4% of NSE volumes)
India's No. 1 Registrar & Securities Transfer Agents
Among the to top 3 Depository Participants
Largest Network of Branches & Business Associates
ISO 9002 certified operations by DNV
Among top 10 Investment bankers
Largest Distributor of Financial Products
Adjudged as one of the top 50 IT uses in India by MIS Asia
Full Fledged IT driven operations
Organization Chart
Managing Director
Chief Managing Director
Vice-President Vice-President Vice-President Vice-President
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Karvy Karvy Karvy KarvySecurities Ltd. Stock Broking Ltd Consultants Ltd. Investors Services Ltd.
Deputy Deputy Deputy Deputy
General General General General
Manager Manager Manager Manager
Senior Manager Senior Manager Senior Manager SenoirManager
Branch Manager
Number of Team Leaders
N number of Executives
Introduction to commodity market
Ever since the drawn of civilization, commodity trading has
become an integral part of mankind. The first and foremost reason is
that commodity represents the fundamental elements of lifestyle of
human beings. In the early days, people used to exchange goods for
goods, which was called as Barter System. With the advancement of
civilization, trading system has gone through various changes and has
now entered into an era of Future trading besides existence physical
trading across the world. The history of Commodity Future trading can
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be traced back to 1688 with the introduction of Future trading in rice in
Japan. This was followed by an increased participation in commodity
derivatives, especially in Futures, in the industrialized countries like
America and Britain. All the countries opened the avenue for
introduction of Future trading in commodities in 19th century. Major
commodity Future trading platforms opened in the world are Chicago
Board of Trade (NYBOT) and New York Mercantile Exchange (NYMEX).
A Commodity derivative is a contract which derives its value from
an underlying commodity. The main purpose of Future market is to
provide a mechanism for successfully managing the price risk
associated with commodities. Future markets provide a platform for
buyers and sellers to trade in a huge number of diverse commodities
such as agricultural products, metals and energy. These markets are not
only meant for hedgers, speculators and arbitrages, but also for retail
investors who want to trade in booming commodity market.
Indian scenario
The commodity derivatives markets in India are as old as those of
the US. The origin of commodity derivatives markets in India can be
traced back to 1875, when Bombay Cotton Trade Association Ltd., was
set up to start trading in cotton Futures. Subsequent to this, many otherassociations have started Future trading in commodities at different
places. For example, the Futures trading in oilseeds started in 1900 at
Bombay, raw jute and jute products in 1912 in Calcutta, wheat in Hapur
in 1913, bullion in Bombay in 1920. However, in 1939, the Option
trading in cotton was banned by the government of Bombay to restrict
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the speculative activity in the cotton market. in subsequent years,
forward trading in various commodities like oilseeds, food grains,
vegetable oil, sugar cloth were also prohibited.
Indias commodity exchanges have come a long way since their
opening up in the early twenty first century. In India, three national level
exchanges namely Multi Commodity Exchange of India (MCEX), National
Commodity and Derivatives Exchange (NCDEX) and National Multi
Commodity Exchanges are operating to cater to the needs of Indian
investors. Apart from these national level exchanges, nearly 20 regional
exchanges are in operation, to deal with specified commodities in that
region.
Present Scenario
Over the last 20 years, the prices of commodities have generally
been bearish. Even as recently as 2002-03, the outlook on the recovery
in the global economy and world trade was generally subdued due to
depressed equity markets, weakening US dollar and geopoliticalconcerns. Commodity market across the world was impacted by these
developments. However, of late, the scenario has completely changed
as the global economy recovered from its slump aided by the boom in
the US markets and increased demand from developing economies like
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India and China. In the global investment market, the newly hailed,
attractive, asset class is commodities. So, investors are being attracted
to this new booming market for investment.
Meaning of commodity derivative market
FCRA Forward Contracts (Regulation) Act, 1952 defines goods as
every kind of movable property other than actionable claims, money
and securities. Futures trading is organized in such goods or
commodities as are permitted by the Central Government. At present,
all goods and products of agricultural (including plantation), mineral and
fossil origin are allowed for futures trading under the auspices of the
commodity exchanges recognized under the FCRA.
A commodity derivative is a contract which derives its value from
an underlying commodity. The main purpose of future market is to
provide a mechanism for successfully managing the price risks
associated with commodities. Future market provides a platform for
buyer and seller to trade in a huge number of diverse commodities suchas agriculture products, metals and energy. These markets are not only
meant for hedgers, speculators and arbitrages, but also for retail
investors who want to trade in booming commodity market.
Commodity derivatives market trade contracts for which the
underlying asset is commodity. It can be an agricultural commodity like
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wheat, soybeans, rapeseed, cotton, etc or precious metals like gold,
silver, etc.
Difference between Commodity and Financialderivatives
The basic concept of a derivative contract remains the same
whether the underlying happens to be a commodity or a financial asset.
However there are some features which are very peculiar to commodity
derivative markets. In the case of financial derivatives, most of these
contracts are cash settled. Even in the case of physical settlement,
financial assets are not bulky and do not need special facility for
storage. Due to the bulky nature of the underlying assets, physical
settlement in commodity derivatives creates the need for warehousing.
