Investing 2.0 Where to Invest : Commodities

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Investing 2.0 Where to Invest : Commodities

When it comes to investing, a key ingredient to success is diversification. Simply put, it is the act of reducing risk by distributing resources among various financial instruments. Diversification can happen not only within a single asset class such as equity, but can also be achieved among various asset classes. For instance, retail investors may consider investing commodity besides equity and debt. Unlike popular perception, investing commodity is not as complicated or risky and offer immense potential for market-savvy investors.


Basics of investing commodity

To understand what are commodities investments, let’s look at how commodities are classified into five broad sectors:
● Agriculture
● Metals and materials
● Energy
● Services
● Precious metals

Each of these categories have different commodities under their heads as explained below:



Where does trading happen?

Now that you know what are commodities investments, it is a good idea to know there are three main exchanges where you can trade in commodities. These are the National Commodity and Derivatives Exchange (NCDEX), Multi Commodity Exchange of India (MCX) and the National Multi Commodity Exchange of India. All the three exchanges have a national presence and electronic trading and settlement systems and can offer benefits of investing in commodities.


Investing in commodities made easy


There are a host of equity traders who have a well established presence in commodities as well, and offer trading facilities through the internet platform. If you are new to trading, you can also check the list of brokers registered with the above exchanges to make a final choice. You can begin trade by entering into an agreement with the broker and undergo the normal Know Your Customer (KYC) procedure. Besides a bank account, you will need a commodity demat account from National Securities Depository Ltd. You will need to pay your broker a percentage of the contract value. For different commodities there will be different brokerages. It will also differ on the basis of transaction type meaning trading or delivery. However, it cannot exceed the maximum limit as specified by the commodity exchanges.

Pricing and contracts in commodity trading

There are two types of prices in commodity trading: spot and future.

● Spot price is the price in which one buys and sells a commodity on the spot

● Future price is the price of the same commodity at a future date.

A futures contract is thus an agreement to buy or sell a stipulated amount of a commodity of your choice at a certain price on a future date. On this date, the commodity being traded (type and quantity) must be delivered at the contracted price, irrespective of a rise of fall in the market price. Trading in commodity futures is done on margin. This means, as an investor you have deposit only a fraction of the futures contract with the broker. This provides higher leverage and the option to reap higher returns.


Cash or delivery settlement mechanism

A contract may be settled through a cash or a delivery mechanism. If you want a cash settlement, you must indicate so at the time of placing an order. Else, if you wish to make a delivery, you need to have the required warehouse receipts. You have the option of changing this mechanism as many times till the expiry of the contract date.


How does a transaction take place?

A transaction is made electronically between the brokers of both the buyer and seller of a commodity. Both parties enter into respective obligations. While one party decides to purchase, the other decides to sell. The buyer is obliged to take delivery and pay for the commodity for the ascertained price, while the seller has the obligation to deliver the commodity on the said date. Both the buyer and seller can however absolve themselves can absolve themselves of this obligation by offsetting their trade before contract expiry. This is what most speculators do to make gains by speculating on the direction of the price of the commodity.


How is commodity trading advantageous?

The right mix of commodities in your portfolio can help your portfolio as they are an excellent means of diversification. For instance, gold has a low co-relation to equities and will typically provide gains when equities are down. You could also consider mutual funds investing in commodities to add to your portfolio. Further, as commodity prices determine inflation, investing in commodity futures may be used as a hedge against inflation. However, it is imperative to understand the risks involved in commodity trading before taking a leap.

 


Disclaimer:
Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.


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Investing 2.0: Where to Invest Derivatives

