TERM PAPER

ON

COMMODITY MARKET & IT’s

FUTURE PROSPECT

(The Authors are students of ICFAI Business School, Kolkata and this paper are in
part fulfillment of their curriculum. The views expressed in this paper do not
represent the views of the institute in any way.)

Submitted to
Prof Tamal Dutta Choudhary
Prepared by:
Nisha Kumari
(06bs2056) Nitin
Parasar (06bs2099)
 Pratik N Manek (06bs2152)

Executive summary

After the dot-com bubble burst in 2000, commodities prices and the level of
investment in commodities rose significantly. Commodities could provide the yield
investors were looking for but, more important, investors began taking greater
advantage of the negative price correlation to bonds and equities to diversify their
portfolios. While the FSA monitors the commodity markets through a combination
of exchange and firm supervision, commodities have historically been a small and
specialized market predominantly used by producers and consumers to hedge their
price risk. Organized commodity derivatives in India started as early as 1875, barely
about a decade after they started in Chicago. However, many feared that derivatives
fuelled unnecessary speculation and were detrimental to the healthy functioning of
the markets for the underlying commodities. As a result, after independence,
commodity options trading and cash settlement of commodity futures were banned
in 1952. A further blow came in 1960s when, following several years of severe
draughts that forced many farmers to default on forward contracts (and even caused
some suicides), forward trading was banned in many commodities considered
primary or essential. Consequently, the commodities derivative markets dismantled
and remained dormant for about four decades until the new millennium when the
Government, in a complete change in policy, started actively encouraging the
commodity derivatives market. Since 2002, the commodities futures market in India
has experienced an unprecedented boom in terms of the number of modern
exchanges, number of commodities allowed for derivatives trading as well as the
value of futures trading in commodities, which might cross the $ 1 Trillion mark in
2008. However, there are several impediments to be overcome and issues to be
decided for sustainable development of the market.: So this Report will focus on
how did India pull it off in such a short time since 2002? Is this progress sustainable
and what are the obstacles that need urgent attention if the market is to realize its
full potential? Why are commodity derivatives important and what could other
emerging economies learn from the Indian mistakes and experience?

As the markets have grown, new investors have been attracted to commodities, with
increased interest from pension funds, high net worth individuals and even some
retail investors. Most commentators expect investment from pension funds to
continue growing and most of that money to flow into index funds. Unlike previous
cyclical bouts of investment we expect much of this money to stay. As a result, a
wealth of new products has been developed both on and off exchange to meet
investors’ needs. These range from new futures contracts in coal and ethanol to
exchange traded funds and similar products which may make it easier for retail
investors to gain exposure.

Challenges and risks arising from the changes in the market.

For exchanges the increase in volumes primarily brings systems and controls
challenges – that is, can their trading platforms and monitoring capabilities cope
with the huge increase in trading? It is vital that systems are designed and
thoroughly tested to ensure they remain robust. For firms there are several
challenges. Recruiting and retaining staff with the appropriate level of expertise and
experience is a challenge for all. As more firms have entered the market or expanded
their operations the limited pool of experienced staff in the market has become
stretched. Firms themselves acknowledge the problem and it is imperative that they
manage this risk. Staffing issues apply equally to commodities exchanges which
must ensure compliance functions are adequately resourced. Secondly, firms are
facing increased volatility in some markets which raises the cost of trading and the
risk of financial failure. It is essential that firms have appropriate and robust risk
management systems and procedures in place. This includes thorough testing and
modeling for algorithmic trading systems.
Thirdly, in some cases firms are investing in commodities through the acquisition
of physical assets such as power stations. This significantly alters their portfolio of
risk. Again, risk management systems must be appropriate and senior management
must fully appreciate the risks they are assuming. A further issue affecting firms and
exchanges arises from the increasing number of users not previously participating in
commodities markets. Aggressive and high volume
trading and ever more ambitious investment funds pose fresh challenges for more
traditional users of the markets and for the infrastructure providers who must now
operate in a significantly changed environment. Given the growth of investment and
the range of new participants we will be increasing our monitoring of commodities
markets. While these markets are no more susceptible to improper practices than any
other, firms should ensure they have adequate controls in place. Consumers risk
being exposed to unsuitable investments that they do not fully understand. A
growing number of products allow retail exposure to commodities, while indirect
exposure through pension funds is also increasing.