Similarly, the concept of varying quality of asset does not really exist as
far as financial underlings are concerned. However in the case of
commodities, the quality of the asset underlying a contract can vary at
times.
Why are Commodity Derivatives Required
India is among the top-5 producers of most of the commodities, in
addition to being a major consumer of bullion and energy products.
Agriculture contributes about 22% to the GDP of the Indian economy. It
employees around 57% of the labor force on a total of 163 million
hectares of land. Agriculture sector is an important factor in achieving a
GDP growth of 8-10%. All this indicates that India can be promoted as a
major center for trading of commodity derivatives.
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It is unfortunate that the policies of FMC during the most of 1950s
to 1980s suppressed the very markets it was supposed to encourage
and nurture to grow with times. It was a mistake other emerging
economies of the world would want to avoid. However, it is not in India
alone that derivatives were suspected of creating too much speculation
that would be to the detriment of the healthy growth of the markets and
the farmers. Such suspicions might normally arise due to a
misunderstanding of the characteristics and role of derivative product.
It is important to understand why commodity derivatives are
required and the role they can play in risk management. It is common
knowledge that prices of commodities, metals, shares and currenciesfluctuate over time. The possibility of adverse price changes in future
creates risk for businesses. Derivatives are used to reduce or eliminate
price risk arising from unforeseen price changes. A derivative is a
financial contract whose price depends on, or is derived from, the price
of another asset.
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Spread trade in commodities
In Future trading, a spread trade refers to the act of buying one
commodity or Futures contract and selling a related one, in an attempt
to profit from the price difference between the two. Basically, it is an act
of entering long (buying) as well as short (selling) position
simultaneously in an attempt to make profit.
There can be three types of spread one can enter in Commodity
Derivative Market.
1. A spread can be established between different
months of the same commodity (called an inter
delivery spread).
2. Between the same related commodities, usually
for the same month (inter commodity spread).
3. Between the same or related commodities traded
on two different exchanges (inter market spread).
Spread trading can be done at the market price or at desired difference
level between the commodities. For example, Buy one contract of
February of December Gold and at the same time sell one contract of
February Gold when the February Gold contract is 100 points higher
than the December contract.
In this case first and foremost thing that need to be observed is the
liquidity present in both the contracts. The benefits that can be arrived
from entering in spread trading is the lower margin requirement,
because these strategies normally carry less risk. Spreads are usually
less volatile and prices move less quickly, which can be good forbeginners who may be intimated by the speed and price fluctuations of
a single outright trade in Future Market.
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Myths on commodities trading
In recent past, we notice that the regulators banned trading in few
commodities, thereby creating misconception in the minds of traders
about the commodities market. Hence, the following is an attempt to
demystify the common myths prevailing among the investors.
Commodity market is too complex to understand:
Commodities markets are not complex as the product dealt in are
natural and therefore cannot be artificially manipulated. The demand
and supply also depends upon economic factors. It is easier to
understand commodities as in our daily life we are familiar with
commodities, we know the ruling prices of these commodities in the
market, while in stocks, we are not fully aware about internal affairs of
the company.
2) Only farmers are interested In trading and
also only they should be trading:
It is in correct to say that farmers would use this market. Actually, the
farmers only use the commodity future prices as a tool to decide which
crop to grow and to what extent and some large formers would use this
market to hedge their risk through an intermediary. These
intermediaries would normally be the same commission agents who help
formers to sell their crop in cash market. Apart from farmer, others
related to commodity trading either directly or indirectly can participate
in trading to hedge their price risk.
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3) Commodity markets are operating to serve
the needs of speculators and not of the real
investors:
Commodities markets existence serves for price discovery and
price risk management. Through this platform everybody related to
commodities can find better price discovery mechanism. Producers and
consumers of the commodity can minimize their price risk by way of
hedging. However, speculators constitute only one dimension the
market. they can work only because someone is hedging their risk in the
market. this market provides the price signals to producers as well as
consumers to meet their long term requirement. These price signals are
not available to users unless there is a commodity futures exchange and
in its absence, the markets have price fluctuations. Price stabilization
comes from the price discovery process when market participants react
positively to the information available to decide a price.
4) Large membership is required to run
commodity exchanges:
It is a misconception that to be a successful commodity exchange itneeds large number of members. Success of any commodity exchange
depends upon good and well-spread brokerage houses and there
penetration levels. Once the commodity futures trading is well
established, then the services will be broadened to many intermediaries
with separate trading rights and have few members with separate
trading rights and have few members with clearing rights like banks.
5) Commodities are only cash settled contracts:
Unlike equity market, commodities traded through exchanges are
deliverable on expiry. To facilitate smooth delivery process, the Forward
Markets Commission (FMC) has categorized the delivery mechanism into
three dimensions viz., compulsory delivery contracts, sellers option
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contracts. On expiry of the contracts, the open positions will be either
settled by delivery or cash depending upon sellers and buyers. Since the
delivery process takes long time to materialize and one has to keep
track of all the delivery process transactions, nobody wants to take
burden of delivery handling process.
