A Study On Commodity Market

TABLE OF CONTENTS 1. Introduction…………………………………………………………………………………………. 1 1.1.Spot Vs Forward Transactions………………………………………………………………… 4 1.2.Limitations…………………………………………………………………………………...... 5 2. Company Profile……………………………………………………………………………………. 7 3. History of Commodity trading and Precious Metals……………………………………………….. 9 3.1. Commodity trading in India………………………………………………………………….... 9 3.2. Kabra committee report……………………………………………………………………...... 10 3.3. Forward Market Commission………………………………………………………………….. 12 3.4. Multi-commodity exchange of India……………………………………………………………13 3.5. National Commodity and Derivatives Exchange limited……………………………………… 15 3.6. History of Gold Market………………………………………………………………………... 19 3.6.1.Gold Trading…………………………………………………………………………….. 20 3.6.2.Production of the Gold…………………………………………………………………… 20 3.6.3.Why central Banks Hold Gold…………………………………………………………… 21 3.7.History of silver Market……………………………………………………………………….. 23 3.7.1.Production of silver……………………………………………………………………. ... 24 4. Pricing Commodity Futures………………………………………………………………………..

26

4.1.Investment Vs Consumption Assets…………………………………………………………..... 26 4.2.Cost of Carry model………………………………………………………………………….... 27 4.3.Pricing Futures Contract on Investment commodities………………………………………… 29 4.4.Pricing Futures Contract on Consumption commodities……………………………………… 32 5. Clearing, Settlement and Risk Management……………………………………………………….. 35 5.1.Clearing………………………………………………………………………………………… 35 5.2.Settlement………………………………………………………………………………………. 37 5.3.Risk Management……………………………………………………………………………… 40 6. Fundamental and Technical Analysis………………………………………………………………. 42 6.1.Fundamental

analysis………………………………………………………………………......

42 6.1.1.Demand and Consumption………………………………………………………………. 42

6.1.2.Consumption of gold in India…………………………………………………………….. 44 6.1.3.Uses of Gold……………………………………………………………………………… 44 6.2.Technical analysis……………………………………………………………………………… 46 6.2.1.Dow Theory……………………………………………………………………………… 46 6.2.2.Basic principles of Technical analysis…………………………………………………… 50 6.2.3.Line

Chart…………………………………………………………………………………

51 6.2.4.Bar

Chart…………………………………………………………………………………..

52 6.2.5.Japanese Candlestick Chart………………………………………………………………. 55 6.2.6.Chart

Patterns…………………………………………………………………………......

59 6.2.6.1. Support and resistance patterns…………………………………………………. 59 6.2.6.2 Reversal pattern…………………………………………………………………. 62 6.3. Mathematical Indicators………………………………………………………………………. 64 6.3.1. Moving Average………………………………………………………………………… 64 6.3.1.1. Simple moving Average…………………………………………………… ….. 64 6.3.1.2. Exponential moving Average………………………………………………….. 66 6.3.2. Oscillators……………………………………………………………………………….. 68 6.3.2.1. Rate of Change indicators……………………………………………………… 68 6.3.3. Market Indicators……………………………………………………………………….. 71 7.

References………………………………………………………………………………………….. 72

ABSTRACT

Aim: An empirical study on precious metals based on fundamental and technical analysis. Abstract: We study the gold and silver prices based on fundamental analysis like inventories in the entire globe, central bank reserves and currency fluctuations. We study the Inventories which will effect due to strikes, political conditions and demand & supply mismatch. According to central Bank policies and central agreements reserves will various. Currency trading on Dollar verses Euro or Dollar verses sterling pound causes volatility which leads to gold/silver price fluctuations. We forecast the gold and silver prices with advanced technical analysis tools by using mathematical indicators and Market indicators like Simple moving average, Exponential moving average. Market indicators are the indicators used by technical analysts to study the trend of the market as a whole. Oscillators like Rate of change Indicators. We use mathematical indicators to know the average prices of the commodity, and we use Oscillators to identify overbought and oversold conditions.