In conclusion, there has been a significant expansion in commodities investment in

recent years, bringing with it a range of new participants. These developments raise
various risks and challenges for those involved. It is essential that all parties
fully appreciate and address these risks.
 Introduction

Two of the statutory regulatory objectives are to maintain confidence in the

financial system and to secure the appropriate degree of protection for consumers.
Against these objectives commodities have traditionally been a specialised market,
dominated by professional participants, so they have received less regulatory
attention than the larger and more high-profile equity and bond markets. However, a
significant bull run has been underway in commodities in recent years. Bull markets
are nothing new but this time the number of participants and the amount of assets
invested has grown significantly. Many are investing in commodities for the first
time. The Indian economy is witnessing a mini revolution in commodity derivatives
and risk management. Commodity options trading and cash settlement of
commodity futures had been banned since 1952 and until 2002 commodity
derivatives market was virtually non-existent, except some negligible activity on an
OTC basis. Now in September 2005, the country has 3 national level electronic
exchanges and 21 regional exchanges for trading commodity derivatives. As many
as eighty (80) commodities have been allowed for derivatives trading. The value of
trading has been booming and is likely to cross the $ 1 Trillion mark in 2008 and, if
all goes well, seems to be set to touch $5 Trillion in a few years.
History
The history of organized commodity derivatives in India goes back to the
nineteenth century when the Cotton Trade Association started futures trading in
1875, barely about a decade after the commodity derivatives started in Chicago.
Over time the derivatives market developed in several other commodities in India.
Following cotton, derivatives trading started in oilseeds in Bombay (1900), raw jute
and jute goods in Calcutta (1912), wheat in Hapur (1913) and in Bullion in Bombay
(1920). However, many feared that derivatives fuelled unnecessary speculation in
essential commodities, and were detrimental to the healthy functioning of the
markets for the underlying commodities, and hence to the farmers. With a view to
restricting speculative activity in cotton market, the Government of Bombay
prohibited options business in cotton in 1939. Later in 1943, forward trading was
prohibited in oilseeds and some other commodities including food-grains, spices,
vegetable oils, sugar and cloth. After Independence, the Parliament passed Forward
Contracts (Regulation) Act, 1952 which regulated forward contracts in commodities
all over India. The Act applies to goods, which are defined as any movable property
other than security, currency and actionable claims. The Act prohibited options
trading in goods along with cash settlements of forward trades, rendering a crushing
blow to the commodity derivatives market. Under the Act, only those
associations/exchanges, which are granted recognition by the Government, are
allowed to organize forward trading in regulated commodities. The Act envisages
three-tier regulation: (i) The Exchange which organizes forward trading in
commodities can regulate trading on a day-to-day basis; (ii) the Forward Markets
Commission provides regulatory oversight under the powers delegated to it by the
central Government, and (iii) the Central Government - Department of Consumer
Affairs, Ministry of Consumer Affairs, Food and Public Distribution - is the ultimate
regulatory authority. The already shaken commodity derivatives market got a
crushing blow when in 1960s, following several years of severe draughts that forced
many farmers to default on forward contracts (and even caused some suicides),
forward trading was banned in many commodities considered primary or essential.
As a result, commodities derivative markets dismantled and went underground
where to some extent they continued as OTC contracts at negligible volumes. Much
later, in 1970s and 1980s the Government relaxed forward trading rules for some
commodities, but the market could never regain the lost volumes.