Note:
Compulsory delivery option- it is an option where on the expiry of
contract of a particular commodity, all the open outstanding positions
are closed out by way of delivery. Heavy penalties are levied in case of
default in delivery.
Seller option it is an option where the sellers has right to deliver the
particular commodity on the expiry of the contract. In this option seller
has to give his intention 5 working days prior to the expiry of the
contract. The client who has not delivery intention and having open
position at the expiry of the contract has to bear a stipulated penalty.
Both Option/Intention Matching in both the option contract the delivery
happens only case of where the intention from buyer as well as seller
received for a prescribed commodity to the extent of matched quantity.
These contracts are generally cash selected and there is no penalty foropen position.
6) The quality of produce stored in godown is
guaranteed by depository/warehouse:
Quality of produce is stored in exchange designated warehouse is not
guaranteed by anyone until the standards in warehousing management
improve to ensure preservation of the quality of goods stored. If the
quality is not assured no benefit accrues to the user. Therefore, the
exchange should provide a system, whereby the seller must ensure
quality certification before tendering delivery and the buyer must have
option to recheck the at the time of collecting delivery and in case of
any discrepancies compare to the contract specifications, they should
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have an option to reject it. Worldwide no demat delivery is operational in
commodity.
7) Commodity future markets are more risky
and so it is not advisable to trade in
commodities:
While scrip price can go down even by 30-40 percent in a single trading
session, it cannot happen in commodity futures price is based on the
intrinsic value of the commodity. For instance, a scrip future can go
down from Rs.4000 to Rs.2800 in a trading session, but Gold Feb 2004
contract would normally not come down from Rs.10300 to Rs.8400 in a
single trading session, because the inherent value of the gold would not
fall so drastically. Therefore it would volatile than stocks.
What can commodity market offer?
If you are an investor, commodities futures represent a good form of
investment because of the following reasons..
High Leverage The margins in the commodity futures market are less
than the F&O section of the equity market.
Less Manipulations - Commodities markets, as they are governed by
international price movements are less prone to rigging or price
manipulations.
Diversification The returns from commodities market are free from
the direct influence of the equity and debt market, which means that
they are capable of being used as effective hedging instrumentsproviding better diversification. If you are an importer or an exporter,
commodities futures can help you in the following ways
Hedge against price fluctuations Wide fluctuations in the prices of
import or export products can directly affect your bottom-line as the
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price at which you import/export is fixed before-hand. Commodity
futures help you to procure or sell the commodities at a price decided
months before the actual transaction, thereby ironing out any change in
prices that happen subsequently.
If you are a producer of a commodity, futures can help you as follows:
Lock-in the price for your produce If you are a farmer, there is
every chance that the price of your produce may come down drastically
at the time of harvest. By taking positions in commodity futures you can
effectively lock-in the price at which you wish to sell your produce
Assured demand Any glut in the market can make you wait
unendingly for a buyer. Selling commodity futures contract can give you
assured demand at the time of harvest. If you are a large scale
consumer of a product, here is how this market can help you.
Control your cost If you are an industrialist, the raw material cost
dictates the final price of your output. Any sudden rise in the price of
raw materials can compel you to pass on the hike to your customers and
make your products unattractive in the market. By buying commodity
futures, you can fix the price of your raw material.
Ensure continuous supply Any shortfall in the supply of raw
materials can stall your production and make you default on your sale
obligations. You can avoid this risk by buying a commodity futures
contract by which you are assured of supply of a fixed quantity of
materials at a pre-decided price at the appointed time.
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Research Methodology
TOPIC:
Study of Commodity Market with Special Reference to
Gold. at KARVY Finapolis Belgaum for fulfillment of requirement of
MBA IVth semester in Institute of Management Education and research.
It was an opportunity to learn the practical aspects of the firm.
OBJECTIVES:
To study the mechanism of commodity market.
To study the spot gold market.
To study whether the goldsmiths of Belgaum city aware of
commodity market and their perception.
To analyses the impact of spot gold market on future gold
market.
To study the factors such as economic factors of US, world
political and other factors affect on future market.
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SAMPLE SIZE:
The sample size is consisting of goldsmiths and gold traders
of Belgaum city. 100 random sample sizes have taken to identify the
awareness level of gold commodity market in Belgaum city and to know
the spot gold market.
SAMPLE TYPE:
Simple random sampling is adopted to select respondent.
SAMPLE AREA:
Belgaum City
DURATION OF PROJECT:
1st Phase - December to January
2nd Phase - January to April (weekly two days)
TOOL USED FOR ANALYSES:
1. Graphical Representation of Analysis:
a. Pie charts
b. Line Chart
2. SPSS
3. Correlation coefficient: It measures the intensity or the
magnitude of linear relationship between two variables.
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NXY-(X) (Y)Correlation(r) =
[NX2 (X)2]1/2[NY2 (Y)2]1/2
Probability Error: It is an old measure of testing the reliability of an
observed value of correlation coefficient in so far as it depends upon the
condition of the random sampling.
