Nine common myths about investing in this market
Rahul Oberoi dispels nine common myths about investing in this market.
1.Commodity traders are mostly speculators
Cmmodity trading has its share of speculators, but what is wrong in that? Hedgers, arbitrageurs and speculators all help in effi cient price discovery and price-risk management. "Speculators are an important link in the market. They can only work, however, because someone is hedging their risk," says Naveen Mathur, Associate Director, Commodities and Currencies, Angel Broking. Ashwin Vidhate, Economist, NCDEX, agrees. "Speculators are important market players who inject liquidity and help hedgers transfer risk," he says. "Their absence will mean fewer players, making it diffi cult and expensive for participants to transfer risk." Speculators are prepared to assume the risk that hedgers are trying to transfer in the futures market. Speculators add depth and liquidity to the market, but not every investor need be one.
2. Understanding the market is too difficult
Many investors think the commodity market is diffi -cult to understand. Vivek Gupta, Head of Research, CapitalVia Global Research, does not agree. "All commodities are globally traded and the global demand-supply situation is widely known and available to anyone who reaches out for it," he says. "The commodity market is not complex. It moves according to basic economic factors and seasonal cycles that affect prices."
3. There is no assurance of quality of commodities delivered
Most exchanges have quality control measures in place to ensure that commodities delivered to their warehouses meet high quality standards. They also make efforts to see that only quality stocks are delivered to buyers. Experts say commodities delivered within the fi nal validity period are of standard grade and quality. Standards of quality and quantity are ensured by rules set by the government and commodities trading exchanges. "The exchanges have well-established inspection and audit processes to ensure adherence to the highest standards in testing, assaying and storing of commodities, and ensuring the quality of commodities delivered," says Dilip Bhatia, CEO, Ace Derivatives and Commodity Exchange. "The buyer also has the option of getting the stock examined for quality while accepting delivery."
4. Commodity markets are too volatile
Many investors see volatility as a big problem. They have to invest four to 10 per cent value of the commodity, far less than in stock futures. However, many do not know how to gain from such high leverage. Another problem is that they overtrade and use the margin to the hilt. Therefore, if prices rise a little, they can double their money, but if prices fall, they lose all their money. "Commodities are no more volatile than stocks if we remove the leverage," says Shariq Hoda, Executive Vice President (Products), Religare Broking. However, Harish Galipelli, Head (Commodities), JRG Securities, says: "The fact is that prices of derivatives are directly linked to prices in spot markets," Apart from this, unlike stocks, which can move by even 20 per cent in a single session, metal and energy contracts can rise or fall by a maximum of six per cent in a day. In agricultural commodities, the range is only four per cent.
5. Commodity exchanges fuel inflation
Commodity exchanges promote price transparency. Today, a copper wire manufacturer in Punjab can see the live international price of copper in London on his trading terminal. Similarly, a farmer in Haryana can fi nd out the current price of wheat in Delhi. By allowing wider participation, exchanges discourage cartelisation by local traders and associations and facilitate fair price discovery. "By providing futures trading in far-month contracts, exchanges provide price signals to farmers, policy-makers and other value chain participants," says Ashwin of NCDEX.
6. It is hard make money in commodity trading
It is generally believed that most investors lose money in commodities' futures. "This happens only when market participants do not trade with discipline and fall victims to greed and fear," says Mathur of Angel Broking. For example, investors hold on to losses hoping that prices will recover. In case of profi ts, they square off positions for the fear of losing money already earned. Professional guidance can help in such situations. "Traders make huge amounts of money for clients," says Gupta of CapitalVia Global Research. "They have spent time understanding market movements and apply the right blend of technical and economic analysis. Many fund managers and hedge funds trade only in commodities and have a record of giving 20 to 30 per cent a year earnings for more than a decade."