Change in Government Policy

After the Indian economy embarked upon the process of liberalization and
globalization in 1990, the Government set up a Committee in 1993 to examine the
role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended
allowing futures trading in 17 commodity groups. It also recommended
strengthening of the Forward Markets Commission, and certain amendments to
Forward Contracts (Regulation) Act 1952, particularly allowing options trading in
goods and registration of brokers with Forward Markets Commission. The
Government accepted most of these recommendations and futures trading was
permitted in all recommended commodities. Commodity futures trading in India
remained in a state of hibernation for nearly four decades, mainly due to doubts
about the benefits of derivatives. Finally a realization that derivatives do perform a
role in risk management led the government to change its stance. The policy
changes favouring commodity derivatives were also facilitated by the enhanced role
assigned to free market forces under the new liberalization policy of the
Government. Indeed, it was a timely decision too, since internationally the
commodity cycle is on the upswing and the next decade is being touted as the
decade of commodities.

Why are Commodity Derivatives Required?

India is among the top-5 producers of most of the commodities, in addition to

being a major consumer of bullion and energy products. Agriculture contributes
about 22% to the GDP of the Indian economy. It employees around 57% of the labor
force on a total of 163 million hectares of land. Agriculture sector is an important
factor in achieving a GDP growth of 8-10%. All this indicates that India can be
promoted as a major center for trading of commodity derivatives.
It is unfortunate that the policies of FMC during the most of 1950s to 1980s
suppressed the very markets it was supposed to encourage and nurture to grow with
times. It was a mistake other emerging economies of the world would want to avoid.
However, it is not in India alone that derivatives were suspected of creating too
much speculation that would be to the detriment of the healthy growth of the
markets and the farmers. Such suspicions might normally arise due to a
misunderstanding of the characteristics and role of derivative product. It is important
to understand why commodity derivatives are required and the role they can play in
risk management. It is common knowledge that prices of commodities, metals,
shares and currencies fluctuate over time. The possibility of adverse price changes in
future creates risk for businesses. Derivatives are used to reduce or eliminate price
risk arising from unforeseen price changes. A derivative is a financial contract
whose price depends on, or is derived from, the price of another asset.

Two important derivatives are futures and options.

(i) Commodity Futures Contracts: A futures contract is an agreement for buying

or selling a commodity for a predetermined delivery price at a specific future time.
Futures are standardized contracts that are traded on organized futures exchanges
that ensure performance of the contracts and thus remove the default risk. The
commodity futures have existed since the Chicago Board of Trade (CBOT,
www.cbot.com) was established in 1848 to bring farmers and merchants together.
The major function of futures markets is to transfer price risk from hedgers to
speculators. For example, suppose a farmer is expecting his crop of wheat to be
ready in two months time, but is worried that the price of wheat may decline in this
period. In order to minimize his risk, he can enter into a futures contract to sell his
crop in two months’ time at a price determined now. This way he is able to hedge
his risk arising from a possible adverse change in the price of his commodity.

(ii) Commodity Options contracts: Like futures, options are also financial
instruments used for hedging and speculation. The commodity option holder has the
right, but not the obligation, to buy (or sell) a specific quantity of a commodity at a
specified price on or before a specified date. Option contracts involve two parties –
the seller of the option writes the option in favour of the buyer (holder) who pays a
certain premium to the seller as a price for the option. There are two types of
commodity options: a ‘call’ option gives the holder a right to buy a commodity at an
agreed price, while a ‘put’ option gives the holder a right to sell a commodity at an
agreed price on or before a specified date (called expiry date).The option holder will
exercise the option only if it is beneficial to him; otherwise he will let the option
lapse. For example, suppose a farmer buys a put option to sell 100 Quintals of wheat
at a price of $25 per quintal and pays a ‘premium’ of $0.5 per quintal (or a total of
$50). If the price of wheat declines to say $20 before expiry, the farmer will exercise
his option and sell his wheat at the agreed price of $25 per quintal. However, if the
market price of wheat increases to say $30 per quintal, it would be advantageous for
the farmer to sell it directly in the open market at the spot price, rather than exercise
his option to sell at $25 per quintal.
Futures and options trading therefore helps in hedging the price risk and also
provide investment opportunity to speculators who are willing to assume risk for a
possible return. Further, futures trading and the ensuing discovery of price can help
farmers in deciding which crops to grow. They can also help in building a
competitive edge and enable businesses to smoothen their earnings because non
hedging of the risk would increase the volatility of their quarterly earnings. Thus
futures and options markets perform important functions that can not be ignored in
modern business environment. At the same time, it is true that too much speculative
activity in essential commodities would destabilize the markets and therefore, these
markets are normally regulated as per the laws of the country.
Modern Commodity Exchanges
To make up for the loss of growth and development during the four decades of
restrictive government policies, FMC and the Government encouraged setting up of
the commodity exchanges using the most modern systems and practices in the
world. Some of the main regulatory measures imposed by the FMC include daily
mark to market system of margins, creation of trade guarantee fund, back-office
computerization for the existing single commodity Exchanges, online trading for the
new Exchanges, demutualization for the new Exchanges, and one-third
representation of independent Directors on the Boards of existing Exchanges etc.
Responding positively to the favorable policy changes, several Nation-wide Multi-
Commodity Exchanges (NMCE) have been set up since 2002, using modern
practices such as electronic trading and clearing. Selected Information about the two
most important commodity exchanges in India [Multi-Commodity Exchange of
India Limited (MCX), and National Multi-Commodity & Derivatives Exchange of
India Limited (NCDEX)] .