Probable Error = 0.6745* (1-r2)n
Rules:
If, PE *6 > r then correlation is not significant.
If, PE < r then correlation is significant.
In other situation, nothing can be concluding with certainty.
DATA COLLECTION APPROACH:
Primary data is important data for successful research. It has
collected through questionnaire and personal discussion with brokers
and gold traders. And also secondary data which act like key for
successful research is collected from MCX, Gold World website and
articles in newspapers such as Business Line, Economic Standards. Spot
prices were collected from business line news paper and confirm it from
gold smith and future prices were collected from MCX.
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SOURCES OF DATA COLLECTION:
Primary and secondary data are collected from following sources
Primary Data-
Questionnaire
Observation and personal discussion with gold traders.
Secondary data-
Information collected from different websites likes Gold World,
MCX etc.
From various text books, journals, magazines, news papers and
booklets from company.
LIMITATION OF THE STUDY:
Spot prices are varying from shop to shop.
Commission has not included spot prices of the commodity.
Study of awareness and perception of the investor is only based
on sample size.
The study of awareness is limited to Belgaum city.
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INDIAN COMMODITY FUTURES MARKET
India has a long history of commodity futures market, extending
over 125 years. Still, such trading was interrupted suddenly since the
mid seventies in the fond hope of ushering in an elusive socialistic
pattern of society. As the country embarked on economic liberalization
policies and signed the GATT agreement in the early nineties, the
government realized the need for futures trading to strengthen the
competitiveness of Indian agriculture and the commodity trade and
industry. Futures trading began to be permitted in several commodities,
and the ushering in of the 21st century saw the emergence of new
National Commodity Exchanges with countrywide reach for trading in
almost all primary commodities and their products.
There have been 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
two widest exchanges are there which deal in a wide variety of
commodities and which allow nation-wide trading. They are:
1) National Commodity & Derivatives Exchange (NCDEX)
2) Multi Commodity Exchange of India (MCX)
3) National Multi Commodity Exchange (NMCX)
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1) National Commodity & Derivatives Exchange (NCDEX):
NCDEX is a public limited company incorporated on April 23, 2003
under the Companies Act, 1956. NCDEX is a technology driven
commodity exchange with an independent Board of Directors and
professionals not having any vested interest in commodity markets. It is
committed to provide a world-class commodity exchange platform for
market participants to trade in a wide spectrum of commodity
derivatives driven by best global practices, professionalism and
transparency.
Forward Market Commission regulates NCDEX in respect of futures
trading in commodities. Besides, NCDEX is subjected to various laws of
the land like the Companies Act, Stamp Act, Contracts Act, ForwardCommission (Regulation) Act and various other legislations, which
impinge on its working. NCDEX is located in Mumbai and to start with
would offer facilities in about 40 cities throughout India. The reach will
gradually be expanded to other cities.
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2) Multi Commodity Exchange of India (MCX):
Multi Commodity Exchange of India Limited (MCX), is an Exchange
with a mandate for setting up a nationwide, online multi-commodity
marketplace, offering unlimited growth opportunities to commodities
market participants. As a true neutral market, MCX has taken several
initiatives to usher in a new-generation commodities futures market in
the process, become the country's premier Exchange. MCX has started
operations from November 10, 2003.
Statutory framework for regulating commodity futures
Commodity futures contracts and the commodity exchanges
organizing trading in such contracts are regulated by the Government of
India under the Forward Contracts (Regulation) Act, 1952 (FCRA), and
the Rules framed there under. The nodal agency for such regulation is
the Forward Markets Commission (FMC), situated at Mumbai, which
functions under the aegis of the Ministry of Consumer Affairs, Food &Public Distribution of the Central Government.
Forward Markets Commission (FMC)
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 upin 1953 under the Forward Contracts (Regulation) Act, 1952.
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"The Act Provides that the Commission shall consist of not less
then two but not exceeding four members appointed by the Central
Government out of them being nominated by the Central Government to
be the Chairman thereof. Currently Commission comprises three
members among whom Dr. Kewal Ram, IES, is acting as Chairman and
Smt. Padma Swaminathan, CSS and Dr. (Smt.) Jayashree Gupta, CSS,
are the Members of the Commission."
The functions of the Forward Markets Commission are as follows:
To advise the Central Government in respect of the recognition or
the withdrawal of recognition from any association or in respect of
any other matter arising out of the administration of the Forward
Contracts (Regulation) Act 1952.
To keep forward markets under observation and to take such
action in relation to them, as it may consider necessary, in
exercise of the powers assigned to it by or under the Act.
To collect and whenever the Commission thinks it necessary, to
publish information regarding the trading conditions in respect of
goods to which any of the provisions of the act is made applicable,
including information regarding supply, demand and prices, and to
submit to the Central Government, periodical reports on the
working of forward markets relating to such goods;
To make recommendations generally with a view to improving the
organization and working of forward markets;
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To undertake the inspection of the accounts and other documents
of any recognized association or registered association or any
member of such association whenever it considerers it necessary.