7. Commodity trading is only for big traders
I do not think the commodity market is only for investors who have a lot of spare money," says Dharmesh Bhatia, Associate Vice President (Research), Kotak Commodities Services. "Any person can trade by paying a small percentage of the total value of the contract." Exchanges such as Multi Commodity Exchange (MCX), National Commodity and Derivatives Exchange, National Multi Commodity Exchange and Indian Commodity Exchange have several options for high net worth investors, companies and small investors. For instance, the exchanges fi rst launched gold contracts on one kilo bars. Later, they introduced the 100 gram, 8 gram and 1 gram contracts for small investors. MCX launched a 1 gram gold petal contract in 2011 with a four per cent margin requirement. So, one can invest as little as Rs 112 and take exposure of Rs 2,776 (the price of 1 gram of gold as on March 28, 2012).
8. Delivery of commodities 7 is compulsory
There is a common belief that anyone who buys commodity derivatives has to take delivery as well. Delivery is mandatory only in specifi c commodities and that too only if one keeps the position open after the delivery notice period. There is compulsory delivery in commodities such as chana and gold. However, an investor cannot take delivery of crude oil and metals, as trades in these two commodities are cash settled. Settling a futures contract by paying the price difference rather than taking delivery of the physical commodity is known as cash settlement. Bhatia of Kotak Commodity Services says: "It is not necessary to take delivery as long as the trader squares off his positions before the contract's expiry. Only commercial players like hedgers and arbitrageurs take delivery."
9.Prices are easy to manipulate
Most commodities that are traded are produced and consumed across the globe. As such, an individual or a group of people cannot easily manipulate prices. However, illiquid commodities can be manipulated, say experts. Harish Galipelli, Head, Commodities, JRG Securities, says: "Price manipulation is possible only when production is concentrated in one area. It does not happen with essential commodities. Regulators and governments monitor prices of essential commodities and take steps whenever there is an attempt to manipulate the markets." Mathur of Angel Broking agrees."One cannot change a commodity's fundamentals. Commodity prices refl ect demand-supply dynamics and thus operators cannot manipulate prices. Besides, commodities are traded worldwide and hence there is a minimal chance of manipulation by a handful of participants," he says.
Cmmodity trading has its share of speculators, but what is wrong in that? Hedgers, arbitrageurs and speculators all help in effi cient price discovery and price-risk management. "Speculators are an important link in the market. They can only work, however, because someone is hedging their risk," says Naveen Mathur, Associate Director, Commodities and Currencies, Angel Broking. Ashwin Vidhate, Economist, NCDEX, agrees. "Speculators are important market players who inject liquidity and help hedgers transfer risk," he says. "Their absence will mean fewer players, making it diffi cult and expensive for participants to transfer risk." Speculators are prepared to assume the risk that hedgers are trying to transfer in the futures market. Speculators add depth and liquidity to the market, but not every investor need be one.
2. Understanding the market is too difficult
Many investors think the commodity market is diffi -cult to understand. Vivek Gupta, Head of Research, CapitalVia Global Research, does not agree. "All commodities are globally traded and the global demand-supply situation is widely known and available to anyone who reaches out for it," he says. "The commodity market is not complex. It moves according to basic economic factors and seasonal cycles that affect prices."
3. There is no assurance of quality of commodities delivered
Most exchanges have quality control measures in place to ensure that commodities delivered to their warehouses meet high quality standards. They also make efforts to see that only quality stocks are delivered to buyers. Experts say commodities delivered within the fi nal validity period are of standard grade and quality. Standards of quality and quantity are ensured by rules set by the government and commodities trading exchanges. "The exchanges have well-established inspection and audit processes to ensure adherence to the highest standards in testing, assaying and storing of commodities, and ensuring the quality of commodities delivered," says Dilip Bhatia, CEO, Ace Derivatives and Commodity Exchange. "The buyer also has the option of getting the stock examined for quality while accepting delivery."
