Hold Thy Breath As Indian Commodity Markets Getting More ‘Efficient

The commodity markets in India have always been vibrant and thriving with innovations. Geyatee Deshpande explores what is in store for commodity markets in India with the advent of commodity options, and mutual funds being allowed to participate in commodity derivatives. 

 

The Indian financial market is one of the most vibrant markets, not just in the emerging market space but across the world as well. A financial market consists of an equity market, commodity market, derivatives market, and a Forex market. Proper development of all these pillars is extremely essential for the holistic growth of the financial markets in any country.

Most of the investors are aware about the developments and the innovations, which have been taking place in the Indian equity market. In fact, ours is one of the largest equity markets in the world. As markets get incrementally efficient, more and more investors participate in it, which further proliferate its efficacy. Efficient markets are always preferred by both, local and global investors. There was always a feeling amongst the investors and traders that Indian commodity market has not progressed as much as the equity markets, both in terms of technology and available hedging options. 

Recent development in the commodity markets in India: There are essentially two major developments that promise a bright future for the commodity markets in India. 

• Commodity underlying-based options will be making a debut on exchange soon.

• Mutual funds will be allowed to invest in the India’s commodity derivatives market, touted to be a watershed moment for the markets.

Commodity underlying-based options:

The move to launch the commodity underlying based options promises to deepen the 16-year old commodity derivatives market in India. In a landmark announcement, the finance minister has enabled the launch of options contracts, which will base on the underlying commodity in lieu of having a futures contract as its underlying, which is the norm currently.

The detailed norms are expected to be released soon by the SEBI for the benefit of market participants. This facility will allow those exchanges to directly launch options, which are based on underlying commodity, where the futures contracts are not available. This will be a major opportunity for commodity traders and dealers as it promises to improve liquidity in the commodity markets. As of now the commodity options are available with the underlying being futures contracts only. 

At the time of expiry, these commodity options are to be compulsorily converted into future contract, also said to be devolving into futures contract prior to expiry. The problem here is two-fold for traders:

1) Options are limited only to commodities, where the futures contract exists.

2) The compulsory devolving of the option contract into futures contract just before the expiry discourages participation.

With this new development, the commodity markets will be placed at par with the practice of equity segments of NSE, where the index and stock options are traded based on cash market underlying, rather than on futures.

Mutual funds participation in commodity markets

In another major development, SEBI has recently allowed mutual funds in India to participate in the commodity derivatives market. For retail investors, it is great news because this initiative will make diversification easier and more attractive.

Commodity, as an asset class, has proven to be a better alpha provider, as compared to many other asset classes. However, trading in different commodities need lot of data and research on supply and demand factors, affecting the commodity prices. Here is where the mutual funds will have an edge over retail investors. Mutual funds are well equipped to actively participate in the commodity market and generate higher risk adjusted returns.

One of the most important advantages of mutual funds participating in the commodity markets is the fact that it will improve liquidity in the commodities derivatives market manifold. The enhanced liquidity and presence of diverse participation groups may attract foreign investors as well into the commodity markets in India. Amongst the biggest beneficiaries of this move, will be the far month commodity futures contracts. Now one can expect to have some liquidity in these contracts too. One can expect hedgers to be more active in the markets as market participation improves. The price discovery mechanism will improve, and risk management will become less expensive and rewarding as the impact cost of trade is likely to come down drastically.

Commodities Outlook (Metals) 

Karan Joshi

Independent analyst and Trainer, 

Nickel : Nickel has been the best performing metal for this year, so far. However, price has now reached a major supply zone in the 1330-1280 range. This zone has not been breached in the past decade and hence price is expected to undergo a phase of profit booking/correction in the days ahead.

Zinc : Zinc prices slipped lower for four months in succession from May to August after which price has been moving sideways suggesting a phase of consolidation in the 175-189 range. Sustenance over 190 will confirm a breakout from consolidation and can propel the price higher towards 205-212 range which can act as resistance in the medium term. The long term trend of Zinc is positive as the commodity is making higher lows in the weekly chart; 230-235 is expected to act as a major resistance. On the downside price has a major demand zone in the 175-170 range.

Silver : Silver has bottomed out in the first half of 2019 and going ahead the outlook remains positive, ‘Buy on Dips’ appears to be the best strategy for this counter. For the past several weeks price has been consolidating near the 45,000 mark. Price has a strong support in the 43,800-43,300 range and the same can be utilized to create fresh longs. On the upside 46,450 and 48,300 are the resistance levels in the medium term. 

Commodities Outlook (Agri) 

Mustafa Nadeem CEO, Epic Research 

Soybean : The commodity has seen a recent jump in prices, followed by a cool-off period, due to two important reasons. First, the domestic Soybean crops from Madhya Pradesh, one of the major producing states, have seen damage due to extended rainfall. We may see some deterioration of crops in the tune of 20-30%. Secondly, we are seeing upside being capped due to the trade war between the US and China though the market is hopeful for a resolution sooner than later. The Indian soybean enjoys a premium stature as compared to its foreign counterparts, such as the US’s, Brazil’s, and Argentina’s soybean. We believe,the prices may have been forming a short term base around 3,400 after seeing a subdued demand in the last couple of months and are expected to move up in the current pattern; a rounding bottom in the medium term. A breakout from the channel is also seen, which was forming since early 2019. There may be a classic breakout in prices, which, at the moment, are oscillating in a range of 3,900 – 3,500.

Guar Seed : Prices are following a channel since 2016 as it is oscillating between a widerange of 1200 points. The bias is slightly bullish. Prices are taking a hit due to the lower demand. Although lower acreage and extended rainfall may yield prices to take support at a lower level. The acreage has fallen sharply in the last few years, which may provide some support to prices at lower levels of 3,900. Prices in the medium term can move higher if they sustain these lower levels of 3,900/3,800. 

Conclusion:

Asset allocation plays an important role in the overall portfolio management. It is the actual determinant of how much wealth a retail investor accumulates over a long term. Commodities, as an asset class, cannot be ignored by any investor, who is serious about wealth creation in the long run. Till now, what was holding back retail investors from participating in the Indian commodity derivatives market in a big way was the lack of innovation and development in the market. Deeper the market gets, better the prospects for the investors. In recent times, SEBI has taken some bold steps,such as allowing mutual funds to take exposure to commodity derivatives and commodity options being launched as an underlying commodity itself, rather than future contracts. It means sunny days are ahead for the Indian commodity derivatives market. The prospects of maturing commodity markets in India may open vistas of opportunity for retail investors in the coming years.