What risks and challenges arise from these recent developments in

commodities markets?
To answer this we spoke to several exchanges, hedge funds, pension funds and other
firms active in the market. We identified the most recent developments in the market
and saw how developing markets are changing the way firms conduct business (and
vice versa). There are some areas of uncertainty between commentators, especially
when attempting to determine the exact amount invested in commodities so our
research is bound by these constraints. Where these uncertainties exist we have set
out the range of estimates we were given. It is vital that firms, individuals and the
FSA understand the full range of risks facing them. The purpose of this paper is to
illustrate the changing nature of investors, the expanding range of products and to
estimate the current level of investment in commodities markets. Most important,
we identify and investigate issues facing the market and highlight potential risks and
challenges.

Why invest in commodities?

Studies have shown that commodity price movements have traditionally been
negatively correlated to price movements of other financial instruments (such as
equities or bonds), so a natural resource investment can provide important portfolio
diversification. Equities, bonds and other financial instruments have shown that they
tend to follow the same trend in times of economic crisis. In addition, equities are
also bound by country-specific economic pressures. In contrast, commodities such
as zinc and wheat or orange juice will rarely rise and fall in parallel, regardless of
economic fundamentals, and they reflect the global economy. By being able to
efficiently diversify a portfolio, a fund manager reduces the risk that the total value
of their fund will decline given particular economic fundamentals. Even so,
investors should be cautious. Recent price drops have led to media comment quoting
commodities professionals who say that the bull run may be over and that it would
be a bad time for investors to enter this asset class. They say that with some markets
now in contango (i.e. the spot price is lower than the forward price) in the nearby,
the roll on indices has become a negative yield.
Further, and as we cite above, some commentators point to the number of leading
equity indices made up by companies whose share prices are positively correlated
with commodity prices, e.g. BP and oil prices, Rio Tinto and the price of copper.
This means an investment manager must be very careful when seeking to have a
truly diversified portfolio.
Retail investors and institutional funds (if allowed) would be wary of trading in
commodity derivatives due to fear of ending up in delivery and lack of an efficient
portfolio that would keep up the growth momentum in their value of investment in
commodities. Hence an approach has been made here to compare one of the Indian
commodity indices (MCX Comdex) and its global counterparts to find if there is a
steady bull run in the Indian commodities compared with the global markets.
Investing in commodity indices that are efficiently designed for such purposes
would serve the dual purpose of removal of the fear of physical deliveries and would
yield them better returns with a moderate risk. Such commodity indices not only
provide an investment opportunity, but also provide with an alternative risk
mitigation mechanism for investors with intention to spread their eggs across
different commodity baskets. This would also help mitigate risks for those with
exposure to more commodity related industries such as Refineries, Copper wire
manufacturers, edible oil crushers/refiners. As such, investing in indices is not a new
phenomenon to the investors in India, as indices designed based on spot and futures
securities market are commonly traded in the Indian stock exchanges. However,
globally commodity derivative indices are different from their financial derivative
counterparts in that their underlying physical/futures markets in commodities ranges
from paper pulp to gold, pork bellies to live cattle and crude oil. Globally, there are
about ‘half a dozen’ popular indices that reflect the futures prices of commodities
from different underlying markets. The list includes indices such as Goldman Sachs
Commodity index (GSCI), Dow Jones-AIG Commodity Index (DJ-AIGCI), Reuters
CRB Commodity Index (RCRBCI), S&P Commodity Index (S&PCI), Rogers
International Commodity Index (RICI), and Deutsche Bank Liquid Commodity
Index (DBLCI). An interesting feature in these commodity indices is that, unlike
stock indices, all are based on futures contract prices due to the non-availability of
reliable spot prices of commodities at short regular intervals.

