priya commodity

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EXECUTIVE SUMMARY

The title of the project is SUDY OF COMMODITY AND FUNDAMENTAL

RESEARCH its main objective is to study the trading mechanism of the multi-commodity

exchange and to describe the profile of gold and silver as a commodity. It further delves into the

fundamental research of a commodity and to form the trading strategy for the future.

The whole project is divided into five parts where in the first part deals with the objective,

scope and approach of the project. The second part deals with mechanism of commodity trading

carried by the multi commodity exchange. Third part delves into the fundamentals of bullions

i.e. gold and silver. This part enables us to know the fundamental of gold and silver that an

analyst should know for research. Fourth part deals with the brief definition of fundamental and

technical analysis and a fundamental research is carried on the commodity wheat. The

conclusion is drawn as to what should be the trading strategy for trading in wheat for the

coming month futures. In the last section, the analysis is done related with the Indian

commodity market and the suggestions to improve it.

The information provided in the project would be useful to understand the fundamental

knowledge that is required in forming the strategy for trading.

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Chapterno.

Name of the chapter Page no.

1 Part 1 31.1 Objective

1.2 Approach1.3 Scope of the study

1.4 Limitations

2 Part-11 4-20

2.1 Theoretical framework

2.2 Derivatives

2.3 Derivative market

2.4 Commodity

2.5 History of commodity trading

2.6 Evolution of commodity market in India

2.7 Commodity derivatives2.8 Futures contract

2.9 Hedging

2.10 Speculation

2.11 Arbitrage

2.12 Operational mechanism of MCX

3 Part -III 21-333.1 Commodity profile

3.2 Silver

3.3 Gold

4 Part -IV 34-52

4.1 Fundamental analysis

4.2 Technical analysis (basic definition)

4.3 Analysis of wheat.

5 Part-V 53-55

5.1 Analysis of the Indian commodity market

5.2 Macro analysis

References.

PART-I

OBJECTIVE OF THE STUDY:

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o Monitoring and surveillance of the activities of various participants become

extremely difficult in these kind of mixed markets.

o Derivatives markets help increase savings and investment in the long run. The

transfer of risk enables market participants to expand their volume of activity.

Derivative market:

Derivative markets can broadly be classified as commodity derivative market and financial

derivatives markets. As the name suggest, commodity derivatives markets trade contracts for

which the underlying asset is a commodity. It can be an agricultural commodity like wheat,

Soybeans, rapeseed, cotton, etc or precious metals like gold, silver, etc.

The most commonly used derivatives contracts are forwards, futures and options

COMMODITY:

The commodity means any intermediate goods, which is useful for production and which has

constant and standard qualities. Commodity is derived from the Latin word Commodus which

means convenient.

Characteristics of a commodity and commodity market:

1. They have standard and constant value

2. They are scarce

3. They are intermediate

4. They are controllable cost5. Markets are liquid and competitive i.e. liquidity means the total supply equals total

demands or more or less same and fluctuation due to seasonal imbalance and changing

circumstances. Competitiveness is that large number of buyers and sellers and perfect

knowledge of market.

6. There two types of market: centralized and decentralized

Centralized Markets Decentralized markets

Auction market

Centralized

exchange

OTC

Posted price

History of commodity trading:

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Derivatives as a tool for managing risk first originated in the commodities markets. They were

then found useful as a hedging tool in financial markets as well. In India, trading in commodity

futures has been in existence from the nineteenth century with organized trading in cotton

through the establishment of Cotton Trade Association in 1875. Over a period of time, other

commodities were permitted to be traded in futures exchanges. Regulatory constraints in 1960s

resulted in virtual dismantling of the commodities future markets. It is only in the last decade

that Commodity future exchanges have been actively encouraged. However, the markets have

been thin with poor liquidity and have not grown to any significant level.

Evolution of market in India:

Bombay cotton trade association ltd.set up in 1875 was the first organized futures market.

Bombay cotton exchange ltd.was established in1893 following the widespread discontent

among leading cotton mill owners and merchants over functioning at Bombay cotton trade

association. The future trading in oils seed started in 1900 with the establishment of the Gujarat

vyapari mandli, which carried on futures trading in groundnut, castor seed, and cotton. Futures

trading in wheat were existent at several places in Punjab and Uttar Pradesh. But the most

notable futures exchange for wheat was chamber of commerce at hapur set up in 1913.futures

trading in bullion began in Mumbai in1920calcutta Hessian exchange ltd.was established in

1919 for futures trading in raw jute and jute goods. But organized futures trading in raw jute

began only in 1945 to form the east India jute and Hessian ltd, to conduct organized trading in

both raw jute and jute goods. Forward contracts act was enacted in 1952 and the forward marketcommission was established in 1953 under the ministry of consumer affair and public

distribution.

Present scenario:

Out of these 25 commodities the MCX, NCDEX and NMCE are large exchanges and MCX is

the biggest among them. Forward Markets Commission (FMC) headquartered at Mumbai is a

regulatory authority, which is overseen by the Ministry of Consumer Affairs and Public

Distribution, Govt. of India. It is a statutory body set up in 1953 under the Forward Contracts

(Regulation) Act, 1952.

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Commodity derivative

The basic concept of a derivative contract remains the same whether the underlying happens to

be a commodity or a financial asset.

Characteristics of commodity derivatives:

o Due to the bulky nature of the underlying assets, physical settlement in commodity

derivatives creates the need for warehousing.

o In the case of commodities, the quality of the asset underlying a contract can vary largely.

This becomes an important issue to be managed.

Trading tools:

1. FORWARD CONTRACTS:

A forward contract is an agreement to buy or sell an asset on a specified date for a specified

price. One of the parties to the contract assumes a long position and agrees to buy the

underlying asset on a certain specified future date for a certain specified price. The other party

assumes a short position and agrees to sell the asset on the same date for the same price.

Other contract details like delivery date, the parties to the contract negotiate price and quantity

bilaterally. The forward contracts are normally traded outside the exchanges. The salient

features of forward contracts are:

They are bilateral contracts and hence exposed to counter party risk.

Each contract is custom designed, and hence is unique in terms of contract size,

expiration date and the asset type and quality.

The contract price is generally not available in public domain.

On the expiration date, the contract has to be settled by delivery of the asset.

If the party wishes to reverse the contract, it has to compulsorily go to the same counter

party, which often results in high prices being charged.

Example of forward contract is foreign exchange market.

Explanation with an example:

Forward contracts are very useful in hedging and speculation. The classic hedging application

would be that of an exporter who expects to receive payment in dollars three months later. He is

exposed to the risk of exchange rate fluctuations. By using the currency forward market to sell

Dollars forward, he can lock on to a rate today and reduce his uncertainty.

If a speculator has information or analysis, which forecasts an upturn in a price, then he can go

long on the forward market instead of the cash market. The speculator would go long on the

forward, wait for the price to rise, and then take a reversing transaction to book profit

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Speculators may well be required to deposit a margin upfront. However, this is generally a

relatively small proportion of the value of the assets underlying the forward contract. The use of

forward markets here supplies leverage to the speculator.

The disadvantages of forward market are:

1. Lack of liquidity

2. No counter party guarantee

3. No standardization.

2. FUTURES CONTRACT:

A futures contract is an agreement between two parties to buy or sell an asset at a certain time in

the future at a certain price. But unlike forward contracts, the futures contracts are standardized

and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifiescertain standard features of the contract. It is a standardized contract with standard underlying

instrument, a standard quantity and quality of the underlying instrument that can be delivered,

(or which can be used for reference purposes in settlement) and a standard timing of such

settlement. A futures contract may be offset prior to maturity by entering into an equal and

opposite transaction. More than 99% of futures transactions are offset this way.

The standardized item in the future is:

o Quantity of the underlying

o Quality of the underlying

o The date and the month of deliveryo The units of price quotation and minimum price change

o Location of settlement

Terminology used in futures:

Spot price: The price at which an asset trades in the spot market.

Futures price: The price at which the futures contract trades in the futures

market.

Contract cycle: The period over which a contract trades. The commodity futures

contracts on the NCDEX have one-month, two-month and three-month expiry cycles, whichexpire on the 20th day of the delivery month. Thus a January expiration contract expires on

the 20th of January and a February expiration contract ceases trading on the 20th of

February. On the next trading day following the 20th, a new contract having a three-month

expiry is introduced for trading.

Expiry date: It is the date specified in the futures contract. This is the last day on

which the contract will be traded, at the end of which it will cease to exist.

Delivery unit: The amount of asset that has to be delivered less than one

contract. For instance, the delivery unit for futures on Long Staple Cotton on the NCDEX is

55 bales. The delivery unit for the Gold futures contract is 1 kg.