In this study we are applying both fundamental and technical analysis for predicting the future price actions based on historical data and previous trends.

LIST OF FIGURES 1. Consumption of Gold...................................................................................................... 43 2. Primary trend and secondary reactions............................................................................. 47 3. Three Phases of bull market.............................................................................................. 48 4. Three Phases of a bear market.......................................................................................... 49 5. Line chart.......................................................................................................................... 51 6. Bar Chart of silver............................................................................................................. 52 7. Bar chart of Gold.............................................................................................................. 54

8. Bar Chart of Crude oil...................................................................................................... 55 9. Japanese candlesticks of Silver......................................................................................... 56 10. Japanese candlesticks of crude oil.................................................................................... 57 11. Japanese candlesticks of Gold.......................................................................................... 58 12. Support and resistance levels............................................................................................ 61 13.Head and shoulder formation............................................................................................... 62 14. EMA Chart.........................................................................................................................

68 15. ROC Chart..........................................................................................................................

70

LIST OF TABLES

1. Active contracts traded in MCX……………………………………………………….. 14 2. Comparative Data for Three Periods Value of Turnover………………………………. 17 3. Active contracts traded in NCDEX…………………………………………………….. 18

4. NCDEX – indicative warehouse charges……………………………………………….. 30 5. Highest, Lowest and Closing prices of Silver……………………………………………52 6. Highest, Lowest and closing pricesof Gold………………………………………….... 53 7. Highest, Lowest and closing Prices of Crude oil.............................................................. 54 8. Prices of Silver.................................................................................................................. 55 9. Prices of Crude oil............................................................................................................ 56 10. Prices of Gold.................................................................................................................. 57 11. Highest, Lowest and Closing Prices of Gold................................................................... 59 12. Highest, Lowest and closing prices of Silver.................................................................... 63 13. Gold price Five days Simple Moving Average................................................................. 65 14. Gold price of Five – Day EMA.........................................................................................

66 15. 30 days gold price of 7 – day ROC................................................................................... 69

CHAPTER – 1

INTRODUCTION

Trading on derivatives first started to protect farmers from the risk of their values against fluctuations in the price of their crop. From the time it was sown to the time it was ready for harvest, farmers would face price uncertainty. Through the use of simple derivative products the farmers can transfer their risk (i.e. fully or partially) by locking the price of their products. This was developed to reduce the risk of the farmers. Let’s take an example when a farmer who sowed his crop in June which he would receive his harvest in September may face uncertainty in prices over the period because of the oversupply they are selling at a very low cost. In 1848, the Chicago Board of Trade (CBOT) was established to bring farmers and merchants together. A group of traders got together and created the `to-arrive' contract that permitted farmers to lock in to price upfront and deliver the grain later. Today, derivative contracts exist on a variety of commodities such as corn, pepper, cotton, wheat, silver, etc. Besides commodities, derivatives contracts also exist on a lot of financial underlying like stocks, interest rate, exchange rate, etc. Due to the high volatility in Financial Market with high risk & low rate of return had made investors to choose alternate investments such as Bullion market in Commodity market. In India gold has traditionally played a multi-faceted role. Apart from being used for armament purpose, it has also served as an asset of the last resort and a hedge against inflation and currency depreciation. But most importantly, it has most often been treated as an investment.