Commodities selected in Phase I
Bullion
Gold
Silver
AFGRI commodities
Soya bean
Soya oil
Rapeseed/Mustard
Seed Rapeseed/
Mustard Seed Oil
Crude Palm oil
RBD Palmolein
0 Commodities introduced in Phase II
Rubber
Jute
Pepper
Chana (Gram)
Guar
Wheat
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COMMODITY TRADING CONTRACTS
All the commodities are not suitable for futures trading & for being
suitable for futures trading the market for commodity should be
competitive, i.e., there should be large demand for and supply of the
commodity no individual or group of persons acting in concert should be
in a position to influence the demand or supply, and consequently the
price substantially. There should be fluctuations in price. The commodity
should have long shelf life and be capable of standardization and
gradation.
A commodity futures contract is essentially a financial instrument.
Following the absence of futures trading in commodities for nearly four
decades, the new generation of commodity producers, processors,
market functionaries, financial organizations, broking agencies and
investors at large are, unfortunately, unaware at present of the
economic utility, the operational techniques and the financial
advantages of such trading. Commodity future market involves
particularly different types of forward contracts.
Forward contracts
FCRA defines forward contract as "a contract for the delivery of
goods and which not a ready delivery contract is".
All contracts in commodities providing for delivery of goods and/or
payment of price after 11 days from the date of the contract are
"forward" contracts. Forward contracts are of three types
1) Specific Delivery & Ready Delivery Contracts
2) Futures Contracts
3) Option Contracts
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Specific Delivery/Ready Delivery contracts:
Specific delivery contracts provide for the actual delivery of
specific quantities and types of goods during a specified future period,
and in which the names of both the buyer and the seller are mentioned.
Under the Act, a ready delivery contract is one, which provides for
the delivery of goods and the payment of price therefore, either
immediately or within such period not exceeding 11 days after the date
of the contract, subject to such conditions as may be prescribed by the
Central Government. Already delivery contract is required by law to be
fulfilled by giving and taking the physical delivery of goods. In market
parlance, the ready delivery contracts are commonly known as "spot" or
"cash" contracts.
Futures Contract:
A commodity futures contract is essentially a financial instrument.
Following the absence of futures trading in commodities for nearly four
decades, the new generation of commodity producers, processors,market functionaries, financial organizations, broking agencies and
investors at large are, unfortunately, unaware at present of the
economic utility, the operational techniques and the financial
advantages of such trading.
A futures contract is a legally binding agreement between two
parties to buy or sell in the future, on a designated exchange, a specific
quantity of a commodity at a specific price. The buyer and seller of afutures contract agree now on a price for a product to be delivered, or
paid, for at a set time in the future, known as the "settlement date."
Although actual delivery of the commodity can take place in fulfillment
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of the contract, most futures contracts are actually closed out or "offset"
prior to delivery.
A commodity futures contract is a tradable standardized contract,
the terms of which are set in advance by the commodity exchange
organizing trading in it.
The futures contract is for a specified variety of a commodity,
known as the "basis, though quite a few other similar varieties, both
inferior and superior, are allowed to be deliverable or tender-able for
delivery against the specified futures contract.
The parties to the contract are required to negotiate only the
quantity to be bought and sold, and the price. The Exchange prescribes
everything else. Because of the standardized nature of the futures
contract, it can be traded with ease at a moments notice.
Option Contract:
An option on a commodity futures contract is a legally binding
agreement between two parties that gives the buyer, who pays a
market determined price known as a "premium," the right (but not the
obligation), within a specific time period, to exercise his option. Exerciseof the option will result in the person being deemed to have entered into
a futures contract at a specified price known as the "strike price." In
some cases, an option may confer the right to buy or sell the underlying
asset directly, and these options are known as options on the physical
asset.
Commodity future trading contracts rarely are for the actual or
physical delivery allowed to be settled otherwise than by issuing or
giving deliveries. Therefore, speculators use these futures contracts to
benefit from changes in prices and are hardly interested in either taking
or receiving deliveries of goods.
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FUTURE MARKET MECHANISMS
1) Price Discovery through Future Market:
In an active futures market, the demand for information by traders
is enormous. Futures exchanges tend to become collection centers for
statistics on supplies, transportation, storage, purchases, exports,
imports, currency values, interest rates, and other pertinent information.
These data, which are compiled and distributed throughout the
exchange community on a continuous basis, are immediately reflected
in the trading pits as traders digest the new information and adjust theirbids and offers accordingly. As a result of active buying and selling of
futures contracts, the market determines the best estimate of today and
tomorrow's prices for the underlying commodity. In effect, prices are
discovered at futures exchanges. Prices determined via this open and
competitive process are considered to be accurate reflections of the
supply and demand for a commodity, and for this reason they are widely
used as today's best estimate of tomorrow's cash market prices for a
standardized quantity of a commodity.