Derivatives or financial derivatives, as the name suggests, are financial contracts that “derive” their value from an underlying asset. Simply put, derivatives help you make profits by taking a call on the future value of its underlying asset. There are many types of financial derivatives of many assets such as commodities, currency, indices and stocks. For the sake of simplicity however, we will delve into equity financial derivatives for better understanding. How does an equity derivative work?Suppose you buy a derivatives contract on stock A that is trading at Rs 2,000 in the spot market. The expiry date of the contract is a month later. At this time the stock trades at Rs 2,500 in the spot market, but you can still purchase it at Rs 2,000, thereby making a profit of Rs 500 per share. The same holds true if the stock price were to fall by Rs 500. In that case you would incur a loss of Rs 500 per share. What are derivatives used for? To know the uses of financial derivatives let’s look into the below terms:Hedging Derivatives offer you the opportunity to protect yourself against price fluctuations. You can use a derivative strategy to protect yourself against a price rise or a price fall. This is called hedging. Risk transferEvery investor in the market has a different risk appetite or tolerance to bear losses. Derivatives can be used effectively to transfer risks from risk-averse investors who want to protect themselves against price fluctuations to risk-tolerant investors such as speculators who take contrarian trade positions to enhance profits. Different types of derivatives contracts Futures and forwards:As explained earlier, future contracts are agreements coined to buy or sell a specified number of shares at a pre-stipulated time in the future. Forwards can be called a variant of futures but ones that can be customised to a certain extent. Unlike futures, these are non-standardised in nature and cannot be traded on the exchange. Options: Options are similar agreements like futures, but one in which you can exercise a choice or an option to meet the obligation. For example, if you have an option contract to buy 50 shares on the expiry date, you can choose whether or not you wish to do so. Options too can be traded on the stock exchange. What do you need to invest in derivatives? To understand how to trade derivatives here are the following factors you need to consider:A demat account- Just like trading in shares, a demat account is a pre-requisite for dealing in derivatives.Trading account- A trading account is linked to your demat account and serves as your unique identity in the market.Margin maintenance- Initial margin- When you decide to deal in derivatives, you need to deposit an initial margin, that is decided by the stock exchange. It is a risk containment measure on behalf of the exchange, and depends upon the total value of your outstanding position as well as the average volatility of the stock and interest cost over a stipulated time period. This margin is adjusted daily depending upon the market value of the open positions you hold. Exposure margin- This margin is also levied by the exchange and is used to control excessive speculation and volatility.Mark to market margin- Apart from the two margins mentioned above, you also need to maintain a Mark to Market (MTM) margin. This margin covers the difference between the cost and the closing price of the contract on a day to day basis.Derivatives trading must do’sResearch- This is the most important aspect of derivatives trading. Derivatives trading is far more complex than stock trading, so do not make a trade unless you are completely sure of the position you are taking, the purpose of the same and the possible consequences. Maintaining the margin amount- Margin maintenance plays a big role in derivatives trading. It is always prudent to maintain some extra amount in your account as the margin amount changes with the rise and fall in the underlying stocks.      Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.

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Investing 2.0 Where to Invest: How to select investments

Investing may not be rocket science, but it does require basic understanding. First and foremost, it is important to understand yourself as an investor, before selecting the right investment options. A portfolio that is just right for you may not work for someone else. This is because each individual has a different attitude towards risk. Further, each individual has a different set of financial goals depending on which stage you are in in your life. Thus, while it is correct to state that everyone has a different investment selection philosophy, the ground rules for sound investment selection remain the same. They are: Understand your risk tolerance This is the first and foremost step of investment. Know yourself, your risk appetite before taking the next step. Identify your financial goals Different life stages demand different life goals. For instance, if you are just beginning your investment journey, you may have a short-term plan of going on a family vacation. Your medium-term goal may be to buy your first home a few years down the line. Finally, you may also want to save for your retirement that is 30 years away. This can be classified as a long-term goal. For each of these goals, you need to plan differently and may have to invest in different financial products to meet each of these goals. This process of selecting various investment options based on your financial goals is called asset allocation.Diversification is the key to successWhile investing, you do not want to put all your eggs in one basket. The key to success is to diversify. But diversification too, has to be according to your risk appetite. You may thus wish to diversify among different asset classes such as equity, debt, real estate and commodities. This is called vertical diversification.You can also diversify within the same asset class. This is called horizontal diversification. For instance, if you are investing in equity mutual funds, you may want to invest in a combination of large cap and mid cap funds to spread your risks. Similarly, if you are investing in debt funds, you can choose fund with varying durations. The duration of the fund, determines the level of risk in a debt fund. Avoid what you don’t understandDo not go overboard in your effort to diversify. At all cost, stay away from financial products that you do not fully understand or know the specific risks they entail. Consider high risk or complicated products only when you have the raequisite knowledge. Keep monitoring your investment statusOnce your portfolio construction is complete, you need to keep a watch over it to ensure your investments are meeting your financial goals. It is always best to review your portfolio at least once a year. However, don’t keep a tab on your investments on a daily basis. That’s because you may be tempted to act every time markets move unexpectedly. Such decisions may work over a short period but may not help you meet your long-term financial goals. Remember that volatility is part and parcel of the market movement, and you have to accept this fact if you are a long-term investor.The bottom line is that there is no one “right” way to select investments. But so long as you are focused on your financial goals, these ground rules should hold good under any circumstances.   Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.

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The above mentioned are a few things that one must know before indulging in commodity trading in India. As a beginner or seasoned investor, you can contact IndiaNivesh for any assistance relating to the Indian commodity market. Our experts and professionals can help you in finding the best commodity to trade in India according to your risk-taking ability and financial goals. Our aim is to exceed the client’s expectation in all endeavours and we will be glad to serve you.   Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing. 