Many people have become very rich in commodity markets. It is one of the areas where people can make extraordinary profits within a short span of time. For example, Richard Dennis borrowed $1600 and turned it into a $200 million fortune in about ten years. Definition of Derivatives: A derivative is a product whose value is derived from value of one or more underlying assets or variables in a contractual manner. The underlying asset can be equity, forex, commodity or any other assets. For example: A wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. The Forwards Contracts (Regulation) Act, 1952, regulates the forward/ futures contracts in commodities all over India. However when derivatives trading in securities was introduced in 2001, the term security in the Securities Contracts Regulation Act, 1956 (SCRA), was amended to include derivative contracts in securities. Products and participants: Derivative contracts are of different types. The most common ones are forwards, futures, options and swaps. Participants who trade in the derivatives market can be classified under the following three broad categories - Hedgers, Speculators, and Arbitragers. 1. Hedgers: Hedgers face risk associated with the price of an asset. They use the futures or options markets to reduce or eliminate this risk. 2. Speculators: Speculators are participants who wish to bet on future movements in the price of an asset. Futures and options contracts can give them leverage; that is, by putting in small amounts of money upfront, they can take large positions on the market. As a result of this leveraged speculative position, they increase the potential for large gains as well as large losses. 3. Arbitragers: Arbitragers work at making profits by taking advantage of discrepancy between prices of the same product across different markets. If, for example, they see the futures

price of an asset getting out of line with the cash price, they would take offsetting positions in the two markets to lock in the profit.

Spot versus forward transaction: Let us try to understand the difference between spot and derivatives contract. Every transaction has three components like trading, clearing and settlement. A buyer and seller come together, negotiate and arrive at a price this is trading. Clearing involves finding out the net outstanding, that is exactly how much of goods and money the two should exchange. For example ‘A’ buys goods worth Rs.1000 from ‘B’ and sells goods worth Rs.400 to ‘B’. On a net basis ‘A’ has to pay Rs.600 to ‘B’. Settlement is the actual process of exchanging money and goods. In a spot transaction, the trading, clearing and settlement happens immediately, i.e. on the spot. For example on 1March 2009, Suman wants to buy some gold. The goldsmith quotes Rs.15000 per 10 grams. They agree upon this price and Suman buys 20grams of gold. He pays Rs.30000 to the goldsmith and collects his gold. This is a spot transaction. Now suppose Suman does not want to buy the gold on the 1 March, but wants to buy it a month later. Then the goldsmith quotes Rs.15050 per 10 grams. They agree upon the forward price for 20 grams of gold that Suman wants to buy and Suman leaves. A month later, he pays the goldsmith Rs.30100 and collects his gold. This is a forward contract, a contract by which two parties permanently agree to settle a trade at a future date, for a stated price and quantity. No money changes hands when the contract is signed. The exchange of money and the underlying goods only happens at the future date as specified in the contract. In a forward

contract the process of trading, clearing and settlement does not happen immediately. The trading happens today, but the clearing and settlement happens at the end of the specified period.

A forward is the most basic derivative contract. We call it a derivative because it derives value from the price of the asset underlying the contract, in this case gold. If on the 1st of April, gold trades for Rs.15100 in the spot market, the contract becomes more valuable to Suman because it now enables him to buy gold at Rs.15050. If however, the price of gold drops down to Rs.15000, he is worse off because as per the terms of the contract, he is bound to pay Rs.15050 for the same gold. The contract has now lost value from Suman’s point of view. “Note that the value of the forward contract to the goldsmith varies exactly in an opposite manner to its value for Suman”.

Limitations of the Study:

1. The suggestion is based on the study on Fundamental and Technical Analysis such as price movement, Relationship of gold with other factors, Volumes and Open Interest (OI). 2. This analysis will be holding good for a limited time period that is based on present scenario and study conducted, future movement on gold price may or may not be similar.