Price discovery is the process of arriving at a figure at which one
person will buy and another will sell a futures contract for a specific
expiration date. In an active futures market, the process of price
discovery continues from the market's opening until its close. Futures
contracts are standardized as to quantity, quality, and location so
buyers and sellers only bargain over price. Because of this
standardization, commercial interests are better able to compute local
cash prices. In many commodities, futures prices have earned a role as
key reference prices for those who produce, process, and merchandise
the commodity.
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2) Transferring Risk: Hedging through future market
Commodity production and marketing involve sizable price risks,
and risk represents a cost that affects the value of a commodity. While
there is no way to eliminate uncertainty, futures markets provide a
competitive way for commodity producers, merchandisers, processors,
and others who may own the actual commodity to transfer some price
risk to speculators who will willingly assume such risk in hopes of
making a profit.
The process of hedging involves the concurrent use of both cash
and futures markets. Since futures and cash prices tend to move
together (that is, parallel to each other), and at contract expiration
converge to one price, it is possible for a cotton merchant, for example,
to hedge an unsold inventory of cotton with a sale of an equivalent
amount of futures contracts. Since the merchant owns the commodity,
he would have a loss if prices fell. To hedge, the merchant would sell
futures contracts. Now if prices drop, the cash market loss will be at
least partially offset by a gain on the futures contract. When the
merchant sells his inventory at the lower cash market price, he will
simultaneously lift his hedge by buying back his futures contracts at the
lower price. The gain on his futures contracts should roughly equal the
merchant's loss in the cash market.
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Here are three examples of how hedging helps the cash market
work better:
1) Hedging stretches the marketing period. For instance, 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. 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. A jewelrymanufacturer 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 its
capital to acquire only as much gold, silver, or platinum as may be
needed to make the products that will fill its orders.
These are just a few ways that commodity owners use futures
markets. It requires skill and knowledge acquired that comes only by
study and experience.
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PARTICIPANTS IN FUTURES MARKET & TRADING
PROCEDURE
The Futures market participants comprise of:
Farmers
Traders
Producers
Processors
Exporters
Importers
Industries associated with commodities.
The futures market is used for hedging the price risk and for
trading or arbitrage. Brokers of all commodity exchanges, who are
located all across the country, serve the futures market users directly
through their own branch offices' network or through the network of
their franchisees or sub-brokers.
Procedure for Individual investor to start trading in Commodity
Futures Market can be as follows:
Selection of Broker:
A trustworthy, reliable, efficient, effective & innovative broker,
having membership to any of the Exchange like MCX / NCDEX etc. would
be in Investors interest. Broker should be such that recognizes
investors needs & aspirations & work as a dedicated team to deliver
highly effective & customized solutions to investors risk management
needs.
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Information about Self:
After selecting a broker, investor will be asked to provide
information that is personal & financial. A member client agreement
should be signed between the broker & investor. Investor should give
photographs, bank details & should possess normal DMAT Account or
broker opens that account for him/her. If trading is intended with
delivery of commodities then Commodity DMAT Account is been opened.
Depositing the Margin:
In order to trade futures contracts, investor has to deposit margins
in cash with broker. There are two types of margins, namely; initial
margin & mark to market margin.
i) Initial Margin-
Initial Margin is set by the exchanges on basis of volatility in the
particular commodity & is a percentage of the contract.
ii) Mark to market Margin-
At the end of the day, the contract is marked to market; meaning
traders account is credited or debited based on the profit/ loss made
during the session. On this profit or loss there broker can charge marginthat is nothing but mark to market margin.
Intraday Trading:
Then as per individual investors wish he can buy or sell
commodities online. Just he has to specify which commodity & what
price is he going to buy or sell. Electronic terminals are used for this
trading at various broking offices that provides the same information
countrywide. This trading process is called as, Intraday Trading.
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Benefit of this online trading is that it provides a secure,
transparent, fast and user-friendly system. It leads to better price
discovery of commodities like Bullion, Metals and Agro products by
bringing large number of Buyers and Sellers on a common National and
International platform.
Clearing Trades on Commodity Exchange
All trades on Commodity Exchange are supported by an initial
margin. At the End-of day Commodity Exchange does mark-to-market of
all the open positions. This activity results into final position of all
members in respect to booked losses or losses on open positions.
Members make the shortfalls good by way of pay-ins to Commodity
Exchange by next day and the members in profit on such positions are
given the necessary credits. These payments are processed
electronically through a countrywide network of clearing banks.
Settlement of the Contract and Delivery
A contract has a life cycle of two months. At Commodity
Exchange, 5 days before the expiry of a contract, the contract enters
into a tender period. At the start of the tender period, both the parties
must state their intentions to give or receive delivery, based on which
the parties are supposed to act or bear the penal charges for any failure
in doing so. Those who do not express their intention to give or receive
delivery at the beginning of tender period are required to square-up
their open positions before the expiry of the contract. In case they do
not their positions are closed out at 'due date rate'. The links to the
physical market through the delivery process ensures maintenance of
uniformity between spot and futures prices.
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Tendering Delivery to a Buyer by Exchange Seller
Sellers intimate the exchange at the beginning of the tender
period and get the delivery quality certified from empanelled quality
certification agencies. They also submit the documents to the Exchange
with the details of the warehouse within the city, chosen as a delivery
center.
