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Monday, 19 September 2016
Game for agri-commodities?
The Dhaanya index of the NCDEX has delivered annualised return of 19.2 per cent since January 2008, pipping most other asset classes to the post. But the high returns come with high risks
Do you know which asset class delivered the
best return since the beginning of 2008? The answer is agri-commodities. While
not many investors or traders would have put money in coriander or cotton seed
oil cake futures, they would have made more money there than in gold or even
The sharp plunge in equity markets in 2008 and the period of
stagnation since 2010 have resulted in the Indian benchmark, Nifty, delivering
annualised return of just 4 per cent since January 2008. Gold had its moment in
the sun in the fall of 2011 but it has been a downhill ride for the yellow
metal since then; resulting in yearly return of 5 per cent. Crude oil has not
had it good since July 2008, delivering negative annual growth of 8 per cent.
Returns from real estate have also been not much to write home about in the
However, the benchmark index of NCDEX, the Dhaanya index that is
constituted with the highly-traded agri-commodities of the exchange, has
delivered annualised return of 19.2 per cent since January 2008, pipping most
other asset classes to the post. Some of the constituents of this index, such
as rape mustard seed have given annual growth of 33 per cent since January
2008, a feat that can be matched by very few stocks.
That said, agri-commodities are not suitable for investors
because there is no instrument to ride on; unlike gold where ETFs are available
for investors. Agri-commodity futures traded on the commexes mainly serve the
needs of the commodity producers or users of the products to help hedge their
price risk. There are some arbitrageurs and traders who do operate in these
exchanges but they are few in number.
While lack of avenues is a drawback, not many investors would
agree to bet on rape mustard seed or jeera even if ETFs or other similar
instruments were offered to them. What is it that turns off traders and
investors from agri-commodities? Are their fears justified? Here we examine
some of the common misgivings about agri-commodities futures to see if they are
Lack of liquidity
Liquidity is a concern, but it can be surmounted by trading only on exchanges
that trade higher volumes, such as NCDEX and MCX and staying away from illiquid
The three largest exchanges for agri-commodities, the NCDEX, MCX
(agri-commodity segment) and the NMCE together transact contracts worth
₹3,000-4,000 crore every day. This is about 2 per cent of the value of equity
futures and options (F&O) traded on the national exchanges and around a
tenth the value of currency derivative contracts traded on exchanges.
Liquidity in individual contracts is not too much to write home
about. For instance, the top-traded contracts on the NCDEX trade roughly
between ₹200 crore and ₹500 crore every day but many contracts witness less
than ₹100 crore of transaction per day.
Aurobindo Gayan, Vice-President-Research, Kotak Commodities,
says that there are three factors that a person must keep in mind while
selecting a commodity to trade in — the volume or participation level in that
commodity, the sowing and harvesting pattern and his risk appetite. He says
that of the total volume of agri-commodities traded every day, roughly 40 per
cent comes from the edible oil cluster — soyabean, soyaoil, crude palm oil and
mustard. These are followed by sugar, cotton and other spices.
But the sowing and harvesting pattern of a commodity affects seasonal
liquidity, too. For instance, soyabean is harvested between October and
December in India. The users of soyabean try to buy this commodity during this
period making the contract very active in this period. On the other hand, in
March or April, this contract could get quite inactive.
The trader’s risk appetite also needs to be considered as the
exchange charges mark-to-market margin everyday on the outstanding positions.
It is best to set aside a certain sum at the outset as the draw-down or (the
reduction from your capital) that you are willing to take.
Sushil Sinha, Executive Director, Karvy Comtrade, says that it
is possible that an investor might be aware of the factors affecting the price
of a certain commodity as the commodity is grown in the region he resides in or
because he is a user and hence follows it closely. It is best to stick to such
commodities where familiarity is higher.
Thin liquidity on many counters that enables price rigging is one of the main
drawbacks of commexes. Instances of a few players, who are privy to
price-sensitive information regarding a commodity, forming a cartel to rig up
the price are quite common in the Indian agri-commodity market. That is one of
the reasons why the history of this segment is strewn with suspensions and
outright bans of commodities. The guar gum and guar seed episodes of 2011 and
2012, where prices rocketed high in a crazy manner was mainly due to low
liquidity and lack of strong players to act as counter-party.