CHAPTER – 2

GEOJIT BNP PARIBAS FINANCIAL SERVICES LTD

Geojit BNP Paribas Financial Service was founded by Mr. C.J. George and Mr. Ranajit Kanjilal as a partnership firm in the year 1987. And in the year 1993 Mr. Ranajit Kanjilal retired from the firm and Geojit became a proprietary concern of Mr. C.J. George. It became a Public limited company by the name Geojit Securities Ltd. in the year 1994. The Kerala State Industrial Development Corporation Ltd (KSIDC) Became a Co-promoter of Geojit by taking 24% stake in the company in the year 1995. Geojit listed at The Stock Exchange, Mumbai (BSE) in the year 2000. In 2003 the Company was renamed as Geojit Financial Services Ltd. (GFSL). In July 2005, the company is also listed at The National Stock Exchange (NSE). Geojit is a charter member of the Financial Planning Standards Board of India and is one of the largest DP brokers in the country. On March 13, 2007 the formation of Geojit BNP Paribas Financial Services Ltd., was announced in Mumbai and Paris. Through a preferential allotment, BNP Paribas had taken 27% stake in Geojit, which will eventually increase to 34.35%. BNP Paribas has one of the largest international banking networks with significant presence in Asia and the United States. With presence in more than 85 countries the bank has a headcount of more than 138000. With this take over Geojit has become Geojit BNP Paribas Financial Services LTD in April 2009. Currently Geojit BNP Paribas has more than 500 branches, 4.7 lakhs clients and offers services in Equities, Futures and Options, Mutual Funds, Life and General Insurance, Portfolio Management services, Loan against shares. The online trading was first introduced by the Geojit BNP Paribas to their clients that allows the customers to track the markets by setting up their own market watch, receiving

research tips, stock alerts, real-time charts and news and many more features enable the customer to take informed decisions

CHAPTER – 3

HISTORY OF COMMODITY TRADING & PRECIOUS METALS

Commodity trading in India: 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 lead to unnecessary speculation in essential commodities, and were harmful to the healthy functioning of the markets for the underlying commodities, and also 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.

The Act envisages (imagine) three-tier regulation: 1) The Exchange which organizes forward trading in commodities can regulate trading on a day-to-day basis, 2) The Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government,

3) The Central Government - Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution - is the ultimate regulatory authority.

In 1970s and 1980s the Government relaxed forward trading rules for some commodities. The Kabra committee report After the introduction of economic reforms since June 1991 and the consequent gradual trade and industry liberalisation in both the domestic and external sectors, the Government of India appointed in June 1993 a committee on Forward Markets under chairmanship of Prof. K.N. Kabra. The committee was setup with the following objectives: 1. To assess •

The working of the commodity exchanges and their trading practices in India

•

To make suitable recommendations with a view to making them compatible with those of other countries

2. To review the role that forward trading has played in the Indian commodity markets during the last 10 years. 3. To examine the extent to which forward trading has special role to play in promoting exports. 4. To suggest measures to ensure that forward trading in the commodities in which it is allowed to be operative remains constructive and helps in maintaining prices within reasonable limits. The committee submitted its report in September 1994. The recommendations of the Committee were as follows:

➢ The Forward Markets Commission (FMC) and the Forward Contracts (Regulation) Act, 1952, would need to be strengthened. ➢ Due to the inadequate infrastructural facilities such as space and telecommunication facilities the commodities exchanges were not able to function effectively. Enlisting more members, ensuring capital adequacy norms and encouraging computerisation would enable these exchanges to place themselves on a better footing. ➢ In-built devices in commodity exchanges such as the vigilance committee and the panels of surveyors and arbitrators are strengthened further. ➢ The FMC which regulates forward/ futures trading in the country should continue to act a watch.dog and continue to monitor the activities and operations of the commodity exchanges. Amendments to the rules, regulations and bye-laws of the commodity exchanges should require the approval of the FMC only.

All the exchanges have been set up under overall control of Forward Market Commission (FMC) of Government of India.

FORWARD MARKET COMMISSION:-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.

The functions of the Forward Markets Commission are as follows: 1. To advise the Central Government in respect of the recognition or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of the Forward Contracts (Regulation) Act 1952. 2. To keep forward markets under observation and to take such action in relation to them, as it may consider necessary, in exercise of the powers assigned to it by or under the Act. 3. To collect and whenever the Commission thinks it necessary, to publish information regarding the trading conditions in respect of goods to which any of the provisions of the act is made applicable, including information regarding supply, demand and prices, and to submit to the Central Government, periodical reports on the working of forward markets relating to such goods; 4. To make recommendations generally with a view to improving the organization and working of forward markets; 5. To undertake the inspection of the accounts and other documents of any recognized association or registered association or any member of such association whenever it considerers it necessary.