Sellers are free to use any warehouse, as they are responsible for
the goods until the buyer picks up the delivery, which is a practice
followed in the commodities market globally.
Seller would receive the money from the exchange against thegoods delivered, which happens when the buyer has confirmed its
satisfaction over quality and picked up the deliveries within stipulated
time.
Receiving Delivery of Commodities by Buyer
Buyers intending to take delivery will receive it, if there are sellers
willing warehouse at the designated delivery centers on the designated
delivery days.
There are commission agents who help the brokers with handling
of the delivery, logistic support, and associated quality certification
through to give delivery. The Buyer will have to make the payment
within three days after the delivery is allotted. The buyer will take actual
delivery from the empanelled agencies and associated billings due to
tax implications. This support is required as the buyer may be in adifferent city than the place where the delivery is being received.
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Utility of Physical Delivery of Commodity to Client of Buyer
The client of a buyer may use this delivery for his
consumption in the industry, or for exports, or he may sell in the spot
market or may sell in futures market in the subsequent contract, if he is
a regular trader. Generally, the commodities available in the physical
form are consumed by the industry and, rarely, commodities, are stored
in the warehouse for a longer period.
Percentage of Delivery in the Futures Market
Though, Exchanges have specified the deliverable grades in the
contract specifications, which are notified before commencement oftrading in a contract. The seller is required to submit the quality
certification issued by empanelled quality certification agencies, like,
SGS, Geo Chem. etc. Thus, quality of a commodity is ensured, the
percentage is delivery in such market is fairly low. Generally, the futures
markets all over the world are used for hedging where actual delivery
percentage is about 1% any user in the commodities ecosystem unlike
the physical spot or forward market does not use these markets for
regular consumption.
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LIMITATIONS OF COMMODITY FUTURE MARKET
Commodity market is very difficult to predict. Commodity prices
depend upon region, monsoon, transportation cost, demand-supply theory, import/ export policies & Global market trends. So
commodity market experience volatility that cannot be predicted
easily.
Without knowing the spot market for commodities it is very
difficult to play with Future market. In capital market it depends
upon Companies performance, decisions, long run plans, mergers,
etc. there are definite regions to move up & down in the market,
but in the case of Commodity market there are so many regions
for the market movement, it is like a game of luck to the investor.
Customer has to deposit the margin amount that is based on
volatility of commodity plus brokerage that is deducted from total
losses made. So if at all there is a loss, the total loss amount will
be very huge. In this aspect it is very risky market.
Commodity market not yet developed in India so it is less reliable.
Commodity market gives high return but with multiplier of high
risk.
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Gold commodity Future MarketIntroduction
Gold is a unique asset based on few basic characteristics. First, it
is primarily a monetary asset, and partly a commodity. As much as two
thirds of golds total accumulated holdings relate to store of value
considerations. Holdings in this category include the central bank
reserves, private investments, and high-cartage jewelry bought primarily
in developing countries as a vehicle for savings. Thus, gold is primarily a
monetary asset. Less than one third of golds total accumulated holdings
can be considered a commodity, the jewelry bought in Western markets
for adornment, and gold used in industry.
The distinction between gold and commodities is important. Gold
has maintained its value in after-inflation terms over the long run, while
commodities have declined.
Some analysts like to think of gold as a currency without a
country. It is an internationally recognized asset that is not dependent
upon any governments promise to pay. This is an important featurewhen comparing gold to conventional diversifiers like T-bills or bonds,
which unlike gold, do have counter-party risk.
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Gold in Indian Scenario:
Gold is valued in India as a savings and investment vehicle and is
the second preferred investment behind bank deposits. India is theworlds largest consumer of gold in jewelry (much of which is purchased
as investment). The hoarding tendency is well ingrained in Indian
society, not least because inheritance laws in the middle of the
twentieth century lent a great desirability to anonymity. Indian people
are renowned for saving for the future and the financial savings ratio is
strong, with a ratio of financial assets-to-GDP of 93%.
Golds circulates within the system and roughly 30% of goldjewelry fabrication is from recycled pieces. India is typically also the
largest purchaser of coins and bars for investment (>80tpa), although
last year it had to concede first place to Japan in the wake of the heavy
buying in the first quarter due to fears for the stability of the Japanese
banking system. In 1998-2001 inclusive, annual Indian demand for gold
in jewelry exceeded 600 tons; in 2002, however, due to rising and
volatile prices and a poor monsoon season, this dropped back to 490
tons, and coin and bar demand dropped to 67 tons. Indian jewelry off
take is sensitive to price increases and even more so to volatility,
although this decline in tonnage since 1998 is also due in part to
increasing competition from white and brown goods and alternative
investment vehicles, but is also a reflection of the increase in price. The
Indian brides Streedhan, the wealth she takes with her when she
marries and which remains hers, is still gold, however (thus giving gold
an important role in the empowerment of women in India).