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Basis: Basis can be defined as the futures price minus the spot price. There will

be a different basis for each delivery month for each contract. In a normal market, basis will

be positive. This rejects that futures prices normally exceed spot prices.

Cost of carry: The relationship between futures prices and spot prices can be

summarized in terms of what is known as the cost of carry. This measures the storage cost

plus the interest that is paid to finance the asset less the income earned on the asset.

Initial margin: The amount that must be deposited in the margin account at the

time a futures contract is first entered into is known as initial margin.

Marking-to-market (MTM): In the futures market, at the end of each trading day,

the margin account is adjusted to reflect the investor's gain or loss depending upon the

futures closing price. This is called marking to market.

Maintenance margin: This is somewhat lower than the initial margin. This is set

to ensure that the balance in the margin account never becomes negative. If the balance in

the margin account falls below the maintenance margin, the investor receives a margin call

and is expected to top up the

Basic payoffs

A payoff is the likely profit/ loss that would accrue to a market participant with change in the

price of the underlying asset. This is generally depicted in the form of payoff diagrams, which

show the price of the underlying asset on the X-axis and the profits/ losses on the Y-axis.

Payoff for futuresFutures contracts have linear payoff, just like the payoff of the underlying asset that we looked

at earlier. If the price of the underlying rises, the buyer makes profits. If the price of the

underlying falls, the buyer makes losses. The magnitude of profits or losses for a given upward

or downward movement is the same. The profits as well as losses for the buyer and the seller of

a futures contract are unlimited. These linear payoffs are fascinating as they can be combined

with options and the underlying to generate various complex payoffs.

Payoff for buyer of futures: Long futures

The payoff for a person who buys a futures contract is similar to the payoff for a person who

holds an asset. He has a potentially unlimited upside as well as a potentially unlimited

downside.

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Figure-1Payoff for a buyer of gold

The figure shows the profits/ losses from a long position on gold. The investor bought gold at

Rs.6000 per 10 Gms. If the price of gold rises, he profits. If price of gold falls he looses.

Profit

+500

5500 6000 6500

0

-500

Loss

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Figure 2Payoff for a seller of gold

The figure shows the profits/ losses from a short position on cotton. The investor sold long

staple cotton at Rs.6500 per Quintal. If the price of cotton falls, he profits. If the price of cotton

rises, he looses.

6000 6500 7000

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Figure 3Payoff for a buyer of gold futures

The figure shows the profits/ losses for a long futures position. The investor bought futures

when gold futures were trading at Rs.6000 per 10 Gms. If the price of the underlying gold goes

up, the gold futures price too would go up and his futures position starts making profit. If the

price of gold falls, the futures price falls too and his futures position starts showing losses.

Take the case of a speculator who buys a two-month gold futures contract on the NCDEX when

it sells for Rs.6000 per 10 Gms. The underlying asset in this case is gold. When the prices of

gold in the spot market goes up, the futures price too moves up and the long futures position

start making profits. Similarly when the prices of gold in the spot market goes down, the futures

prices too move down and the long futures position starts making losses.

Profit

6000

Gold future price.

Loss

Payoff for seller of futures: Short futuresThe payoff for a person who sells a futures contract is similar to the payoff for a person who

shorts an asset. He has a potentially unlimited upside as well as a potentially unlimited

downside. Take the case of a speculator who sells a two-month cotton futures contract when the

contract sells Rs.6500 per Quintal. The underlying asset in this case is long staple cotton. When

the prices of long staple cotton move down, the cotton futures prices also move down and the

short futures position starts making profits. When the prices of long staple cotton move up, the

cotton futures price also moves up and the short futures position starts making losses.

Figure 4payoff for a seller of cotton futures

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The figure shows the profits/ losses for a short futures position. The investor sold cotton futures

at Rs.6500 per Quintal. If the price of the underlying long staple cotton goes down, the futures

price also falls, and the short futures position starts making profit. If the price of the underlying

long staple cotton rises, the futures too rise, and the short futures position starts showing losses.

Profit

6500

Loss

How to use the trading tools:

The technique of HEDGING:

Many participants in the commodity futures market are hedgers. They use the futures market to

reduce a particular risk that they face. This risk might relate to the price of wheat or oil or any

other commodity that the person deals in. The classic hedging example is that of wheat farmer

who wants to hedge the risk of fluctuations in the price of wheat around the time that his crop isready for harvesting. By selling his crop forward, he obtains a hedge by locking in to a

predetermined price.

What hedging does however is, that it makes the outcome more certain. Hedgers could be

government institutions, private corporations like financial institutions, trading companies and

even other participants in the value chain, for instance farmers, extractors, ginners, processors

etc., who are influenced by the commodity prices.

Basic principles of hedging: When an individual or a company decides to use the futures

markets to hedge a risk, the objective is to take a position that neutralizes the risk as much as

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possible. Take the case of a company that knows that it will gain Rs.1, 00,000 for each 1 rupee

increase in the price of a commodity over the next three months and will lose Rs.1, 00,000 for

each 1 rupee decrease in the price of a commodity over the same period. To hedge, the company

should take a short futures position that is designed to offset this risk. The futures position

should lead to a loss of Rs.1, 00,000 for each 1-rupee increase in the price of the commodity

over the next three months and a gain of Rs.1, 00,000 for each 1-rupee decrease in the price

during this period. If the price of the commodity goes down, the gain on the futures position

offsets the loss on the commodity.

There are basically two kinds of hedges that can be taken. A company that wants to sell an asset

at a particular time in the future can hedge by taking short futures position. This is called a

short hedge. Similarly, a company that knows that it is due to buy an asset in the future can

hedge by taking long futures position. This is known as long hedge.

.

Short hedge

A short hedge is appropriate when the hedger already owns the asset, or is likely to own the

asset and expects to sell it at some time in the future. For example, a cotton farmer who expects

the cotton crop to be ready for sale in the next two months could use a short hedge.

Example:

15th of January and that a refined soy oil producer has just negotiated a contract to sell 10,000

Kgs of soy oil. It has been agreed that the price that will apply in the contract is the market price

on the 15th April. The oil producer is therefore in a position where he will gain Rs.10000 each 1

rupee increase in the price of oil over the next three months and lose Rs.10000 for each onerupee decrease in the price of oil during this period. Suppose the spot price for soy oil on

January 15 is Rs.450 per 10 Kgs and the April soy oil futures price on the NCDEX is Rs.465

per 10 Kgs. The producer can hedge his exposure by selling 10,000 Kgs worth of April futures

contracts (10 units). If the oil producers closes his position on April 15, the effect of the strategy

would be to lock in a price close to Rs.465 per 10 Kgs. On April 15, the spot price can either be

above Rs.465 or below Rs.465.

Case 1: The spot price is Rs.455 per 10 Kgs. The company realizes Rs.4, 55,000 under its sales

contract. Because April is the delivery month for the futures contract, the futures price on April

15 should be very close to the spot price of Rs.455 on that date. The company closes its short

futures position at Rs.455, making a gain of Rs.465 - Rs.455 = Rs.10 per 10 Kgs, or Rs.10, 000

on its short futures position. The total amount realized from both the futures position and the

sales contract is therefore about Rs.465 per 10 Kgs, Rs.4, 65,000 in total.

Case 2: The spot price is Rs.475 per 10 Kgs. The company realizes Rs.4, 75,000 under its sales

contract. Because April is the delivery month for the futures contract, the futures price on April

15 should be very close to the spot price of Rs.475 on that date. The company closes its short

futures position at Rs.475, making a loss of Rs.475 - Rs.465 = Rs.10 per 10 Kgs, or Rs.10, 000

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on its short futures position. The total amount realized from both the futures position and the

sales contract is therefore about Rs.465 per 10 Kgs, Rs.4, 65,000 in total.

Long hedge:

A long hedge is appropriate when a company knows it will have to purchase a certain asset in

the future and wants to lock in a price now. Suppose that it is now January 15. A firm involved

in industrial fabrication knows that it will require 300 Kgs of silver on April 15 to meet a

certain contract. The spot price of silver is Rs.1680

The payoff for an industrial fabricator who takes a long hedge. Irrespective of what the spot

price of silver is three months later, by going in for a long hedge he locks on to a price of

Rs.1730 per kg.

The payoff for the buyer of a long hedge. Let us look at how this works. On April 15, the spot

price can either be above Rs.1730 or below Rs.1730.