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  • Systematic Withdrawal Plans – How to use SWP?

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    The world of investments has a vast number of financial instruments such as shares, stocks, bonds and many more. Commodities, too, are one such investment option available for investment. Even though the commodity market has grown substantially in the last few years, the participation of retail investors in commodities is still limited. However, the commodity market has huge potential and making the right investments in commodities can help improve the performance of your portfolio. What are commodities? Commodities are tangible goods that are either naturally occurring or can be agriculturally grown.  Commodities are consumed directly or used as raw materials for manufacturing finished goods meant for public consumption. All commodities can be classified under either of the two categories- Soft commodities- Those, that are grown and cannot be stored for an extended period. Examples of soft commodities include agricultural products such as grains, tea, coffee, and livestock. 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The price of any commodity investment is a function of demand and supply and by doing proper research and analysis you can make profits from commodity market investments.2. To provide a hedge against inflation Inflation is the general rise in the price of goods and services over time. For any investment to be fruitful, it is important that the returns generated beat the rate of inflation.  Higher inflation effectively erodes the real returns generated by your investments in stocks and fixed income securities. However, in the case of commodities, higher inflation relates to the higher price of commodities. So, unlike other investments, your commodity investments will result in a strong performance when inflation is high. Given the current situation when inflation is constantly on the rise, investing in commodities will provide a hedge against inflation.3. To improve potential returns The prices of individual commodities can fluctuate significantly due to several factors such as demand and supply, the impact of natural calamities, exchange rates and the economic health of the nation.  The rise in infrastructure projects in a developing country like ours and also globally has had a positive impact on commodity prices. As the commodity market is still an untapped arena, many of them are trading at a lower price than their actual potential. Proper research and effective implementation of investment strategy in commodities can help investors improve the overall returns on their portfolio. What are the various options to invest in commodities? The commodities market is a very deep market and investors have many investment vehicles to access it.  Let us look at the various options available for investors to buy and sell commodities1) Investing in the physical form Commodities such as gold, silver, etc., are bought by investors in physical form.  However, not all commodities can be bought in physical form as it has its drawbacks of storage and spoilage. Even in the case of precious metals security and insurance increase the cost of your investment. Moreover, most of the time you want to invest in a commodity, not for end-use but to make profits if you anticipate that the price will increase. So, buying a commodity in physical form, except for precious metals, is generally not recommended for retail investors.2) Investment through commodity futures One of the most common ways to trade in commodities is through a commodities futures contract. It is a standardised agreement to buy or sell fixed quantities of the underlying commodity at a predetermined price on a specific date as mentioned in the contract. Also, commodity trades happen electronically through commodity exchanges where investing real-time commodity is possible.  Multi Commodity Exchange of India (MCX), National Commodity and Derivatives Exchange (NCDEX) are two of the many commodity exchanges present in the country which help investors trade in commodities. All the commodity exchanges come under the regulation of the Forward Markets Commission (FMC). 3) Commodity ETFs Commodity ETFs are another popular investment option available for retail investors to diversify their holdings in commodities. Commodity ETFs invest in a single commodity and physically hold and store it, invest in a commodity futures contract or invest in a commodity index that tracks the performance of multiple commodities. Investors can invest in commodity ETFs electronically in their Demat account. 4) Commodity Stocks Investors who are not comfortable with investing in commodity futures or ETFs can diversify their portfolio in commodities is by investing in commodity stocks. Commodity stocks are stocks of those companies which are directly or indirectly related in the manufacturing process of the commodity and hence have a positive correlation with the commodity.  For example, if you feel that the steel prices are going to increase, then you can invest in the stocks of various steel companies listed on the exchange. 5) Mutual funds One of the biggest reasons for an investor to shy away from commodity investment is that commodity investments require a lot of time, knowledge and expertise to make the right investment choices. However, now SEBI has permitted mutual funds to invest in the commodities market through the exchange-traded commodities derivatives (ETCD) route.  Thus, retail investors can now participate in commodity markets in a structured manner through professionally managed mutual funds. Takeaway Commodities are a broad and diversified asset class that offers a great investment opportunity to investors. Given the high inflationary pressure and volatility in the markets, dedicating a small portion of your portfolio to commodities will help enhance the overall performance of your investments. Investing in commodities may look intimidating and you may feel a little hesitant to explore your options, but correct guidance from an experienced financial advisor can help you understand the nuances of commodity markets and make the right investment decisions as per your investment needs. 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