This is a real life incident — I wanted to convince my cousin, a doubting Thomas, about the virtues of investing in commodities.
I took him to Churchgate and boarded a local train and we stood on opposite doors of the compartment. We started talking loudly about what stocks would zoom/ sink. Apart from a few inquisitive glances and eavesdroppers, we didn’t get much of a response. I veered the conversation to why gold, silver, wheat, rice, dal and milk prices should zoom higher. When we got off the train, I had run out of visiting cards!
People wanted to know whether they should stock up grains, buy gold jewellery for a teenage daughter’s wedding and time their purchase of spices. The common man’s interest in the commodity markets established, I had convinced my cousin that commodities were the next big market.
Unfortunately, the misplaced perception of the lay investor is that equities are the only game in town. They are not to be blamed entirely — commodity and forex trading was illegal not-to-long ago. Even now, both these markets are in their nascent stages of evolution. But what about the empirical evidence worldwide? Commodity markets’ turnover overshadows that of equities by a factor of 10-20, depending on how matured that country’s markets are. Forex, on the other hand, outpaces commodities by a similar factor!
So equity investors who think our markets are getting bigger since turnover in the cash segment on NSE is frequently over Rs 15,000 crore a day (it was Rs 1,000 crore a day in 1996) need to note that MCX volumes are far higher.
Though lower than the NSE futures & options segment, it may be noted that commodity traders do not afford the luxury of options as they are not permitted by the Forward Markets Commission as the necessary act needs modification.
Once done, it will be the game changer. So for all segments of the market, be it traders, brokers, media, analysts and advisors, ignore the commodity and forex markets at your own peril. People who suffer from tunnel vision of equities are about to go the way of the dinosaur. A few thoughts:
1Commodities are earthy instruments and do not multiply in value at geometric rates. Since they impact economies and lives, their prices are closely monitored and regulated. For a trader in the commodity market, to make the same amount of money that a Nifty or stock futures trader makes, he will have to take a higher exposure as price movements are narrower than the Nifty. That results in huge turnover and in time, open interest build up.
2The trade timing is extensive and 15-hour sessions are the norm. Going by the way equity bourses are clamouring for extended trading hours to discount all the variables, commodity exchanges are likely to make similar demands. It will automatically result in a volumes push.
3Right now, the only avenue available to a commodity players is by way of futures exposure. Apart from bullion, delivery investments are unthinkable from the exchanges.
The system is actually putting off delivery investors rather than enticing them. That will change as the uptight mindsets change gradually. If investors can deploy funds to take delivery of industrial metals/ bullion/ agri-commodities by way of paper receipts (like demat shares), participation will explode. I foresee such a market within 3-5 years on the outside.
4Mutual funds, hedge funds, NRI’s, overseas investment bodies and foreign nationals are not permitted to invest in the commodity market. Ultimately, some amount of these controls will be loosened up and volumes will automatically balloon. Exchange-traded funds except in gold are unheard of. Till last year, when I spoke of buying gold ETF’s on TV, many — including the media guys — thought I was from Mars. Within half a decade, you will have ETF’s for bullion, industrials, agri-commodities, energy, power, water and maybe even weather! Where do you think the turnover is headed?
5The process of data dissemination is poor, inadequate and rudimentary. Apart from the quotation list providing the daily ranges, turnover and open interest, exchanges provide a trader like me nothing else.
Equity traders who build trading models in Microsoft Excel/ Visual Basic need tonnes of more data like how many transactions took place, what was the average lot size per transaction, what were the pressure points of volumes where prices turned, etc. Most of this data is available on NSE’s website.
But Indian commodity markets are lagging the equity exchanges on this front. That is likely to change. Overseas commodity exchanges even provide trading data split into trades initiated by speculators, commercials and hedgers. You can actually know which side of the street you are on with the help of this COT (commitment of traders) report. I expect the stiff competition between various commodity exchanges to result in availability of this data which will raise the probability of trading success significantly. It will be a win-win situation. Many specialised traders I know would not even venture into a market where exchanges do not provide this data as a matter of trader’s rights.
6Being new animals, commodity and forex exchanges are in their learning stages. The quality of advice and research provided is poor and sometimes valid for under 30 minutes.
Equity trade analysts are put to work on commodity/ forex research, not realising that these are unique avenues and one size cannot fit all. This results in high trader losses, frustration and churn ratio of clients exiting from the market, to be replaced by newer batches of curious participants. With time, this aspect of the market, the back-end functions and advisory quality will improve significantly, leading to more stable client bases for commodity/ forex brokers.
7Misconceptions, lack of information and education about commodities and forex are dogging trader participation. Many potential traders ask me if they will have to store a few tonnes of copper or wheat in their attics if they buy their futures on the commodity exchange. It reminds you of the year 2001, when fear and ignorance about futures and options inhibited participation levels. Just as traders evolved in equity derivatives, they will repeat their performance in the commodities and forex markets, too.
8Forex is a unique animal altogether. You measure your life in heartbeats. Changes in currency values are measured in 4 decimal places and tick prices are in “pips”. Since our markets are in nascent stages, the lot sizes are a tiny fragment of what they are overseas.
Overseas markets (ultimately our markets will step up lot sizes) can set you back by a few lakhs if you mis-time your trade by a few “pips”. Naturally, the fear of the unknown and bone crushing losses are keeping many a trader away. With time, this will change.
9Cross-exchange hedges are inevitable. To a commodity trader, the currency peg is a make/ break factor. If the dollar falls, commodities become cheaper and vice-versa. So if you are betting on a falling dollar and therefore go long on copper, it makes sense to take a short position on the dollar in the forex market as well. It raises your profit potential and is a calculated risk. The day is not far when commodity and forex trading platforms will merge and you will be able to take these cross-exchange positions in a matter of seconds on the same computer screen. That will drive volumes into the stratosphere!
All in all, the doors of these trading avenues are opening to the trader community, where the savvy will take home profits beyond the horizon of avarice. It will be a repeat of the hare and the tortoise story, only this time the savvy commodity and forex trader (the hare) will beat the tortoise by a few miles. Upgrading your skills and beating your fears will prepare you for potential profits of your dreams. You may opt to be happy with limited returns from equity trading at your own peril. Alpha into omega or omega into alpha, it’s your call.
The writer is the author of A Traders’ Guide to Indian Commodity Markets.
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