According to Goldman Sachs, about $80 billion have been invested globally in the
commodity derivatives of which 60 percent (about $48 billion) has been invested in
passive index-tracking instruments. Of these, a bulk has been invested in
instruments linked to the Goldman Sachs Commodity Index (GSCI), DJAIGCI, and
RCRBCI that are traded on global benchmark exchanges – CME, CBOT and
NYBOT respectively. Apart from futures and options, huge investments have been
done on these commodity indices through over-the-counter instruments such as
swaps and structured notes. Trading houses and derivatives dealers are the principal
players involved in trading and designing of these instruments. Apart from this,
smaller funds such as Pimco’s Commodity Real Return Strategy Fund,
Oppenheimer’s Real Asset Fund, and Rogers International Raw Materials Funds are
available to retail investors interested in accessing global commodity markets
through index funds. These funds either invest in futures markets directly or Over-
The-Counter instruments or both for their commodities exposure. Recently,
Scudder’s Commodity Securities Fund, a path-breaking and an innovative fund
based on commodity derivatives associated with GSCI benchmark (50 percent) and
the shares of companies involved in commodity-based industries, (50 percent) was
launched. However, the current RBI regulations do not allow individuals and
entities from India to participate in trading in these global indices or global funds
tracking these indices.

How are Commodity Indices different from Stock Indices?

The cash prices of the exchange-traded stocks are available on a regular and
continuous basis; hence construction of index based on this data is simple and
continuous. Contrarily, cash prices of commodities are not readily available on a
continuous basis. To have an index that is indicative of the fundamentals and
actively tradable, it would be better to construct an index using futures prices rather
than cash prices in the absence of effective spot exchanges for commodities in the
country, commodity futures traded on an organized platform provides the best
platform to base the indices. However, futures contract expires on the date of their
maturity. In order to have continuous futures prices, commodity indices are
constructed in such a way that futures prices of given maturities (preferably near
(front) months) are considered and all are replaced with (rollover to) the subsequent
month’s contracts during a definite rollover period. The popularity of the
commodity futures indices would have wide implications on the futures industry as
well. Investment in indices is normally a long-term strategy that could help increase
open up interests in futures contracts for various commodities as investor gain better
grip of the fundamentals. A significant spurt in trading activity could be witnessed
during the rollover days, when traders rolled over their positions into new contracts.
As the indices undertakes the movements in the nearest deferred months, funds
would like to hold positions in those underlying contracts. And, in the process this
would increase the trading activity in nearest deferred month contracts as well
during the roll-over period. Another interesting proposition could be that the trading
and investment community would get new trading opportunities whereby they can
take the strategic positions in both the indices and the underlying commodities to
profit out of the mismatched pricing between the two instruments ranging from
crude oil to live stock to precious metals. GSCI is highly volatile, as it gives nearly
75% of its index weight to commodities in energy sector. The futures on GSCI are
listed on Chicago Mercantile exchange.