Case 1: The spot price is Rs.1780 per kg. The fabricator pays rs.5, 34,000 to buy the silver fromthe spot market. Because April is the delivery month for the futures contract, the futures price

on April 15 should be very close to the spot price of Rs.1780 on that date. The company closes

its long futures position at Rs.1780, making a gain of Rs.1780 - Rs.1730 = Rs.50 per kg, or

Rs.15, 000 on its long futures position. The effective cost of silver purchased works out to be

about Rs.1730 per MT, or Rs.5, 19,000 in total.

Case 2: The spot price is Rs.1690 per MT. The fabricator pays Rs.5, 07,000 to buy the silver

from the spot market. Because April is the delivery month for the futures contract, the futures

price on April 15 should be very close to the spot price of Rs.1690 on that date. The companycloses its long futures position at Rs.1690, making a loss of Rs.1730 - Rs.1690 = Rs.40 per kg,

or Rs.12, 000 on its long futures position. The effective cost of silver purchased works out to be

about Rs.1730 per MT, or Rs.5, 19,000 in total. Note that the purpose of hedging is not to make

profits, but to lock on to a price to be paid in the future upfront. In the industrial fabricator

example, since prices of silver rose in three months, on hind sight it would seem that the

company would have been better off buying the silver in January and holding it. But this would

involve incurring interest cost and warehousing costs. Besides, if the prices of silver fell in

April, the company would have not only incurred interest and storage costs, but would also have

ended up buying silver at a much higher price. In the examples above we assume that the

futures position is closed out in the delivery month. The hedge has the same basic effect if

delivery is allowed to happen. However, making or taking delivery can be a costly process. In

most cases, delivery is not made even when the hedger keeps the futures contract until the

delivery month. Hedgers with long positions usually avoid any possibility of having to take

delivery by closing out their positions before the delivery period.

Advantages of hedging:

Besides the basic advantage of risk management, hedging also has other advantages:

1. Hedging stretches the marketing period. For example, a livestock feeder does not have to

wait until his cattle are ready to market before he can sell them. The futures market permits him

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to sell futures contracts to establish the approximate sale price at any time between the time he

buys his calves for feeding and the time the fed cattle are ready to market, some four to six

months later. He can take advantage of good prices even though the cattle are not ready for

market.

2. Hedging protects inventory values. For example, a merchandiser with a large, unsold

inventory can sell futures contracts that will protect the value of the inventory, even if the price

of the commodity drops.

3. Hedging permits forward pricing of products. For example, a jewelry manufacturer can

determine the cost for gold, silver or platinum by buying a futures contract, translate that to a

price for the finished products, and make forward sales to stores at firm prices. Having made the

forward sales, the manufacturer can use his capital to acquire only as much gold, silver, or

platinum as may be needed to make the products that will fill its orders.

Limitation of hedging: basis Risk

Hedging can only minimize the risk but cannot fully eliminate it. The loss made during selling

of an asset may not always be equal to the profits made by taking a short futures position. This

is because the value of the asset sold in the spot market and the value of the asset underlying the

future contract may not be the same. This is called the basis risk. In our examples, the hedger

was able to identify the precise date in the future when an asset would be bought or sold. The

hedger was then able to use the perfect futures contract to remove almost all the risk arising out

of price of the asset on that date. In reality, this may not always be possible for a various

reasons. The asset whose price is to be hedged may not be exactly the same as the asset

underlying the futures contract. For example, in India we have a large number of varieties of

cotton being cultivated. It is impractical for an exchange to have futures contracts with all

these varieties of cotton as an underlying.

The hedger may be uncertain as to the exact date when the asset will be bought or sold.

Often the hedge may require the futures contract to be closed out well before its expiration

date. This could result in an imperfect hedge.

The expiration date of the hedge may be later than the delivery date of the futures

contract. When this happens, the hedger would be required to close out the futures contracts

entered into and take the same position in futures contracts with a later delivery date.

The technique of SPECULATION:

An entity having an opinion on the price movements of a given commodity can speculate using

the commodity market. Commodities are bulky products and come with all the costs and

procedures of handling these products. The commodities futures markets provide speculators

with an easy mechanism to speculate on the price of underlying commodities.

To trade commodity futures on the mcx, a customer must open a futures trading account with a

commodity derivatives broker. Buying futures simply involves putting in the margin money.

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This enables futures traders to take a position in the underlying commodity without having to

actually hold that commodity. With the purchase of futures contract on a commodity, the holder

essentially makes a legally binding promise or obligation to buy the underlying security at some

point in the future (the expiration date of the contract)

Speculation: Bullish commodity, buy futures

Take the case of a speculator who has a view on the direction of the price movements of gold.

Perhaps he knows that towards the end of the year due to festivals and the upcoming wedding

season, the prices of gold are likely to rise. He would like to trade based on this view. Gold

trades for Rs.6000 per 10 Gms in the spot market and he expects its price to go up in the next

two three months. How can he trade based on this belief? In the absence of a deferral product,

he would have to buy gold and hold on to it. Suppose he buys a 1 kg of gold, which costs him

Rs.6, 00,000. Suppose further that his hunch proves correct and three months later gold trades at

Rs.6400 per 10 Gms. He makes a profit of Rs.40, 000 on an investment of Rs.6, 00,000 for a

period of three months. This works out to an annual return of about 26 percent. Today a

speculator can take exactly the same position on gold by using gold futures contracts. Let us see

how this works. Gold trades at Rs.6000 per 10 Gms and three-month gold futures trades at

Rs.6150. The unit of trading is 100 Gms and the delivery unit for the gold futures contract on

the NCDEX is 1 kg. He buys

One kg of gold futures, which have a value of Rs.6, 15,000. Buying an asset in the futures

market only requires making margin payments. To take this position, he pays a margin of Rs.1,

20,000. Three months later gold trades at Rs.6400 per 10 Gms. As we know, on the day of

expiration, the futures price converges to the spot price (else there would be a risk free arbitrageopportunity). He closes his long futures position at Rs.6400 in the process making a profit of

Rs.25, 000 on an initial margin investment of Rs.1, 20,000. This works out to an annual return

of 83 percent. Because of the leverage they provide, commodity futures form an attractive tool

for speculators.

Bearish commodity, sell futures

A speculator who believes that there is likely to be excess supply of a particular commodity in

the near future and hence the prices are likely to see a fall can also use commodity futures. How

can he trade based on this opinion? In the absence of a deferral product, there wasn't much he

could do to profit from his opinion. Today all he needs to do is sell commodity futures. Let us

understand how this works. Simple arbitrage ensures that the price of a futures contract on a

commodity moves correspondingly with the price of the underlying commodity. If the

commodity price rises, so will the futures price. If the commodity price falls, so will the futures

price. Now take the case of the trader who expects to see a fall in the price of cotton. He sells

ten two month cotton futures contract, which is for delivery of 550 bales of cotton. The value of

the contract is Rs.4, 00,000. He pays a small margin on the same. Three months later, if his

hunch were correct the price of cotton falls. So does the price of cotton futures. He close out his

short futures position at Rs.3, 50,000, making a profit of Rs.50, 000.

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The technique of ARBITRAGE:

A central idea in modern economics is the law of one price. This states that in a competitive

market, if two assets are equivalent from the point of view of risk and return, they should sell at

the same price. If the price of the same asset is different in two markets, there will be operators

who will buy in the market where the asset sells cheap and sell in the market where it is costly.

This activity termed as arbitrage, involves the simultaneous purchase and sale of the same or

essentially similar security in two different markets for advantageously different prices. The

buying cheap and selling expensive continues till prices in the two markets reach equilibrium.

Hence, arbitrage helps to equalize prices and restore market efficiency.

Whenever the futures price deviates substantially from its fair value, arbitrage opportunities

arise. To capture mispricing that result in overpriced futures, the arbitrager must sell futures and

buy spot, whereas to capture mispricing that result in under priced futures, the arbitrager must

sell spot and buy futures. In the case of investment commodities, mispricing would result in

both, buying the spot and holding it or selling the spot and investing the proceeds. However, in

the case of consumption assets, which are held primarily for reasons of usage, even if there

exists a mispricing, a person who holds the underlying may not want to sell it to profit from the

arbitrage.

Overpriced commodity futures: buy spot, sell futures. An arbitrager notices that gold futures

seem overpriced. How can he cash in on this opportunity to earn risk less profits? Say for

instance, gold trades for Rs.600 per gram in the spot market. Three month gold futures on the

NCDEX trade at Rs.625 and seem overpriced. He could make risk less profit by entering into

the following set of transactions.

1. On day one, borrow Rs.60, 07,460 at 6% per annum to cover the cost of buying and

holding gold. Buy 10 Kgs of gold on the cash/ spot market at Rs.60, 00,000. Pay (310 +

7150) as warehouse costs. (We assume that fixed charge is Rs.310 per deposit up to 500

Kgs. and the variable storage costs are Rs.55 per kg per week for 13 weeks).2. Simultaneously, sell 10 gold futures contract at Rs.62, 50,000.