4. Commodity markets are too volatile
Many investors see volatility as a big problem. They have to invest four to 10 per cent value of the commodity, far less than in stock futures. However, many do not know how to gain from such high leverage. Another problem is that they overtrade and use the margin to the hilt. Therefore, if prices rise a little, they can double their money, but if prices fall, they lose all their money. "Commodities are no more volatile than stocks if we remove the leverage," says Shariq Hoda, Executive Vice President (Products), Religare Broking. However, Harish Galipelli, Head (Commodities), JRG Securities, says: "The fact is that prices of derivatives are directly linked to prices in spot markets," Apart from this, unlike stocks, which can move by even 20 per cent in a single session, metal and energy contracts can rise or fall by a maximum of six per cent in a day. In agricultural commodities, the range is only four per cent.
5. Commodity exchanges fuel inflation
Commodity exchanges promote price transparency. Today, a copper wire manufacturer in Punjab can see the live international price of copper in London on his trading terminal. Similarly, a farmer in Haryana can fi nd out the current price of wheat in Delhi. By allowing wider participation, exchanges discourage cartelisation by local traders and associations and facilitate fair price discovery. "By providing futures trading in far-month contracts, exchanges provide price signals to farmers, policy-makers and other value chain participants," says Ashwin of NCDEX.
6. It is hard make money in commodity trading
It is generally believed that most investors lose money in commodities' futures. "This happens only when market participants do not trade with discipline and fall victims to greed and fear," says Mathur of Angel Broking. For example, investors hold on to losses hoping that prices will recover. In case of profi ts, they square off positions for the fear of losing money already earned. Professional guidance can help in such situations. "Traders make huge amounts of money for clients," says Gupta of CapitalVia Global Research. "They have spent time understanding market movements and apply the right blend of technical and economic analysis. Many fund managers and hedge funds trade only in commodities and have a record of giving 20 to 30 per cent a year earnings for more than a decade."
7. Commodity trading is only for big traders
I do not think the commodity market is only for investors who have a lot of spare money," says Dharmesh Bhatia, Associate Vice President (Research), Kotak Commodities Services. "Any person can trade by paying a small percentage of the total value of the contract." Exchanges such as Multi Commodity Exchange (MCX), National Commodity and Derivatives Exchange, National Multi Commodity Exchange and Indian Commodity Exchange have several options for high net worth investors, companies and small investors. For instance, the exchanges fi rst launched gold contracts on one kilo bars. Later, they introduced the 100 gram, 8 gram and 1 gram contracts for small investors. MCX launched a 1 gram gold petal contract in 2011 with a four per cent margin requirement. So, one can invest as little as Rs 112 and take exposure of Rs 2,776 (the price of 1 gram of gold as on March 28, 2012).
8. Delivery of commodities 7 is compulsory
There is a common belief that anyone who buys commodity derivatives has to take delivery as well. Delivery is mandatory only in specifi c commodities and that too only if one keeps the position open after the delivery notice period. There is compulsory delivery in commodities such as chana and gold. However, an investor cannot take delivery of crude oil and metals, as trades in these two commodities are cash settled. Settling a futures contract by paying the price difference rather than taking delivery of the physical commodity is known as cash settlement. Bhatia of Kotak Commodity Services says: "It is not necessary to take delivery as long as the trader squares off his positions before the contract's expiry. Only commercial players like hedgers and arbitrageurs take delivery."
9.Prices are easy to manipulate
Most commodities that are traded are produced and consumed across the globe. As such, an individual or a group of people cannot easily manipulate prices. However, illiquid commodities can be manipulated, say experts. Harish Galipelli, Head, Commodities, JRG Securities, says: "Price manipulation is possible only when production is concentrated in one area. It does not happen with essential commodities. Regulators and governments monitor prices of essential commodities and take steps whenever there is an attempt to manipulate the markets." Mathur of Angel Broking agrees."One cannot change a commodity's fundamentals. Commodity prices refl ect demand-supply dynamics and thus operators cannot manipulate prices. Besides, commodities are traded worldwide and hence there is a minimal chance of manipulation by a handful of participants," he says.
