Chapter 18 - Introduction to Commodities And Commodity Trading

Commodity trading

As we all know, a market where commodities are traded is referred to as a commodity market. Growth of a transparent commodity market is a sign of development of an economy. It is therefore important to have active commodity markets functioning in a country. Markets have existed for centuries worldwide for selling and buying of goods and services. The concept of market started with agricultural products and hence it is as old as the agricultural products or the business of farming itself. Traditionally, farmers used to bring their products to a central marketplace (called mandi/bazaar) in a town/village where grain merchants/ traders would also come and buy the products and transport, distribute and sell them to other markets.

In a traditional market, agricultural products would be brought and kept in the market and the potential buyers would come and see the quality of the products and negotiate with the farmers directly on the price that they would be willing to pay and the quantity that they would like to buy. Deals were struck once mutual agreement was reached on the price and the quantity to be bought/ sold. In traditional markets, shortage of a commodity in a given season would lead to increase in price for the commodity. On the other hand, oversupply of a commodity on even a single day could result in decline in price - sometimes below the cost of production. Neither farmers nor merchants were happy with this situation. Farmers often returned from the market with their products since they failed to fetch their expected price and since there were no storage facilities available close to the marketplace. This effectively started the system of commodity market forward contracts, which subsequently led to futures market too. So let us discuss about commodity as an asset class for Investment.

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