Commodity Exchanges in India: The two important commodity exchanges in India are MultiCommodity Exchange of India Limited (MCX), and National Multi-Commodity & Derivatives Exchange of India Limited (NCDEX).

I. Multi-Commodity Exchange of India Limited (MCX) MCX an independent multi-commodity exchange has permanent recognition from Government of India for facilitating online trading, clearing and settlement operations for commodity futures markets across the country. Key shareholders of MCX are Financial Technologies (India) Ltd., State Bank of India, NABARD, NSE, HDFC Bank, State Bank of Indore, State Bank of Hyderabad, State Bank of Saurashtra, SBI Life Insurance Co. Ltd., Union Bank of India, Bank Of India, Bank Of Baroda, Canara Bank, Corporation Bank. Headquartered in Mumbai, MCX is led by an expert management team with deep domain knowledge of the commodity futures markets. Through the integration of dedicated resources, robust technology and scalable infrastructure, since inception MCX has recorded many first to its credit. Inaugurated in November 2003 by Shri Mukesh Ambani, Chairman & Managing Director, Reliance Industries Ltd, MCX offers futures trading in the following commodity categories: Agri Commodities, Bullion, Metals- Ferrous & Non-ferrous, Pulses, Oils & Oilseeds, Energy, Plantations, Spices and other soft commodities. MCX has built strategic alliances with some of the largest players in commodities eco-system, namely, Bombay Bullion Association, Bombay Metal Exchange, Solvent Extractors' Association of India, Pulses Importers Association, Shetkari Sanghatana, United Planters Association of India and India Pepper and Spice Trade Association. Today MCX is offering spectacular growth opportunities and advantages to a large cross section of the participants including Producers / Processors, Traders, Corporate, Regional Trading Centers, Importers, Exporters, Cooperatives, Industry Associations, amongst others

MCX being nation-wide commodity exchange, offering multiple commodities for trading with wide reach and penetration and robust infrastructure, is well placed to tap this vast potential.