While the market is maturing, this threat has not entirely
vanished, as is evidenced by the suspension of the castor seed contracts in
January and the chana futures in June this year. Threat of excessive
speculation affecting the spot prices was cited as a reason for these recent
The market regulator has plans to increase participation in
agri-commodities by allowing domestic financial institutions, mutual funds and
foreign institutional investors to participate here. Once that happens and
volumes increase, this issue can be addressed. Traders can, meanwhile, mitigate
this risk somewhat by staying in the more liquid counters. But the threat of
the contract getting suspended, if there is a sharp one-sided movement in the
commodity, continues and remains one of the greatest risks in this segment.
Fragmented spot market
The absence of a unified spot market that can provide the underlying price for
anchoring the futures price is considered another drawback for the Indian
agri-commodity segment. But exchanges have a process in place to ensure that
spot and future prices are not entirely out of whack.
This is done through a price polling mechanism that is followed
by the agri-commodity exchanges. The NCDEX follows a pretty elaborate method
under which spot prices of each commodity are collected from a set of
empanelled dealers and stakeholders most relevant for that commodity from
various spot markets andmandis. These prices are bootstrapped (removing the
outlier prices) and subject to further smoothening through statistical means to
arrive at the spot price that is flashed live on the exchange.
SEBI, in a circular issued this month, has laid down rules
regarding the disclosure needed to be made by exchanges regarding the
methodology followed, the centres and panellists used for each commodity.
Finding a spot price to anchor commodity prices will become a
lot easier once the proposed National Agriculture Market is fully operational.
This is a pan-India electronic platform that will connect all the APMCmandisto create a unified spot market for
NCDEX puts out live data on both the spot and future prices of
contracts; this can help you select the commodity with the least variance.
Fear of government intervention
This is also not too great a concern as, over the years, the agri market has
realised that it is best not to show too much interest in commodities too prone
to government control.
If we consider the weights in the CPI index, for the base year
of 2012, cereals and products have weights of 12 per cent in the rural basket
and 6.5 per cent in the urban basket. Of the main cereals consumed in the
country, rice has already been suspended from trading. While wheat and maize
are traded on agri-commexes, volumes are not too high on these counters.
Of the politically sensitive pulses cluster, tur, arhar, etc,
have already been suspended from trading. Trading in chana was suspended in
June. Sugar continues to be vulnerable to political risk and hence, traders
here need to keep a tight watch on government policies as well.
Edible oils, such as mustard, and soy refined oil have higher
weights in the CPI and hence, are exposed to risk from government intervention.
So, traders need to tread cautiously here as well.
There is a perception that commodities are a black-box with information hard to
come by. But this is far from the truth. Exchanges provide a wealth of
information on factors governing the price of each commodity, its price
patterns and so on. Brokers also issue reports on commodities that can be quite
helpful. Apart from this, investors should track the harvesting and sowing
periods of a commodity, says Sushil Sinha. It is also important to follow the
monsoon, on the IMD website. Most commodities are internationally traded, too,
so information can be obtained from international exchanges, and research
reports. Sites such as USDA (US Department of Agriculture) and the Indian
Ministry of Agriculture can also be tapped.
Keeping track ofmandiprices
is essential at present. This can be done by following these prices on exchange
websites or from the daily reports issued by brokers.
Game for risk?
To sum up, liquidity is generally low in commodity exchanges but some counters
(in certain seasons) show enough liquidity to enable trading. Information is
also not too hard to come by for those interested in following the market.
Also, exchanges are trying to make the futures price as close as possible to
the price traded on the mandis.
But the risk of sharp price movements due to price manipulation
by a few insiders remains open. With SEBI at the helm, these wrongdoers could
be checked, and the system cleaned up eventually. But that could take years.
Meanwhile, the regulators continue to remain jumpy and continue to suspend
trading in contracts with excessive price movements, leaving the users of these
contracts in the lurch. This is eroding the credibility of these exchanges.
So, while agri-commodities could be an alternate avenue for
making some money, it is suited only for the risk-takers.