Types Of Commodity Markets
Commodity markets are physical or virtual marketplaces which are used for buying and selling commodities. So, let us discuss each of them respectively.
Physical Markets are markets where commodities are purchased and sold in physical forms. When we hold a commodity in its physical form, it is generally perishable and needs to be stored in a proper place. Spot trades are delivered in a physical market in T+11 days. Forward contracts with future settlements are regulated through State Agriculture Marketing Boards, operated under the APMC Act of various states.
There are restrictions on farmers to contact directly with processors/manufacturing/bulk purchasers. Multiple states have amended their acts and promoted: Direct marketing, Contract farming, Private markets, Cooperatives, etc.
There are two types of trades take place in a physical market:
1.Price based trading
2.Auction based trading
But there are a few problems with a physical market:
1.Lack of proper price dissemination and transparency.
2.Lack of proper certifications and standardizations.
3.High intermediary costs involved, which leads to distress sale by farmers.
4.High dependency on unorganized money lenders by farmers.
Now, let us understand what Virtual Commodity Markets are:
Electronic Spot Exchanges:
Electronic Exchanges are considered to be better than physical markets. Trades in electronic exchanges are not Over –The – Counter (OTC), instead trades are placed online,where an exchange acts as an intermediary. Trades in spot markets are executed on spot prices, i.e., price as of now.
Spot exchanges reflect prices on a real-time basis based on demand and supply, and trades are done in paper/dematerialized (Demat) form.
Few advantages of the Spot exchanges are:
1.Transparency in prices.
2.Reduces intermediary costs.
3.Facilitates clearing and settlement, by acting as a clearinghouse.
4.Takes margin deposits and eliminates credit risks.
A derivative is a financial instrument which derives its value from an underlying asset like a commodity, equity, foreign exchange, etc.
Commodity derivative markets are exactly like equity derivatives markets with a few minor differences.
The underlying in a commodity derivative market is a commodity, unlike equity markets.
Since commodities are perishable in nature, the cost of storing a commodity becomes vital when calculating the price of a derivative.
Commodity derivatives are contracts that allow an investor to profit from certain commodities without possessing them. The buyer of a derivative contract buys the right to buy/sell a commodity at a specific price on a specified future date.
We will discuss more on the Commodity exchanges, derivatives, options and swaps in the upcoming units of our module.