S.NO 1

COMMODITIY NAME GOLD

2

GOLDM

3

GOLD GUINEA

4 5 6 7 8 9 10 11 12

SILVER SIVERM MENTHA OIL KAPASIA KHALLI ALUMINIUM COPPER NICKEL

13

NATURAL GAS

ZINC LIGHT SWEET CRUDE OIL

Active Contracts Traded in MCX

Price/Unit

Trading Lot

Rs / 10Gms Rs / 10Gms Rs/ 8Gms

1 KG

MUMBAI

100

Initial Margin % 7

100Gms

MUMBAI

10

5

8Gms

1

14.5

RS/ KG Rs / 1 KG Rs/KG Rs/50 KG Rs/KG Rs/KG RS/KG RS/KG Rs/Barrel

30 KG 5 KGS 360 KG

MUMBAI /AHMEDABAD AHMEDABAD AHMEDABAD

30 5 360 200 5000 1000 250 5000 100

8 8 11 6.5 7 12 15.5 11 12

Rs/mmBtu

1250/mmBtu

1250

10.5

10 MT

5 MT 1 MT 250 KG 5000 KG 100/Barrel

Delivery Center

CHANDAUSI

AKOLA MUMBAI MUMBAI MUMBAI

MUMBAI JNPT-MUMBAI

Multiplier

II. National Commodity & Derivatives Exchange Limited (NCDEX) National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed online multi commodity exchange promoted by ICICI Bank Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India Limited (NSE). Punjab National Bank (PNB), CRISIL Limited (formerly the Credit Rating Information Services of India Limited), Indian Farmers Fertiliser Cooperative Limited (IFFCO) and Canara Bank by subscribing to the equity shares have joined the initial promoters as shareholders of the Exchange. NCDEX is the only commodity exchange in the country promoted by national level institutions. This unique parentage enables it to offer a bouquet of benefits, which are currently in short supply in the commodity markets. The institutional promoters of NCDEX are prominent players in their respective fields and bring with them institutional building experience, trust, nationwide reach, technology and risk management skills. NCDEX is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for Commencement of Business on May 9, 2003. It has commenced its operations on December 15, 2003. NCDEX is a nation-level, technology driven de-mutualized on-line commodity exchange with an independent Board of Directors and professionals not having any vested interest in commodity markets. It is committed to provide a world-class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency. NCDEX is regulated by Forward Market Commission in respect of futures trading in commodities. Besides, NCDEX is subjected to various laws of the land like the Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various other legislations, which impinge on its working. NCDEX is located in Mumbai and offers facilities to

its members in more than 390 centres throughout India. The reach will gradually be expanded to more centres. NCDEX currently facilitates trading of thirty six commodities - Cashew, Castor Seed, Chana, Chilli, Coffee, Cotton, Cotton Seed Oilcake, Crude Palm Oil, Expeller Mustard Oil, Gold, Guar gum, Guar Seeds, Gur, Jeera, Jute sacking bags, Mild Steel Ingot, Mulberry Green Cocoons, Pepper, Rapeseed - Mustard Seed ,Raw Jute, RBD Palmolein, Refined Soy Oil, Rice, Rubber, Sesame Seeds, Silk, Silver, Soy Bean, Sugar, Tur, Turmeric, Urad (Black Matpe), Wheat, Yellow Peas, Yellow Red Maize & Yellow Soybean Meal. At subsequent phases trading in more commodities would be facilitated. Since 2002 when the first national level commodity derivatives exchange started, the exchanges have conducted brisk business in commodities futures trading. In the last three years, there has been a great revival of the commodities futures trading in India, both in terms of the number of commodities allowed for futures trading as well as the value of trading. While in year 2000, futures trading were allowed in only 8 commodities, the number jumped to 80 commodities in June 2004. The value of trading in local currency saw a quantum jump from about INR 350 billion in 2001-02 to INR 1.3 Trillion in 2003-04. The data in the below Table indicates that the value of commodity derivatives in India could cross the US$ 1 Trillion mark in 2006. The market regulator Forward Markets Commission (FMC) disseminates fortnightly trading data for each of the 3 national & 21 regional exchanges that have been set up in recent years to carry on the futures trading in commodities in the country. Exhibit presents comparative trading data for three fortnightly periods in March, June and September 2005 and brings up some interesting facts. The market regulator Forward Markets Commission (FMC) disseminates fortnightly trading data for each of the 3 national & 21 regional exchanges that have been set up in recent years to carry on the futures trading in commodities in the country. Below Table

represents comparative trading data for three fortnightly periods in March, June and September 2005 and brings up some interesting facts.

Comparative Data for Three Periods Value of Turnover in USD Millions Sl.No.

Name of the Exchange

1

Multi-Commodity Exchange of India Limited, Mumbai.

2

National Multi-Commodity Exchange of India Limited,

3

16 Mar 05

16 Jun 05

16 Sep 05

to 31 Mar 05

to 30 Jun 05

to 30 Sep 05

$m 3,503.69

$m 4,974.76

$m 11,042.25

$m 135.64

$m 113.13

$m 106.85

$m 5,360.45

$m 7,950.49

$m 10,694.29

$m 8,999.78

$m 13038.38

Ahmadabad. National Commodity & Derivatives Exchange Limited, Mumbai. Total of three exchanges

$m 21,843.39

Active Contracts Traded in NCDEX S.NO

Price/Unit

1

COMMODITIY NAME PURE KILO GOLD

Rs / 10Gms

Trading Lot 1 KG

Delivery Center MUMBAI

2

Multiplier

PURE SILVER

Rs / 1 KG

30 KGS

DELHI

30

18

3

SILVER 5 (mini Lot)

Rs / 1 KG

5 KG

DELHI

5

9

4

GOLD 100 (mini Lot)