3. Take delivery of the gold purchased and hold it for three months.

4. On the futures expiration date, the spot and the futures price converge. Now unwind the

position.

7. Say gold closes at Rs.615 in the spot market. Sell the gold for Rs.61, 50,000.

8. Futures position expires with profit of Rs.1, 00,000.

9. From the Rs.62, 50,000 held in hand, return the borrowed amount plus interest of Rs.60,

98,251.

10. The result is a risk less profit of Rs.1, 51,749.

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When does it make sense to enter into this arbitrage? If the cost of borrowing funds to buy the

commodity is less than the arbitrage profit possible, it makes sense to arbitrage. This is termed

as cash and carry arbitrage. Remember however, that exploiting an arbitrage opportunity

involves trading on the spot and futures market. In the real world, one has to build in the

transactions costs into the arbitrage strategy.

Under priced commodity futures: buy futures, sell spot

An arbitrager notices that gold futures seem under priced. How can he cash in on this

opportunity to earn risk less profits say for instance, gold trades for Rs.600 per gram in the spot

market Three month gold futures on the NCDEX trade at Rs.605 and seem under priced. If he

happens to hold gold, he could make risk less profit by entering into the following set of

transactions.

1. On day one, sell 10 Kgs of gold in the spot market at Rs.60, 00,000.

2. Invest the Rs.60, 00,000 plus the Rs.7150 saved by way of warehouse costs for three months

6%.

3. Simultaneously, buy three-month gold futures on NCDEX at Rs.60, 50,000.

4. Suppose the price of gold is Rs.615 per gram. On the futures expiration date, the spot and the

futures price of gold converge. Now unwind the position.

5. The gold sales proceeds grow to Rs.60, 97,936.

6. The futures position expires with a profit of Rs.1, 00,000.

7. Buy back gold at Rs.61, 50,000 on the spot market.

8. The result is a risk less profit of Rs.47, 936.

If the returns you get by investing in risk less instruments is more than the return from the

Arbitrage trades; it makes sense for you to arbitrage. This is termed as reverse cash and carry

arbitrage. It is this arbitrage activity that ensures that the spot and futures prices stay in line with

the cost carry. As we can see, exploiting arbitrage involves trading on the spot market. As

more and more players in the market develop the knowledge and skills to do cash-and-carry and

reverse cash-and-carry, we will see increased volumes and lower spreads in both the cash as

well as the derivatives market.

Operational mechanism with respect to the trading of commodities at MCX:

MCX is designed in a manner to ensure that it broad bases the market participation by making

its operations inclusive and expansive, but at the same time building in sufficient measures that

would ensure the safety and integrity of the market is maintained at all times. Moreover, in

order to provide a strong correlation between the Physicals and Futures markets, and based on

Indias long history of trade practice continuing since over 100 years, MCX provides for

settlement of all open positions at the end of the contract through delivery.

The salient features of the MCX market framework include the following:

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Matching System - Order Driven system of matching based on the logic of price-time priority

Margins Initial margins are computed and adjusted online whereas the Mark to Market

margins are collected by the next day. The business is based on the deposit contribution made

by the Members to MCX that is earmarked online with every trade. Thus, Members are able to

take only such positions as their deposit entitles them, based on the commodity specific margin

utilization.

Guarantee MCX, through its Settlement Guarantee Fund, guarantees the net settlement

liability of futures contract executed in the Exchange as per its Rules, Byelaws, Business Rules

and Regulations.

Settlement - All net outstanding futures contracts during the delivery period may be settled by

delivery of the underlying commodity. The objective is to ensure that MCX is able to maintain

close association between the Futures Market and the Physical Market.

Delivery - To start with the trade practice, which has been in existence in the country for over

100 years that delivery will be sellers option and the Buyers obligation, has been adopted.

However, going forward, should the market desire so, suitable amendments can be done to

make the delivery rules, inclined to the market requirements.

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PART-III

COMMODITY PROFILE

SILVER:

Silvers unique properties make its a very useful Industrial Commodity, despite it being

classed as a precious metal.

Demand: Demand for silver is built on three main pillars; industrial uses, photography and

jewelry & silverware accounting for 342, 205 and 259 million ounces respectively in 2009.

1. In terms of fabrication demand, silver possesses many physical characteristics, which

make it a key component in numerous products used on a daily basis. The main uses for

silver are in.2. Jewelry and silverware,

3. Photographic films and papers, and

4. Electrical contacts and connectors.

5. Mirror, medical instruments, dental alloys, brazing alloys, silver-bearing batteries, and

bearings.

Briefing of demand:

Together, industrial and decorative uses, photography and jewelry and silverware

represent more than 95% of annual silver consumption.

Industrial use of silver is the largest component of silver fabrication demand, with silver

being used in a wide range of products. Electrical and electronics applications account for

the largest area of industrial silver off take, (roughly 85% of the silver demand)

Jewelry and silverware fabrication demand represents second largest component of the

silver demand. World demand of silver:

Demand Drivers 2009 (in tons) 2010 (in tons)

Fabrication

- Industrial Application 341.4 351.2

- Photography 205.7 196.1- Jewelry & Silverware 265.9 276.7

- Coins & Medals 32.8 35.3

Total Fabrication 845.8 859.2

Net Government Purchases - -

Producer De- hedging 24.8 21.0

Implied Net Investment - -

Total Demand 870.7 880.2.

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Supply:

The supply of silver is based on two facts: mine production and recycled silver scraps. Mine

production is surprisingly the largest components of silver supply. It normally accounts for a

little less than two third of the total

Silver is often mined as by product of other base metal production, which accounts for

r-fifth of the total supply.

Other sources of supply are scrap: it is the silver that returns to the market when

recovered from the existing manufactured goods and wastes. it makes fifth of the supply.

Disinvestments

Government sales.

Producers hedging

Recycling

PRODUCTION:

In many instances, silver occurs in ores along with gold, copper, lead, zinc and other metals. In

many mines, the primary product is one of these metals, with silver being a by-product. At some

mines, silver is the sole product or main co-product.

Just over half of mined silver comes from Mexico, Peru and United States, respectively, the

first, second and fourth largest producing countries. The third largest is Australia.

Silver occurs in the metallic state, commonly associated with gold, copper, lead, andzinc. It is also found in some 60 minerals including: argentite (a sulfide), cerargyrite (a

chloride), many other sulfides and telluride.

Relative abundance in solar system: -0.313 log Abundance earth's crust: -1.2 log

The amount of silver extracted from primary silver mines fell, while silver mined as a

co-product of copper, lead, zinc, gold, or poly-metallic deposits rose.

Growth in silver bearing products worldwide has also led to increases in the amount of

silver recovered from scrap recycling. Most scrap comes from photographic materials,

jewelry, and silverware.

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2009 World Mine Production of Silver by Source

Fig-1: World Silver Supply from Aboveground Stocks

World Silver Supply and Demand (million ounces) (Totals may not add due to

rounding)

Supply

2009 2010

Mine Production 596.4 595.6

Net government Sales 61.2 82.6Oil Silver Scrap 186.8 199.6

Producer hedging - -

Implied net disinvestments 26.2 10.4

Total Supply 870.7 880.2

Indian Scenario

Silver imports into India for domestic consumption in 2009 was 3,400 tons down 25 % from

record 4,540 tons in 2008.

Open General License (OGL) imports are the only significant source of supply to the Indian

market.

Non-duty paid silver for the export sector rose sharply in 2009, up by close to 200% year-on-

year to 150 tons.

Around 50% of Indias silver requirements last year were met through imports of Chinese

silver and other important sources of supply being UK, CIS, Australia and Dubai.

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Indian industrial demand in 2009 is estimated at 1375 tons down by 13 % from 1,579 tons in

2008. In spite of this fall, India is still one of the largest users of silver in the world, ranking

alongside those Industrial giants, Japan and the United States.

By contrast with United States and Japan, Indian industrial off take for fabrication in hardcore

industrial applications like electronics and brazing alloys accounts for only 15 % and the rest

being for foils for use in the decorative covering of food, plating of jewelry and silverware and

jari.

In India silver price volatility is also an important determinant of silver demand as it is for

gold.