Capital and Commodity Markets a comparison

I. Capital market
Progress on developing India’s capital market, which is already more competitive,
deep and developed by international markets standards, continued. Business in the
country’s oldest stock exchange, namely the Bombay Stock Exchange (BSE) dating
back to 1875, which is also one of the oldest stock exchanges in the world,
continued to thrive. The National Stock Exchange (NSE), which emerged in the
mid-1990s and catalyzed improvements in trading systems to provide the necessary
depth and choice to investors, made sustained progress. With the BSE and NSE
emerging as the two apex institutions of the country’s capital market, restructuring
of other stock exchanges went apace. Overseen by Securities and Exchange Board
of India (SEBI), an independent statutory regulatory authority, the country’s capital
market dealt in scrips of a large number of listed companies with a wide
geographical outreach, providing a world class trading and settlement system, a
wide range of product availability with a fast growing derivatives market, and well
laid down corporate governance and investor protection measures. As a part of the
on-going financial and regulatory reforms of the primary and secondary market
segments of the capital market, a number of initiatives were taken in 2005-06 and
the current year so far. These measures, together with accelerated economic growth
and macroeconomic stability, sustained the confidence of investors (both domestic
and foreign) in the country’s capital market. The stock market scaled new peaks
year after year since 2003, with the BSE and NSE indices crossing the 14,000 and
4,000 marks, respectively, in January 2007.

Primary market
The primary capital market has remained upbeat during 2006-07 so far. The
aggregate resource mobilization in the market, especially through Initial Public
Offerings (IPO’s) and private placements, was much higher in calendar year 2006
than during the previous year (Table 4.1).
Out of Rs. 161,769 crore mobilized in the primary capital market, Rs. 117,407 crore,
or 72.5 per cent of the total resources mobilized, was raised through private
placement. Seventy five IPOs raised Rs. 24,779 crore, which accounted for 76 per
cent of resources raised through equity. The number of IPOs showed a steady rise to
75 during 2006; on an average, there were around 6 IPOs per month.Net
mobilization of resources by mutual funds increased by more than four-fold to Rs.
104,950 crore in 2006 from Rs. 25,454 crore in 2005. The sharp rise in mobilization
by mutual funds was due to buoyant inflows under both income/debt oriented
schemes and growth/equity oriented schemes. After suffering negative inflows in
2003 and 2004, inflows turned positive for public sector mutual funds in 2005 and
accelerated in 2006. The share of UTI and other public sector mutual funds in the
total amount mobilized was around 22.5 per cent in 2005 and 17.8 per cent in 2006
(Table 4.2).
Secondary market

