How are Prices Determined in the Commodities Market?
Commodity trading has become very popular and advanced in recent times. It allows the investors to gain very good returns while diversifying their investments across various perishable and non-perishable commodities.
Moreover, apart from mitigating the risks associated with the share markets, commodity trading helps in hedging against the spiralling inflation rates.
In this article, you will understand the concept of the commodity market in India and how commodity market prices are determined. Let’s get started.
What is the Commodity Market?
In simple terms, a commodity market is a marketplace wherein various commodities are traded (sold and purchased) just like the stocks in the stock markets. Commodities are the products derived from primary economic activities, including agriculture, poultry, mining, drilling, etc. The most commonly traded commodities across the world are gold, silver, copper, crude oil, natural gas, corn, soybean, milk, rice, etc.
Commodity trading started approximately thousands of years ago, even before stock trading. Today, the commodity market in India has advanced a lot with the availability of new-age financial instruments, such as futures, derivatives, swaps, options, etc.
Amsterdam stock exchange is considered the world’s first stock exchange that acted as a commodity trading marketplace. At present, the Chicago Mercantile Exchange (CME) is the world’s largest commodity marketplace, whereas the LME (London Metal Exchange) is the largest commodity marketplace in the world that deals in base and other metals.
Also Read: Foreign Stock Exchange
India has six commodity exchanges or marketplaces in total. The National Commodity and Derivatives Exchange (NCDEX), the Multi Commodity Exchange (MCX), and the Indian Commodity Exchange (ICX) are some of the most prominent ones. Commodity trading in India takes place on these exchanges only under the regulations of the SEBI (Securities and Exchange Board of India).
Participants in the Commodity Markets
Before you understand how commodity market prices are determined, it is crucial to know about the participants in the commodity markets. It is because of these participants and their actions that commodity prices go up and down. Typically, there are two types of participants in the commodity markets, namely, hedgers and speculators.
Hedgers are the manufacturers or large industries that require raw materials in substantial quantities. Thus, they want to secure the commodities at stable prices. For example, construction companies require large volumes of steel, packaged food companies require large volumes of grains, and dairy companies require large volumes of milk.
On the other hand, speculators are the ones who have no real need for commodities, but they can speculate the movement of commodity prices and try to make profits from those movements. They try to buy commodities at relatively lower prices and sell them to hedgers when their prices go up.
How are Commodity Market Prices Determined?
Now that you have a fair idea of the commodity markets and their participants, you’re better placed to have an understanding how commodity market prices are determined. Just like the stock markets, commodity markets can experience high volatility daily. Several factors are responsible for this volatility in commodity prices:
- Demand and supply
Supply and demand are one of the major factors that determine commodity market prices. Commodity traders or investors place buy and sell orders on commodity exchanges every day. When the demand for a specific commodity increase, buy orders begin to outnumber sell orders. In other words, the demand for that commodity becomes more than the supply. And in such cases, the commodity prices start increasing.
For example, during the winter season, the demand for inflammable commodities rises as people need them to heat their rooms, offices, or events. That is why, the prices of commodities such as coal, petrol, natural gas, etc., start to move upwards.
- Geopolitical situations
Various geopolitical developments also play a crucial role in determining commodity market prices. For example, if there is turmoil in the Middle East countries, it can impact crude oil prices all around the world since these countries are its major exporters.
Similarly, a sudden increase in the production of a certain commodity in a specific part of the world may impact the demand and supply ratio, and hence, the prices of that commodity may go down for a brief period.
- Currency movements
The prices of certain commodities are hugely dependent on the current value of the country’s currency from which they are being exported. Therefore, a fall in the currency value of that country may adversely impact the commodity prices in various marketplaces across the globe.
For example, when the US imposed economic sanctions on Iran, its currency started degrading, and hence, the prices of Iranian crude oil also started to degrade.
- Speculator trading
We have already told you how speculators participate in commodity markets. They take possession of certain commodities with speculation that their prices will go up in the near future. When many speculators start doing the same, they enlarge the demand-supply gap for some commodities, and hence, the prices of those commodities automatically start increasing.
Also Read: Gap Up & Gap Down in Stock Market
Commodity trading can be a good option to diversify your investment portfolio and earn good returns. However, you need to understand the risks involved with these financial markets before starting your trading journey. At the same time, you need to be diligent enough to speculate commodity prices based on the factors mentioned above.
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Frequently Asked Questions
Trading in commodity markets is equivalent to trading in the stock markets. You can place buy and sell orders for various commodities in the commodity exchanges. You can also buy and sell futures contracts at these exchanges to make profits. You need to have a commodity trading account to trade in commodity markets.
Just like stock market trading, commodity trading involves a fair bit of risks. However, if you’re diligent enough to understand and speculate the movements of the commodity market prices, you can mitigate the risks and make good profits.
Speculating the movement of commodity prices isn’t that easy. You need to consider various factors, such as demand and supply, prevailing geopolitical situations, consumer behaviours, etc. to make speculations. You can also take the help of a full-service commodity broker to learn how to speculate commodity prices.