Percentage

Pharmacy & Chemicals 22.4Foil 9.0

Plating 13.7

Solders & Brazing 5.4

Electrical 13.5

Photography 0.85

Jari 17.1

Table-1: India Industrial Fabrication, 2009:

World Markets

London Bullion Market is the global hub of OTC (Over-The-Counter) trading in silver. Comex

futures in New York is where most fund activity is focused

Frequency Distribution of Silver London Fixing Volatility from 2002 till date

Percentage Change

>7 % 5-7% 3-5%


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Biggest Price Movement since 2002

Between February 4 6, 2005, daily prices rocketed by 22.3%, based on a noted US financier

had accumulated nearly 130 ounces of physical silver.

Note: Post September 2006 daily silver prices have shown more than 5% movement not once

and weekly silver prices only once.

FACTORS INFLUENCING PRICES OF SILVER:

The price of silver is not only a function of its primary output but more a function of the price

of other metals also, as world mine production is more a function of the prices of other metals

1. Inflation

2. Changing value of paper currency.

3. Fluctuation in deficit

4. Interest rates.5. Prices and demand of the main products: the greater profitability to the miner in other

metals will lead to the increment in production of the metal and hence of the silver in

tandem.

DEMAND /SUPPLY DYNAMICS:

The reality of these trends is that as investment demand for bullion increases, jewelry demand

decreases and vice versa. Thus, we have a pendulum demand/ supply behavior. When we

adjust for currency changes, hedging and de-hedging, we end up with a stable, long-term

staircase style upward secular trend projection for gold bullion over the next decade.

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GOLD:

Gold is primarily a monetary asset and partly a commodity.

More than two thirds of golds total accumulated holdings relate to value for

investment with central bank reserves, private players and high-carat jewelry.

Less than one third of golds total accumulated holdings are as a commodity for

jewelry in Western markets and usage in industry.

Gold market is highly liquid and gold held by central banks, other major institutions and

retail jewelry keep coming back to the market.

Economic forces that determine the price of gold are different from, and in many cases

opposed to the forces that influence most financial assets.

South Africa is the world's largest gold producer with 394 tons in 2008, followed by US

and Australia.

India is the world's largest gold consumer with an annual demand of 800 tons.

Demand:

Industrial uses:

Gold possesses a unique combination of properties that have resulted in its use in a wide

range of industrial applications. These applications in total account for a current

consumption of approximately 450 tonnes of gold per annum..

Gold and its alloys have been used fordecorative purposes. The most significant uses of gold in electronics

A number of gold products are used in dentistry.

Gold is not a liability of any government or corporation it does not, unlike currencies, bonds

and equities, run any risk of becoming worthless through the default of the issuer. In more

recent times its role as an excellent portfolio diversifier. Since, unlike jeweler and industrial

demand, investment is measured on a net basis this makes it appear more volatile. However

interest in gold also rises and falls as a result of the political and economic situation; its role as a

safe haven often prompts buying during time of worry or uncertainty.

Investment holdings (institutional and retail) account for 16% of the total stocks of gold .Over the last five years net retail investment has accounted for 13% of total demand. Its share

of gold stocks is greater than its share of demand, due to the greater importance investment had

as a share of demand in earlier years.

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Source:

Due to large stocks of gold as against its demand, it is argued that the core driver of the real

price of gold is stock equilibrium rather that the flow equilibrium

SUPPLY:

The main suppliers of gold are Grasberg, Australia, Russia, Switzerland, Netherlands,

Germany and Greece. Gold is produced in every continent except for Antarctica.

The main sources of supply are:

1. Mining

2. Scrap

3. Hedging activity

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Mine Production by major region, 2010(total, 2,593 tonnes)

PRODUCTION: The grade of ore refers to the proportion of gold contained in the ore of a

particular mine and is quoted in grams per tonnes (g/t). The type of mine depends on the depth

and grade of the ore. At a rough estimate, the larger, better quality South African underground

operations are around 8-10g/t (Anglogold), while the marginal South African underground

mines run at around 4-6g/t. Many of the operations elsewhere in the world are open pit mines,

which run at lower grades, from as little as 1g/t up to around 3-4g/t. A more significant piece of

information than average gold mining grade is cost per ounce, which is a combination of grade

(grams/tonnes) and operating costs (USD/tonnes).

COST OF PRODUCTION:

Production costs vary widely, according to the nature of the mine, be it open pit or underground

and at what depth, the nature and distribution of the ore-body (and by implication the

metallurgy which affects processing techniques) and the grade. Average quoted cash costs for

2010 were estimated by GFMS at US$222/ounce with total cash costs (including depreciation,

amortization, reclamation and mine closure costs) at US$278/ounce.

ABOVE THE GROUND GOLD:

South Africa 14% 376 tonnes

USA 11% 285 tonnes

Australia 11% 284 tonnes

China 8%

Russia 7%

Peru 7% 172 tonnes

Indonesia 6% 163 tonnes

Canada 5%

Other Latin America 9%

Other Asia 6%

Other Africa 9%

Other CIS 5%

Rest of World 1%

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RECYCLED GOLD:

In the statistics, scrap is defined as being gold that has been sourced from old

fabricated products that have been recovered and refined back into bars. It does not

include jewellery that has simply been traded in and resold without being re-

refined, or resold investment bars and coins.

Most recycled gold generated originates from jewellery. Smaller amounts come from

recuperated electronics components and, at times, from investment bars and coins.

The supply of scrap depends largely on economic circumstances and on the behavior of the gold

price. It is common practice in the Middle East and Asia for customers to trade in one piece of

jewellery in exchange for another, and the piece traded in may be melted down rather than

simply being resold. But gold can also be sold for cash either if the owner has need of money or

if the owner wants to cash in a profit following a rise in the gold price. It follows that scrapsupply typically rises in times of economic distress or following a price rise.

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JEWELLERY:

JEWELLERY is not a homogenous market globally. Its use, the type of jewellery acquired and

the conditions under which it is bought and sold are determined by custom and usage which

vary both from country to country and also within countries according to social factors. A broad

- although somewhat oversimplified - distinction can be made between two types of jewellery:

that which is primarily for adornment; and that which is also bought as a means of saving.

World scenario:

In recent years retail investment in gold has been largely concentrated in a few countries.

These are

The USA, Turkey where the official gold coin is widely used for savings and is also used as

currency

Vietnam due to the use of gold for the purchase of property India due to the high propensity to use gold for savings

Japan where saving plans encourage regular purchases and where banking crises and other

economic fears often encourage surges in buying.

Indonesia, Thailand, South Korea, Saudi Arabia and the Gulf States are also normally

net investors although at a lower rate.

In China latent demand has been heavily restrained due to regulations largely prohibiting

investment.

London as the great clearing house

New Yorkas the home of futures trading

Zurich as a physical turntable

Istanbul, Dubai, Singapore and Hong Kong as doorways to important consuming regions

Tokyo where TOCOM sets the mood of Japan

Mumbai under India's liberalized gold regime

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India in world gold industry

(Rounded Figures)India

(In Tons)

World

(In Tons)% Share

Total Stocks 13000 145000 9Central Bank holding 400 28000 1.4

Annual Production 2 2600 0.08

Annual Recycling 100-300 1100-1200 13

Annual Demand 800 3700 22

Annual Imports 600 --- ---

Annual Exports 60 --- ---

Indian Gold Market

Gold is valued in India as a savings and investment vehicle and is the second preferredinvestment after bank deposits.

India is the worlds largest consumer of gold in jewellery as investment.

In July 2004 the RBI authorized the commercial banks to import gold for sale or loan to

jewelers and exporters. At present, 13 banks are active in the import of gold.

This reduced the disparity between international and domestic prices of gold from 57

percent during 1986 to 1991 to 8.5 percent in 2008.

The gold hoarding tendency is well ingrained in Indian society.

Domestic consumption is dictated by monsoon, harvest and marriage season. Indian

jewellery off take is sensitive to price increases and even more so to volatility. In the cities gold is facing competition from the stock market and a wide range of

consumer goods.

Facilities for refining, assaying, making them into standard bars in India, as compared to

the rest of the world, are insignificant, both qualitatively and quantitatively.

Frequency Dist. of Gold London Fixing Volatility from 2002 till date

Percentage Change > 5% 2 - 5 % < 2%

Daily

Number of times 4 54 2147

Percentage times 0.2 2.4 97.4

Weekly

Number of times 3 62 376

Percentage times 0.7 14.1 85.3

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Biggest Price Movement since 2002

GOLD SCENARIO IN OTHER MKTS:

In the Middle and Far East, where financial and banking are not fully developed or

available, universally takes the form of high carat, heavy jewelry. Sold at a low markup it

can easily be turned into bullion.