In the secondary market, the up trends continued in 2006-07 with BSE Sensex and
NSE Nifty indices closing above 14,000 (14,015) and 4,000 marks (4,024) for the
first time, respectively on January 3, 2007. After a somewhat dull first half,
conditions on the bourses turned buoyant during the later part of the year with large
inflows from Foreign Institutional Investors (FIIs) and larger participation of
domestic investors. During 2006, on a point-to-point basis, Sensex and Nifty Indices
rose by 46.7 and 39.8 per cent, respectively. The pick up in the stock indices could
be attributed to impressive growth in the profitability of Indian corporate, overall
higher growth in the economy, and other global factors such as continuation of
relatively soft interest rates and fall in crude oil prices in international markets.
Amongst the NSE indices, both Nifty and Nifty Junior delivered strong positive
returns, appreciating by 39.8 per cent and 28.2 per cent, respectively during the
calendar year 2006. While Nifty gave compounded returns of 28.3 per cent, Nifty
Junior recorded compounded returns of 27.8 per cent per year between 2004 and
2006 . The NSE indices (Nifty and Nifty Junior), on a climb since November 2005,
dipped in May and June 2006 owing to bearish sentiments and selling by FIIs. But
there was a rapid recovery thereafter and an uptrend in the indices. Similarly, BSE
Sensex (top 30 stocks) which was 9,398 at end-December 2005 and 10,399 at end-
May 2006, after dropping to 8,929 on June 14, 2006, recovered soon thereafter to
rise steadily to 13,787 by end-December 2006 .
The BSE Sensex has continued its movement upwards in 2007 so far. It closed at
14,652 on February 8, 2007. The journey from 13,000 to 14,000 mark, achieved in
just 26 trading sessions, was one of the fastestever climbs. The Sensex gained 4,389
points and appreciated by 46.7 per cent during 2006. It recorded compounded
returns of 33.2 per cent per year between 2004 and 2006. BSE 500 recorded a gain
of 38.9 per cent during 2006 to close at 5,271. The compounded returns of BSE 500
between 2004 and 2006 were 30.6 per cent per year.
According to the number of transactions, NSE continued to occupy the third
position among the world’s biggest exchanges in 2006, as in the previous three
years. BSE occupied the sixth position in 2006, slipping one position from 2005
(Table 4.5). In terms of listed companies, the BSE ranks first in the world.
With the stock indices soaring, capitalisation also increased significantly by over 45
per cent during 2006. The year under review saw increased daily volatility (as
measured by standard deviation of returns) in the Indian markets partly due to a
sharp sell off in the market during the month of May in line with global markets in
reaction to the trend in global interest rates. The market soon recovered thereafter to
touch new highs reflecting the underlying strength of the fundamentals of the Indian
economy. The price-to-earnings (P/E) ratio, which partly reflects investors’
expectations of corporate income growth in future, was higher at a little over 20 by
end-December 2006 as compared to 17-18 at end-December 2005 . investors’
wealth as reflected in market
In terms of volatility of weekly returns, uncertainties as reflected by the Indian
indices were higher than that depicted by indices outside India such as S&P 500 of
United States of America and Kospi of South Korea. The Indian indices recorded
higher volatility on weekly returns during the two-year period January 2005 to
December 2006 as compared to January 2004 to December 2005
The market valuation of Indian stocks at the end of December 2006, with the Sensex
trading at a P/E multiple of 22.76 and S&P CNX Nifty at 21.26, was higher than
those in most emerging markets of Asia, e.g. South Korea, Thailand, Malaysia and
Taiwan; and was the second highest among emerging markets. The better valuation
could be on account of the good fundamentals and expected future growth in
earnings of Indian corporates (Table 4.8)

Market capitalisation in terms of GDP indicates the relative size of the capital
market, besides investor confidence and discounted future earnings of the corporate
sector. As on January 12, 2007, market capitalisation (NSE) at US$834 billion was
91.5 per cent of GDP. India’s market capitalisation compares well with other
emerging economies and shows signs of catching up with some of the mature
economies (Table 4.9).

Liquidity, which serves as a fuel for the price discovery process, is one of the main
criteria sought by the investor while investing in the stock market. Market forces of
demand and supply determine the price of any security at any point of time. Impact
cost quantifies the impact of a small change in such forces on prices. Higher the
liquidity, lower the impact cost. The impact cost for purchase or sale of Rs.50 lakh
of the Nifty portfolio and that of Rs. 25 lakh of Nifty Junior portfolio remained
constant at 0.08 per cent and 0.16 per cent, respectively, over 2005 and 2006 (Table
4.10).
The turnover in the spot and derivatives market, both on the NSE and BSE, has
shown steady growth in the recent years. NSE and BSE spot market turnover more
than doubled between 2003 and 2006. In respect of derivatives, the turnover on NSE
nearly doubled in a single year between 2005 and 2006 (Table 4.11).

NSE and BSE spot market turnovers adding up to Rs. 2,877,880 crore and NSE
and BSE derivatives turnover adding up to Rs. 7,050,677 crore in 2006 showed
significant growth over the previous year. At the end of 2006, as a proportion of
GDP (advance estimate for 2006-07), the turnover in the spot market was 70.2 per
cent, while that in the derivatives market was 171.9 per cent.In terms of the
composition of market participants, the stock market continued to be dominated by
retail investors. The average transaction size of the spot market indicated its
continued accessibility to small investors (Table 4.12).
The daily average volume of trade in the commodity exchanges in December 2006
was Rs. 12,000 crore. In the fortnight ending on December 31, 2006, gold, silver
and copper recorded the highest volumes of trade in MCX, while in NMCEX,
pepper, rubber and raw jute, and in NCDEX, guar seed, chana and soy oil had the
highest volumes of trade. MCX emerged as the largest commodity
futures exchange during 2006-07 both in terms of turnover and number of contracts.
The growth of MCX during 2006-07 is comparable with some of the international
commodity futures exchanges like Goldman Sachs Commodity Index (GSCI), Dow
Jones AIG Commodity Index Cash Index (DJAIG) and Reuters/Jefferies
Commodity ResearchBureau (RJCRB) (Figure 4.2).

