Commodity trading as an investment option.

In an era where the bank deposits provide a rate of return on investment which is even lower than the rate of inflation, investment in commodity trading is a good option one can look at. However, before taking the plunge it is advisable to know as to what is it all about.

Commodity trading is as complicated as any other investment, and requires as much, if not more research if you are not make a total hash of it. Commodity markets thrive when economies grow and at present India is at the helm of a global economic boom. Soon, India will be an important contributor to global commodity trade. Given the existing circumstances, commodity trading is all the more lucrative.

The last two and a half years have seen the commodity market getting far more regularised in India, with three fully computerised exchanges operational now- the National Multi Commodity Exchange of India Ltd. (NMCE), the National Commodity & Derivatives Exchange Ltd. (NCDEX) and MCX.

The commodity trading operates as thus. At any point, there are three concurrent contracts starting from the 21st of each month. If you enter the market on, say, July 28, you can purchase three futures- the August future,the September future and the October future – each priced differently. But you pay only a margin amount which varies according to the commodity.

The increase or decrease in price is reflected in your margin account everyday. You stand to make huge profits if first, the market always goes up, and second, the appreciation in the market is good enough to cover your rollover costs. At the end of the contract period (one-three months), you can withdraw your net profit and take a fresh position or buy a new contract. You can, though, terminate your contract before the due date, even on the day you take it.

If one was it pitch on gold at say Rs 10,000 for 10 gm and pick up a kilogram of gold for Rs 10 lakh, one would pay Rs 70,000 upfront i.e 7% margin. If the price goes up by Rs 2000 the next day, the difference of Rs 2000 is credited in ones account. Likewise, if the price falls by a thousand the next day, one is left with only Rs 1000 profit.

In commodities, the assets have physical need and consumption. Hence, price fluctuations are automatically checked. However, the commodity portfolio is more global than equity which means risks may emanate from Sydney or Chicago and not only from India. Moreover there are rupee and dollar rates to monitor.

The fact is nobody can predict markets. If you’ve earmarked money for investment in the market, it would be a good idea to split it between equity and commodities. After all, you put up only a percentage of the full value as margin, but your profits ride on the full value.