In the more affluent Western countries, it is more often-low carat, high design and

high margin fashion jewelry. For this type of jewelry the demand is more income related

than it is price sensitive

Most of the increase in for gold comes from extremely price sensitive markets, such as

the Middle East and the Indian Sub Continent. The typical investor there, unlike his

counterpart in the West, is far more rational and invests for the long haul. They tend to buywhen prices are low and sell when prices are high, which is the reverse of many Western

short-term momentum traders.

As developing countries prosper and urbanize, they tend to switch towards Western

style fashion jewelry. In rural India, it is regarded as the property of women; a haven against

divorce or widowhood. Two-thirds of Indian gold is held in rural India.

Eleven years ago, when India deregulated the gold trade, consumption began to climb

from 200 tons per annum to 900 tons in 2010. Today, China consumes an average 0.02

grams per capita, the same as India before gold was deregulated. Over 90% of Chinese gold

purchases go towards jewelry, for which is growing at over 15% per annum. Goldfields Minerals Services estimates that private investors own 15% of the above-

ground stock of gold (exclusive of jewelry), with the fastest growth occurring in the Eastern

Asian developing countries. GMS also estimates that from 1993 to 2007 retail investment

accounted for a mere 7% of total

OTHER FACTS:

1. The gold price is usually quoted in US dollars per troy ounce. To calculate the cost

of one gram of gold, divide the US dollar price for one troy ounce by 31.1035 (one

fine troy ounce is equal to 31.1035 grams).

2. The price movements of the gold and of sensex has been in opposite or near

opposite direction.

3. Price movement of gold in relation with the dollar is also negatively related.

4. While it is true that bullion responds to adversity in the short run, its trend in the

long run is a function of widened world prosperity, which in turn leads to an

enlarged market for jewery.over half of the ever mined currently resides in the form

of jewelry. As each year passes, this percentage increases.

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FACTORS AFFECTING GOLD PRICES:

1. Dollars

2. Interest rates

3. Political situation

4. Comparative returns on stock markets

5. Prices in the other market

6. Income of the people.

7. Business economic cycle.

8. above ground supply from sales by central banks, reclaimed scrap and official gold loans

9. Producer / miner hedging interest

11. Domestic demand based on monsoon and agricultural output

The peak year for scrap sales occurred during the 2004 / 2005 Asian financial crisis, whereas

the 2008 / 2009 increase was mostly due to profit taking as the price increased.

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PART-IV

FUNDAMANTAL AND TECHNICAL ANALYSIS:

FUNDAMANTAL ANALYSIS:

FUNDAMENTAL ANALYSIS is based on the study of factors external to the trading

markets, which affect the supply and demand of a particular market. It is in stark contrast to

technical ANALYSIS since it focuses, not on price but on factors like weather, government

policies, domestic and foreign political and economic events and changing trade prospects

fundamental analysis theorizes that by monitoring relevant supply and demand factors for a

particular market, a state of current or potential disequilibria of market conditions may be

identified before the state has been reflected in the price level of that market. Fundamental

analysis assumes that markets are imperfect that information is not instantaneously assimilatedor disseminated and that econometric models can be constructed to generate equilibrium prices,

which may indicate that current prices are inconsistent with underlying economic conditions,

and will, accordingly, change in the future.

Another definition:

It is an approach to analyzing market behavior that stresses the study of underlying factors of

supply and demand. It is done in the belief that such analysis will enable one to profit by being

able to anticipate price trends. A Fundamentalist is a market observer-and/or participant who

relies principally on Supply/demand considerations in price forecasting. Components of

fundamental analysis

Supply:

Weather

Acres planted to a crop

Government Programs

USDA Reports

Demand:

USDA Reports

Domestic usage - Feed & processing

Value of the Dollar

Actions of Other Countries

Exports

Transportation

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TECHNICAL ANALAYSIS:

Technical analysis operates on the theory that market prices at any given point in time reflect all

known factors affecting supply and demand for a particular market. Consequently, technical

analysis focuses, not on evaluating those factors directly, but on an analysis of market prices

themselves. This approach theorize that a detailed analysis of, among other things, actual daily,

weekly and monthly price fluctuations is the most effective means of attempting to capitalize on

the future course of price movements. Technical strategies generally utilize a series of

mathematical measurements and calculations designed to monitor market activity. Trading

decisions are based on signals generated by charts, manual calculations, computers or their

combinations.

ANALYSIS OF COMMODITY WHEAT:

BRIEF HISTORY OF FUTURES IN WHEAT IN INDIA:

India has a very long tradition of commodity futures. It was having sporadic of futures markets

almost all over the country in not only such diverse cash crops as Cotton, Oilseeds, and Raw

jute and their products but also food grains. Futures trading started with the setting up of

Bombay Cotton Trade Association in 1875. The organized futures trading started in 1922 by the

East India Cotton Organization. More and more commodities were added between 20s and

40s, for futures trading like Groundnut, Groundnut oil, Raw jute, Jute goods, Castor seed,

Wheat, Rice, Sugar, Gold and Silver. This was indicative of a very long tradition of commodity

futures in our country. This is on the basis of recorded regulation in various provinces in pre-

independence time. But sporadic futures trading are heard even prior to that. Teji, mandi, gali,

phataks are the derivatives of futures heard happening centuries ago.

Wheat markets were in existence in several centers of Punjab and UP. The prominent and active

was the Chamber Of Commerce of Hapur, which was established in 1913. Other markets were

located at Amritsar, Moga, Ludhiana, Jalandhar, Bhatinda, in Punjab and at Meerut, Hathras,Saharan and Barreily in UP.

Futures trading in wheat have been taking place since long back at various renowned

commodity exchanges of world like Chicago Board of Trade (CBOT) in Chicago; USA,

Winnipeg Commodity Exchange in Canada, Kansas City Board of Trade in Kansas, USA,

Minneapolis Grains in Missouri, USA and many other exchanges located in Japan, Australia,

and East European countries.

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This bears testimony to the fact that the food grains are suitable for futures trading. With

evolution of scientific grades and standards, scientific warehousing systems and practices,

advances in transportation and communication, trading, clearing and settlement systems

provides the necessary environment of competitive futures market.

WHEAT SCENARIO IN INDIA:

Wheat is one of the most important staple food grains of human race. India produces about 70

million tones of wheat per year or about 12 per cent of world production. It is now the second

largest producer of wheat in the world. Being the second largest in population, it is also the

second largest in wheat consumption after China, with a huge and growing wheat demand.

GEOGRAPHICAL AREA UNDER WHEAT CULTIVATION:

It is cultivated from a sea level up to even 10,000 feet. More than 95 percent of the wheat area

in India is situated north of a line drawn from Bombay to Calcutta and also in Mysore and

Madras in small amounts.

The Major Wheat producing states in India is placed in the Northern hemisphere of the country

with UP, Punjab and Haryana contributing to nearly 80% of the total wheat production (Chart

1).

Sh are of Major Wh eat Produ cing States in India

average-in % )

Uttar Prades

41%

Punjab

24%

Haryan

13 %

Madhya Prades

12 %

Rajastha

10 %

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TYPES OF WHEAT SIMILARITY BETWEEN INDIA & INTERNATIONAL:

Types

Regions

Uses

Seasons

Indian varieties*

Soft Red Winter Wheat

Eastern US

(Great LakesArea)

Cakes,

Cookies,Snacks

Winter

Dara, Kalyan,

Mexican, Sharbati,147-Avg. Lok-1

Hard Red Winter

Wheat(predominant)

Southern &

Central Plains

of US

Bread

Winter

Dara, Kalyan,

Mexican, Sharbati,

147-Avg. Lok-1

Hard Red Spring Wheat Northern

Plains

Bread

Spring

None

Durum Wheat Northern

Plains

Spaghetti,

macaroni,

pasta

Spring

Desi (Durum)

White Wheat Pacific and

Northwest

Cakes,

Cookies,

snacks

Spring

&Winter

Dara, Kalyan,

Mexican, Sharbati,

147-Avg, Lok-1

NOTE: Dara variety produced all over in India (Maximum production), Desi (Durum)

produced all over in India, Lok-1 in Gujarat and part of MP& Rajsthan, Kalyan

in U.P., 147 Average produced in Sahajanpur (U.P.), Sharbati in M.P., Mexican

produced in Kota (Rajasthan)

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began with wheat was replicated in rice. The area under production of Wheat has increased

from a mere 12.93 million hectares in 1960-61 to 27.49 million hectares in 2006-2007, an

increase of more than 100% over the past 5 decades. The production of Wheat at the same time,

increased from 11 million tones in 1960-61 to 76.37 million tones in 2006-2007. The yield

(kg/hectare) on the other hand, increased from 851 in 1960-61 to 2778 in 2006-2007, an

increase of around 3.56 times. This indicates that although wheat production over the past 5

decades increased by 6.87 times but the yield of wheat has actually increased by only half of

this figure.

