Beyond equities

As a result,retail participation in most commodity exchanges has stagnated below 10%,despite the meteoric rise in futures volume and availability of over 100 contracts. The bulk of volume in commexes comes from jobbers and arbitragers. Experts believe that in an ideal situation,retail participation should be 40-60%.

“Portfolio diversification in commodities for a typical investor largely depends upon his risk-taking capability. As commodities are an asset class giving quicker and higher returns,anyone who has more risk-taking ability should earmark a larger proportion of his portfolio for commodities. And those who have less risk-taking ability should allocate a larger proportion into currencies or bonds,” says Basant Vaid,senior research analyst,Bonanza Portfolio. The following primer will guide a retail investor through the maze of trading in commodities.

Basic requirements

Like in equities,you have to fulfill the ‘know-your-customer’ norms with a commodity broker. A photo identification,PAN and proof of address are essential for registration. You will also have to sign the necessary agreements with the broker. Choose a reputed broking house providing quality service. The broker will hep you open a demat account. Make sure you are clear about the service deliverable from your broker. Request regular research reports,which would help you unravel the commodities market.

Selecting commodities

Attempt to gather some basic information on the commodities which have been giving consistently good returns over a fairly long period. Some experts say one should start with a few commodities. Familiarise yourself with the initial amount for margin money,charges from opening the account and yearly maintenance charges. New commodity investors typically start with precious metals. Currently,over 100 commodities including agriculture,bullion,minerals and fossil fuels are traded in four national exchanges which do screen-based trading,and around 21 regional exchanges where trading in is done through the open outcry method.

Vaid of Bonanza Portfolio suggests retail investors should begin with gold as it is less volatile among international commodities and less prone to demand-supply mismatches. “Base metals and agricultural commodities are more speculative in nature,have more fund play and are therefore avoidable for people with less-risk taking ability,” he says.

Trading in futures

Commodities futures is quite similar to equity futures. You could take a long position (where you buy a contract) or a short position (where you sell it). In other words,if you think prices are going to rise,you take a long position and when prices are headed south you take a short position.

However,experts do not have a clear view on delivery in commodity futures trading. Some say that futures is not a platform for taking deliveries (for which there are physical trading platforms),but deliveries do help instill confidence. Currently,it is low in most commodities,but things are improving as the recent tie-up between a large national exchange and a financial company will allow investors to take gold deliveries in a safe and secure manner.

Risks

Analysts say risks in commodity trading are higher than in equity futures. However,information on demand and supply cycles in commodity markets is not as robust and controlled as in equites. Moreover,as India is a price-taker in many commodities,external factors like currency movement and supply disruptions could have a big influence on domestic commodity prices. Commodity futures are more volatile than equities and are cyclical,unlike equities. In perishable commodities and in crude oil,the market is driven mainly by demand and supply factors. Other factors like weather and government policies too influence the demand-supply balance.