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The distinction between gold and commodities is important. Gold
has maintained its value in after-inflation terms over the long run, while
commodities have declined.
Some analysts like to think of gold as a currency without a
country. It is an internationally recognized asset that is not dependent
upon any governments promise to pay. This is an important feature
when comparing gold to conventional diversifiers like T-bills or bonds,
which unlike gold, do have counter-party risk.
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World Markets
Today's gold market is a round-the-world, round-the-clock
business, played out largely on dealers' trading screens. The core of the
business, however, remains in the key markets of London, as the great
clearing house, New York as the home of futures trading, Zurich as
physical turntable, Istanbul, Dubai, Singapore and Hong Kong as
doorways to important consuming regions and Tokyo where the
Commodity Exchange (TOCOM) sets the mood of Japan. Even Paris still
has a small market, a reminder of the days when the French were great
hoarders, while Mumbai has increasing importance under India's
liberalized gold regime that permits official imports through localmarkets.
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Gold an Independent Asset
Its not difficult to understand why the gold price moves
independently from the economic cycle when one considers the
diversity of its demand and supply base, the ultimate determinants of
price movements.
There are three sources of gold supply: mine production, official
sector sales and scrap or recycled gold. Mine production is by far the
largest element, accounting for 70% of total supply last year. Changes in
annual mine supply bear no relation to changes in US or even global
GDP growth. The upward trend in mine production that was underway in
the late 1980s was not arrested by 1990 recession (the US economy
suffered an outright contraction, while world GDP growth slowed to 1.6%
from 2.9% the previous year). Nor was the downtrend in mining output
that began in 2001 reversed by the sharp acceleration in world growth.
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Mine production is influenced by very specific factors, such as the
level of exploration spending, the success or otherwise in discovering
new gold deposits and the cost of extraction (some new discoveries may
not be economically viable). Lead times in gold mining are often very
long. It can take years to re-open a closed mine, let alone find and mine
new reserves.
The decision to build a mine shaft (and often an entire
infrastructure) is a long term one that will often see business cycles
comes and goes. Central bank decisions to buy or sell gold (they remain
net sellers) are also usually strategic in nature, rather than reactive to
the economic cycle. The decision to buy or sell gold is often made years
in advance and then carried out over a period of years. In Switzerland,
for example, the proposition to sell gold (the first gold sales
programmed) was first recommended by a group of experts in 1997.
However, the actual sales programmed did not commence until May
2000, with the sales then taking place over a period of five years.
Scrap supply is influenced by many factors, perhaps the most
important being price and price volatility, but recessions and periods of
economic distress have also had an impact. The most dramatic exampleis when Korea was pushed into recession during the 1998 Asian
currency crisis; its scrap supply increased by almost 200 tonnes as the
government bought gold from the local populace in exchange for won-
denominated bonds. It then sold the gold on the international market in
order to raise the dollars necessary to avoid defaulting on its external
debt.
Similarly, in Indonesia the 1998 recession saw scrap supply
increase by 72 tonnes in the first quarter of the year, in this instance
purely for independent reasons rather than at the behest of the
government.
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Turning to demand
Conventional wisdom argues that recessions are bad for
commodity prices. The reasoning goes that as consumer and business
confidence falls, demand for goods and services is cut back and hence
the materials used in the production of those goods or in the provision of
services (many of which are commodities) declines, thereby depressing
their price.
The argument is logical. However, a few points are worth bearing
in mind with respect to gold. Demand for gold as an intermediate good
is relatively small in comparison to many other commodities. Last year,just 14% of gold demand came from the industrial sector (mainly
electronics). This is in stark contrast to base metals and even other
precious metals, where the vast majority of demand comes from
industry. As a result, gold is much less vulnerable to the vagaries of the
economic cycle. That said, demand for gold in electronics is likely to fall
if the economy falls into recession as consumer spending on non-
essential electronics goods declines. A US recession would undoubtedly
have negative implications for gold jewelry demand in America, as
consumer spending slows. However, this negative implication could be
at least partially offset by the higher share of gold jewelry in the retail
market that gold jewelry has enjoyed in recent years. Moreover, gold is
much less vulnerable than other jewelry materials, such as diamonds or
platinum, to a US recession as far more demand for gold comes from
outside of the US 70% of diamond jewelry demand comes from the US
market, compared with just 10% for gold.
India is in fact the single largest consumer of gold jewellery in the
world in tonnage terms. Last year, Indian households bought 558 tonnes
of gold jewelry, more than double their US counterparts (Chart 7).
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Chinese consumers rank second, having bought 331 tonnes. US
consumers are third in tonnage terms, although US demand remains
highest in retail value terms due to its higher trade margins. The extent
to which worldwide gold jewelry demand suffers from a US recession will
depend partly on the spill-over effects to other countries. If proponents
of decoupling prove to be correct (they argue that emerging market
economies are now strong enough domestically to withstand a US
slowdown) then worldwide jewelry demand need not fare badly.
The final source of demand comes from investors. Investors buy
gold for many reasons. Chief among these are golds inflation and dollar-
hedging properties, both of which have been proven over
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