SUPPLY-DEMAND BALANCE OF WHEAT IN INDIA:

As can be seen from Chart 3, the demand of wheat has increased by 2% (approximately) over

the past 7 years while the supply of wheat has increased by 3% over the same time period. This

indicates that the supply of wheat is more than needed for domestic use leading to stock

surpluses.

Deman d & Supp ly of Wheat (in

62

64

66

68

70

72

74

76

78

80

94/95 95/96 96/97 97/98 98/99 99/00 00/01

Ye a r

Supply

54

56

58

60

62

64

66

Dem

and

Total Suppl

Demand

Since 2005 Indias share in world wheat production is around 12% to 13%, at the same time.

Indias share in world wheat consumption is around 10% to 11%. It proves that some sort ofextra stock (around 1% to 2%) arises every year. The demand-supply gap which is open at a

rate of about 1 to 2 per cent per year is equivalent to 0.7 to 1.4 million tones of wheat, growing

larger over the years. Resultantly the ending stocks of wheat have been increasing and the same

thing can be visualized from the following chart

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Indian Wheat Consumption and Stock variables

ANALYSIS OF PRICE TREND OF WHEAT IN INDIA & DEMAND ELASTICITY OF

WHEAT:

Since the Green Revolution, Indian production of cereals including Wheat has been on the rise

with the production of wheat rising from a mere 8.6 million tones in 1960-61 to 73.53 million

tones in 2006-2007[1]. A study of the supply and demand trends over the past decade also

40
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indicates that there is always a 1%-2% surplus in Wheat. The MSP for Wheat has also increased

from Rs. 275 in 1992-93 to Rs. 620 in 2009-03 (Please refer Table 2).

However, although the MSP has risen over the past decade substantially above Cost of

Production leading to price distortion. For instance, in 2007-01, the MSP was set at Rs 610

(Rs/qtnl.). As against this, the C2 (Cost of Production i.e., all costs including the imputed costs

of family labour, owned capital and rental on owned land) in case of Punjab was Rs 422 leading

to a margin of Rs 188(Rs/qtnl.) Similarly, [2]the C2 in UP was at around Rs 439 leading to a

margin of Rs 171 (Rs/qtnl.) In addition, the fragmentation of the Wheat market has resulted in

further widening of price differentials between the North and South regions of the country.

RATIO OF FCIs ECONOMIC COST TO MSP

Years MSP (Rs./qntl.) Economic Cost

(Rs./qntl.)

Ratio of Eco Cost

to MSP

1999-00 275 507 1.84

2000-01 330 532 1.61

2001-02 350 551 1.57

2002-03 360 584 1.62

2003-04 380 663 1.74

2004-05 475 798 1.682005-06 510 800 1.57

2006-07 550 888 1.61

2007-08 580 858 1.48

2008-09 610 871 1.43

2009-10 620 - -

From the above table it is clear that during the 90s MSP has shown a steadily rising trend and

at the same time economic cost has increased physically, but the ratio of FCIs economic cost

to what it pays for wheat has gradually decreased.

MSP, PROCUREMENT AND STOCKS WHEAT

Year MSP Rs./quintal WPI all commodities

03-04 base

What MSP would be if it

had grown at same rate

as WPI

2003-04 380 127.2 380.0

2004-05 475 132.8 396.7

2005-06 510 140.7 420.3

2006-07 550 145.3 434.1

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2007-08 580 155.7 465.1

2008-09 610 161.3 481.9

The distortions in prices are evident from the above table also. If consider Wholesale Price

Index 127.2 as base during 96-97 when MSP was Rs. 380/- per quintal for both wheat and rice

then MSP in 2008 should have been Rs. 481.90 as against Rs.610/- per quintal.

The demand of Wheat in the country is pretty stable over the past few years with the average

demand of Wheat staying at around 63 MMT over the past 4 years. (Please see table 4) On the

other hand, the supply of Wheat has also remained steady at 77 MMT (approximately) over the

same time period. This condition is highly conducive to commencement of futures trading in

wheat with better chances of price discovery. The reason being that stable demand and supply

would help in correct future forecasting and future spot price fixation. This in turn would lead to

convergence between futures price and future spot price and hence correct risk management

mechanism.

Year Total Supply Demand

94/95 68.37 57.66

95/96 75.20 61.32

96/97 75.61 62.02

97/98 75.32 61.69

98/99 76.29 62.56

99/00 77.41 63.53

00/01 78.66 64.60

Indian Wheat Whoesale Prices (Rs/qntl)

0

100

200

300

400

500

600

700

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Months (2002)

Prices(Rs./qntl.)

HARVESTING--

SUPP LY of WINTER

WHEAT

SOWING OF

WINTER

Wheat

SLACK SEASON--MAY-AUG

MSP Prices (Rs 620/qntl.)

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As can be seen from Chart 4A, the MSP is always higher than the Mandi Prices in entire

year of 2009 indicating that the MSP prices are not reflecting actual demand-supply of

Wheat in country.

INDIAS POSITION IN WORLD WHEAT MARKET

% Share of Country

Italy

4%

Turkey

4%

Pakistan

3%

Canada

5%

Australia

4%

Russian Federation

6% Romania

6% France

7%

USA

13%

India

13%

China

22%

Others

13%

Wheat production in India has increased by over ten times in the past five decades and

India has become the second largest wheat producer in the world. Today wheat plays

an increasingly important role in the management of Indias food economy.

Since 2005-99 Indias share in world Wheat production hovers around 11% to13%.

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INDIAS POSITION IN THE WORLD WHEAT MARKET

India's share in World Wheat Production

Year Production share (%)

2005/99 11.25

2006/00 12.07

2007-01 13.07

001/02(12-June) 11.86

2009/03(12- June) 12.54

Starting from 2005-99 till date Indias share in world wheat export shows a rising trend. Not

only share, Indias physical export also sharply rising. Indias percentage share in both world

total export during 2008-02-July was 2.79 (i.e. around 3%).

INDIAS WHEAT EXPORT

Year India's Export figure

(In Thousand Metric Tons)

2005/06 0

2006/07 200

2007/08 2357

2008/09(12-June) 3000

2009/10(11-July) 4000

GOVERNMENT POLICY REGARDING WHEAT:

Since wheat prices at procurement level and at disposal level are placed under controlled

mechanism with defined objectivity, scope of general price trend analysis also becomes govt.

policies centric. The related price in the open market has got a substantial relationship with the

prices of wheat traded in the open market. Therefore our presentation on this aspect has a notion

that the price elasticity of demand has got direct relationship on prices of wheat of other

varieties (whatsoever be the size of share in total production). However, availability of targeted

variety (Mexican/Dara) wheat shall increase, if Govt. withdraws gradually from procurement at

MSP; in the open market, which shall concede volatility.

PURCHASES:

The policy of Minimum Support Price (MSP) supports economic growth. MSP is a critical

policy component of the Indian Economy. It generates broadly different purchasing power,

health and wealth. Governments works out the MSP giving due consideration to all the

economic factors like cost of input, power, capital; and labor with reasonable going margins.

With the certainty about the support price, farmers expend better effort and resources provide

confidence and motivation to the growers. MSP and commodity options are consistent with the

requirements of the produced economy.

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PROCUREMENT OF WHEAT (CENTRAL POOL ACCOUNT)

(Figs. In Lac Tonnes)

Marketing

Year

2001-

02

2002-

03

2003-

05

2004-

05

2005-

06

2006-

2007

2007-

08

2008-

09

2009-10

Wheat 119 123 82 93 126 141 163 206 #190.2

STATEWISE PROCUREMENT OF WHEAT BY FCI

(In Lac Tons)

State 2006-2007 2007-08 2008-09

Punjab 78.31 94.24 105.60Uttar Pradesh 12.61 15.45 24.46

Haryana 48.70 44.98 64.07

Rajasthan 6.37 5.39 6.76

Other 5.44 3.50 5.41

All India 141.43 163.56 206.30

SALES/LIQUIDATION OF INVENTORIES:

The prime objective of MSP of providing assured market to the growers achieved and

production kept on upward swing which culminated into comfort level of food security andpaused much more serious issues. One of them was the slower pace of replenishing the

inventories. Pricing policies of disposal of stocks thrusted at the social commitment of the

Government. Government kept on pumping wheat stocks at the issue price, which need to be

lower than MSP through States machinery of Public Distribution channels throughout the

country that has helped to sustain the high growth rate and maintain regular, supply of Wheat

and Rice.