segment. The recent policy initiatives to address the systemic issues in the primary
capital market may increase the reliance on public issues as a major source of funds
for Indian corporates besides helping to broaden the investor base. With increased
globalisation, behaviour of stock prices in the near-term will be largely influenced
by a host of domestic as well as international factors. Global economy, after four
consecutive years of strong growth, is expected to post an equally impressive
growth in 2007. Favourable international economic conditions enhance the growth
prospects of developing countries which in turn facilitates sustained flow of cross-
border portfolio investment to emerging economies. On the domestic front, there are
expectations of higher corporate investment and earnings, GDP growth of over 8 per
cent for the fourth year in a row with macroeconomic stability, and Government’s
commitment to carry forward the economic reforms. These are expected to sustain
the interest of not only the domestic investors but also scale-up FII interest in Indian
equity and debt papers and to retain India as one of the preferred destinations for
portfolio investment. Improved investor awareness and expanding equity-cult
among the small savers appear to augur well for buoyant stock markets. Recent
trend of increased investors’ preference to participate in equity markets through
mutual fund conduit would enhance institutional investment in equity markets. The
institutional and regulatory architecture should facilitate this further as this would
counterbalance and cushion the impact of the swings in the stock prices.
While Government securities market is expected to attain further width and breadth
as a result of the latest policy initiatives such as introduction of intra-day short sale
and ‘when issued’ market, measures need to be taken to revive the corporate debt
market to remove its sluggishness and encourage individual investment as well as
institutional investment including those by FIIs.
The commodity exchanges, which have seen consistent increase in turnovers for the
last few years, may remain vibrant in 2007- 08 witnessing larger volume and value
of commodities traded. Gold and crude oil account for the major part of the total
transactions in futures market at present. But, other commodities, particularly
agricultural commodities, are expected to gain importance helping their price
discovery process and thereby providing an opportunity for farmers, traders and
consumers to obtain a reasonable price. The proposed amendments to the Forward
Contracts (Regulation Act), 1952 are expected to strengthen the regulatory aspects
and ensure orderly conditions in the commodity futures market.

Different index and relationship between factors

There are some nationalized index which are predicting and tracking the commodity
market movement .the commodity index are consist of certain factors and it’s
showing the movement of commodity market pattern as per scenario goes. In our
project we try to show the relationship between different indices.

Rainfall Vs spot commodity index

3000

2500
value

2000

1500

1000
Index Value
500
0
Actual Cummulative
28- 06- 14- 23- 01- 10- 18- Rainfall(mm) since
10- 10- 09- 08- 08- 07- 06- 06/01/2007
2007 2007 2007 2007 2007 2007 2007
date

relationship between rain fall index and future

index

3000
2500
index value

2000 rain fall index

1500
commodity future
1000 index
500
0
06 0-2 07
25 0-2 07
14 9-2 07
03 9-2 07
23 9-2 07
12 8-2 07
01 8-2 07
21 8-2 07
10 7-2 07
29 7-2 07
6- 7
07
-0 00
-1 0
-1 0
-0 0
-0 0
-0 0
-0 0
-0 0
-0 0
-0 0
-0 0

20
17 0-2
-1
28

date
 index value

1000
1500
2000
2500
3000

0
500
28-10-2007
17-10-2007
06-10-2007
25-09-2007
14-09-2007
03-09-2007

date
23-08-2007
12-08-2007
01-08-2007
21-07-2007
10-07-2007
spot commodity index

29-06-2007
index
relationship between rainfall index and

rain fall index

spot commodity
References:

www.mcxindia.com

www.indiabullion.com

www.indiainfoline.com

www.ssrn.com