What is a commodity?
A commodity is a good, merchandise, or, a raw material which has a value, and, at the same time, can be used for commercial purposes. Rice, wheat, pulses, etc. are some of the common types of commodities, whereas gold, silver, etc. are considered to be important investment – grade commodities. Commodity prices are driven by both, the supply of both, local and global markets, and demand scenarios. Local Markets where commodities are purchased and sold are called Mandis, whereas, local intermediaries through which they are sold are called Arthiyas Mandi Fees. Commodity markets were developed much before equity or bond markets.
Need for commodity markets arises because every country has its own demographics, and any investment decision in a country is taken after evaluating the factors that affect the GDP of that country. For example, Saudi Arabia is an oil-producing country, and any change in prices of oil can change the flow of investments in Saudi Arabia. There are various companies who have an indirect exposure into the commodity business, for example, ONGC, etc.
A major cost of any company is the cost of raw materials it purchases; raw materials are most of the times a kind of commodity. This means that any company which wants to reduce these costs, should have good knowledge about the commodities that they deal in so that the future price movements can be made about that commodity.
One more reason is that commodity stocks represent almost 15% of the Nifty Index. A market reacts when there is any major news about a commodity. This means that an investor who has purchased a fund which represents NIFTY for example, should have an idea about commodities to correctly predict the price movements.
Various fund managers consider commodities as an important investment vehicle because commodities move in opposite directions when compared to the equity markets.
Commodity markets are considered to be more volatile than the equity markets, and more specialisation is required for these markets. Due to their extreme nature, anyone who wants to generate profits from these markets should be skilled and have expert knowledge.
It is seen that picking a skilled manager is considered important when selecting a fund which deals in commodities because the difference between the returns of a top-quartile fund, and a bottom quartile fund are significant. Major differences in a fund’s returns are not that significant in equity markets.
Having an exposure into a commodity can provide an investor with diversification benefits. Next, we will learn the different classifications of commodities that will help you to make a diversified portfolio.