Government of India introduced a new scheme called Targeted Public Distribution Scheme

(TPDS) in 2004 where in ultimate consumers were segmented in two categories i.e., Below

Poverty Line and Above Poverty Line as per the recommendation of Planning Commission. The

issue price of Wheat during 2008 and 2009 were as under:-

(Rs./Quintal)

Commodities As on BPL APL

Wheat 1.04.2009 415 510

12.07.2008 415 610

Besides above stocks were earmarked for various other welfare schemes by the Government

like Jawahar Rojgar Yojona, Mid Day Mill Scheme etc.

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MSP is say Rs 620/qntl. then the trading in market would not go below Rs 620 in any case

distorting the functioning of futures market. Even if the International markets were trading

lower, the Indian markets would still stay above the Rs 620 mark.

As can be seen from Chart 8, the Issue price of Wheat, which is administered by FCI, was at

around Rs. 525 per quintal for 2009. A comparison with FOB prices of US Wheat prices in the

same time period indicates that the US Wheat Export Prices are more subsidized and

competitive against Indian Wheat.

In the light of the above discussion, MSP and Issue Price should not be enhanced in the future

but kept constant and removed in a phased manner over a time frame. In its place, futures

should be introduced as price management mechanism correlating International and domestic

wheat markets to avoid price distortions.

CORRELATION BETWEEN INDIAN AND US WHEAT PRICES:

Indian and US Wheat Prices (in qntl)

0

20

40

60

80

100

120

140

160

180

200

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecMonths 2002

USWheatPrices($/qntl)

0

100

200

300

400

500

600

IndiaWheat

Prices(Rs/qntl)

US Wheat

Prices

India Wheat Prices

(Rs/1ntl)

Indian Export Wheat Issue

Price (Rs/qntl)

The Government fixes an issue price for Export of wheat for one year (Please see Table -9). In

case of 2009, the Government declared an issue price for export at Rs. 5250 per tone (525

Rs/qntl). In comparison with the US FOB prices of Wheat for exports, it can be seen from Chart

8 above that from January-July 2009, the US Wheat FOB prices were much below the Indian

Export Issue Prices. One reason could be that although wheat export is subsidized in both India

and USA, it is highly subsided in case of USA. In addition, in 2009, the MSP (Procurement

price) by FCI was set as high as Rs. 620 per quintal (Please see Table 2 of report). This resulted

in high procurement cost for FCI.

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Year Issue Price of Wheat Export

(Rs./tonnes)

2006-07 4910

2007-08 5110

2008-09 5110

2009-10 5250

2010-11* 5550

Wheat grown in India is of winter variety i.e. it is sown in Winter (November) and harvested in

summer (April). In 2009, there was a bumper crop of wheat and owing to issue price being

much higher than mandi prices there was excessive stock of Wheat by FCI, which was then

released during September -November resulting in declining prices. On the contrary, during

August September, US winter wheat prices showed an upward trend, this is due to part

declining of wheat ending stocks, which was the result of lower production caused by drought.

That was the smallest US wheat crop in 30 years as ending stocks were lowest since 1966-67.

Again during November and December of 2009 as seen in Chart 8 US and Indian prices moved

in opposite direction in starting of December, Indian prices indicated an upturn because of Food

Corporation of Indias (FCI) decision to stop sale of sound wheat under the OMSS scheme tillMarch 31st, 2010.

To summarize, during 2009 the movement of wholesale prices of Indian wheat reflect the

procurement and prices declared by FCI. During the harvest season from January to July 2009,

FCI procured huge stocks of wheat, which it then released in August-mid November leading to

declining in prices during that time. However, from mid November to December, FCI stopped

the sale of sound wheat through OMSS scheme leading to hike in prices during that time.

In case of US wheat prices (FOB) in 2009, the prices reflect demand-supply condition. In

January-July, which is the harvest season for winter wheat in USA, the prices are low. The hike

in price between August-September was owing to lower stocks of wheat. The lower prices in

December of 2009 of US export prices may be for boosting up exports.

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stocks. The locking in of Futures price and buying/selling forward on estimated production

would help in removing intra seasonal and inters seasonal abnormal price variance.

Such a futures market would not only provide management of price risks through hedging but

also assist in efficient discovery of prices, which could serve as reference for trade in physical

commodities in both domestic and international markets.

Comparative study of Indian and US Wheat Types (on basis of uses)

Bread, Pastries, Cereals & Cookies:

India:

Type of Wheat: Emmer Wheat

Area Grown: Maharastra, Tamil Nadu & Karnataka

Seasons: Winter

Usa:

Type pf Wheat: a) Soft Red Winter Wheat (SRW) & b) White Wheat

Area Grown: SRW is grown in Great Lakes Area of USA and White Wheat in Northern Plains

Seasons: SRW is grown in Winter & White Wheat Spring as well as in Winter

Macaroni, Suji, Pasta:

India:

Type of Wheat: T. Durham (Desi) Wheat

Area Grown: Punjab, M.P. (Max), Tamil Nadu, Gujarat, Karnataka, West Bengal and H.P.

Seasons: Winter

Usa:

Type of Wheat: Durham

Area Grown: Northern Plains

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Seasons: Spring

Bread:

India:

Type of Wheat: Common Bread

Area Grown: Punjab, U.P. Bihar & parts of Rajas than (Bulk of Crop)

Seasons: Winter

USA:

Type of Wheat: a) Hard Red Winter (HRW) & b) Hard Red Spring (HRS)

Area Grown: HRW in Northern Plains & HRS in Southern Plains

SOME FACTS ABOUT WHEAT:

1. In rural areas the wheat consumption rises significantly with income levels. Thus,

income increase in rural areas will lead to a larger increase in wheat consumption. In urban

areas, too, the rise is present but not as much. However, the average consumption of wheat

is somewhat higher in urban than in rural areas.

2. The consumption of wheat and rice rises with income whereas the consumption of

coarse cereals falls. The consumption of rice rises to a certain level and then tapers off. The

consumption of wheat starts at a lower level but continues to increase as income rises this

indicates a more buoyant demand for wheat with income growth. Thus, the three different

cereal types show quite different consumption behaviour in relation to income, and wheat

shows a sustained rise with income increase.

3. For wheat the bound rate of duty is 100 per cent, but roller flourmills are allowed to

import at zero import duty.

4. The cost of production of wheat varies considerably across states and ranges from an

average of Rs.292 per quintal to Rs.377 per quintal (2002/96). Haryana shows the lowest

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cost in all the years followed by Punjab and Uttar Pradesh. Madhya Pradesh has the highest

cost of production. The differences are due to agroecology as well as crop management.

5. The system includes the Commission on Agricultural Costs and Prices (CACP), the

Food Corporation of India (FCI), and State Civil Supplies Corporations.

6. Minimum support prices (MSP) or procurement prices are announced by the

government every year at the beginning of every wheat season. These prices are based

largely on the cost of cultivation, which is systematically studied based on farm-level

information every year by the CACP, as well as on market information

7. The issue prices or the price at which the grain is released to the government Public

Distribution System (PDS) is fixed and revised only from time to time. The distribution is mainly

by state governments through thousands of fair price shops spread throughout the country in the

urban and rural areas. There is an element of subsidy in this but the government has been trying to

target and reduce this in recent years.

PART V

ANALYSIS:

1. Reasons for investing in commodities:

Lesser risk

Lower margins

Lesser variations.

2. Lacking in commodity market:

There is no concrete information available.

Lack of awareness (No liquidity)

No fluctuation.

The lack of liquidity and fluctuation in the market keeps the main players viz:

1. Producers

2. Traders

3. Manufacturers

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The reasons being the government policies like floor price i.e. minimum supply price,

subsidies, export subsidies etc (macro factors). All these affect the free movements of the

prices.

3. Reasons for not investing in commodity market:

High brokerage.

Low volume

Lack of information.

Lack of awareness

No fluctuation.

Need constant watch.

No sense of taking delivery i.e. you don t get dividend or bonus after taking the

delivery as happens in shares.

To understand the commodity market it is necessary to understand the worldeconomy.

After losing in the share market, no further risks.

4. Improvements needed in commodities market:

More price publication in the newspaper.

More charts and trend line should be made available.

More terminals should be allotted.

More investments from FIIs.

Factors that are holding back the healthy growth of commodity market are: Absence of main players like producers, traders, manufacturers.

Government policy like floor rates, quota, subsidy (all these tampers with the free

movement of the prices)

Lack of exchange in the country.

No turnover & No volatility.

Macro analysis:

India has tremendous potential as far as commodity market is concerned. So the dealers canlook forward to tap this potential .at present very minimal proportion of the total trade-taking

place is done throu

priya commodity

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