100 Gms

MUMBAI

10

8

5

JEERA

Rs / 10 Gms Rs / Quintal

3 MT

UNJHA

30

8

100

Initial Margin % 8

6

PEPPER

Rs / Quintal

1 MT

KOCHI

10

15

7

TURMERIC FINGERS

Rs / Quintal

10 MT

NIZAMABAD

100

12

8

CHILLI LCA 334

Rs / Quintal

5 MT

GUNTUR

50

33

9

MAIZE

Rs / Quintal

50 MT

NIZAMABAD

500

21

10

GUAR SEED

Rs / Quintal

10 MT

JODHPUR

100

15

11

GUARGUM

Rs / Quintal

5 MT

JODHPUR

50

15

History of Gold: In India Gold is having a history of more than 7000 years which can find in religious book of Hindu, where it is considered as a metal of immense value. But looking at the history of world, gold is found at the Egypt at 2000B.C, which is the first metal used by the humans value for ornament and rituals. Gold has long been considered one of the most precious metals, and its value has been used as the standard for many currencies in history. Gold has been used as a symbol for purity, value, royalty, and particularly roles that combine these properties. As a tangible investment gold is held as part of a portfolio by the countries as a reserves because over the long period gold has an extensive history of maintaining its value. However, gold does become particularly desirable in times of extremely weak confidence and during hyperinflation because gold maintains its value even as fiat money becomes worthless when the value of currency depreciates.

It has a special role in India and in certain countries, gold Jewelry is worn for ornamental value on all social functions, festivals and celebrations. It is the popular form of investment in rural areas between the farmers after having bumper crop or after harvesting, this all factor makes India as largest consumer (18.7% of world total demand in 2004) and importer of gold due to its low production, which is negligible, and untapped gold reserves. This is due to lack of new technology in finding gold reserves and low interest shown by government in financing, encouraging for exploration programs in gold mines. HISTORY OF GOLD TRADING Gold future trading debuted first at Winnipeg Commodity Exchange (know is Comex) in Canada in 1972. The gold contract gain popularity among traders, led to many countries had too started gold future trading. Which include London gold future, Sydney future exchange, Singapore International Monetary Exchange (Simex), Tokyo Commodity Exchange (Tocom), Chicago Mercantile Exchange, Chicago Board of Trade (CBOT), Shanghai Gold Exchange, Dubai Gold and Commodity Exchange are some of the world Top recognized exchange, and in India, National Commodity and Derivative Exchange (NCDEX) and Multi-Commodity Exchange (MCX), and National Board of Trade (NBOT) are some Indian exchanges where Gold are traded. History of gold trading in India is dates back to 1948 with Bombay Bullion Association, which is formed by the group of Merchants.

PRODUCTION OF GOLD Till now the total gold is extracted from the mines is about $1 trillion dollar, which is accumulated in physical form is enough to built Eiffel tower. Annual gold production worldwide is about US$35 billion and by far the one of the largest-trading world commodity. Worldwide, gold mines produce about 2,464 tonnes in the

year 2004 from total supply of 3328 tonnes but unable to meet identifiable demand of 3497 tonnes. Gold is mined in more than 118 countries around the world, with the large number of development projects in these countries expected to keep production growing well into the next century. Currently, South Africa is the largest gold producing country, followed by the United States, Australia, Canada, Indonesia, Russia and others, some of these countries also account for highest gold reserves from potential 50,000 tonnes of world-wide reserves.

Why central banks hold gold Monetary authorities have long held gold in their reserves. Today their stocks amount to some 30,000 tonnes - similar to their holdings 60 years ago. It is sometimes suggested that maintaining such holdings is inefficient in comparison to foreign exchange. However, there are good reasons for countries continuing to hold gold as part of their reserves. These are recognized by central banks themselves although different central banks would emphasize different factors. Diversification: In any asset portfolio, it rarely makes sense to have all your eggs in one basket. Obviously the price of gold can fluctuate - but so too do the exchange and interest rates of currencies held in reserves. A strategy of reserve diversification will normally provide a less volatile return than one based on a single asset. Gold has good diversification properties in a currency portfolio. These stem from the fact that its value is determined by supply and demand in the world gold markets, whereas currencies and government securities depend on government promises and the variations in central banks’ monetary policies. The price of gold therefore behaves in a completely different way from the prices of currencies or the exchange rates between currencies. Physical Security: Countries have in the past imposed exchange controls or, at the worst, total asset freezes. Reserves held in the form of foreign securities are vulnerable to such

measures. Where appropriately located, gold is much less vulnerable. Reserves are for using when you need to. Total and incontrovertible liquidity is therefore essential. Gold provides this.

Unexpected needs: If there is one thing of which we can be certain, it is that today’s status quo will not last forever. Economic developments both at home and in the rest of the world can upset countries’ plans, while global shocks can affect the whole international monetary system. Owning gold is thus an option against an unknown future. It provides a form of insurance against some improbable but, if it occurs, highly damaging event. Such events might include war, an unexpected surge in inflation, a generalised crisis leading to repudiation of foreign debts by major sovereign borrowers, a regression to a world of currency or trading blocs or the international isolation of a country. In emergencies countries may need liquid resources. Gold is liquid and is universally acceptable as a means of payment. It can also serve as collateral for borrowing. Confidence: The public takes confidence from knowing that it’s Government holds gold - an indestructible asset and one not prone to the inflationary worries overhanging paper money. Some countries give explicit recognition to its support for the domestic currency. And rating agencies will take comfort from the presence of gold in a country's reserves. The IMF's Executive Board, representing the world's governments, has recognized that the Fund's own holdings of gold give a "fundamental strength" to its balance sheet. The same applies to gold held on the balance sheet of a central bank. Income: Gold is sometimes described as a non income-earning asset. This is untrue. There is a gold lending market and gold can also be traded to generate profits. There may be an "opportunity cost" of holding gold but, in a world of low interest rates, this is less than is often thought. The other advantages of gold may well offset any such costs.

Insurance: The opportunity cost of holding gold may be viewed as comparable to an insurance premium. It is the price deliberately paid to provide protection against a highly improbable but highly damaging event. Such an event might be war, an unexpected surge of inflation, a generalized debt crisis involving the repudiation of foreign debts by major sovereign borrowers, a regression to a world of currency and trading blocs, or the international isolation of a country.

History of Silver Market Major markets like the London market (London Bullion Market Association), which started trading in the 17th century provide a vehicle for trade in silver on a spot basis, or on a forward basis. The London market has a fix which offers the chance to buy or sell silver at a single price. The fix begins at 12:15 p.m. and is a balancing exercise; the price is fixed at the point at which all the members of the fixing can balance their own, plus clients, buying and selling orders. Trading in silver futures resumed at the Comex in New York in 1963, after a gap of 30 years. The London Metal Exchange and the Chicago Board of Trade introduced futures trading in silver in 1968 and 1969, respectively. In the United States, the silver futures market functions under the surveillance of an official body, the Commodity Futures Trading Commission (CFTC). Although London remains the true center of the physical silver trade for most of the world, the most significant paper contracts trading market for silver in the United States is the COMEX division of the New York Mercantile Exchange. Spot prices for silver are determined by levels prevailing at the COMEX. Although there is no American equivalent to the London fix, Handy & Harman, a precious metals company, publishes a price for 99.9% pure silver at noon each working day.

Production of Silver

Silver ore is most often found in combination with other elements, and silver has been mined and treasured longer than any of the other precious metals. Mexico is the world’s leading producer of silver, followed by Peru, Canada, the United States, and Australia. The main consumer countries for silver are the United States, which is the world’s largest consumer of silver, followed by Canada, Mexico, the United Kingdom, France, Germany, Italy, Japan and India. The main factors affecting these countries demand for silver are macro economic factors such as GDP growth, industrial production, income levels, and a whole host of other financial macroeconomic indicators.

CHAPTER – 3

PRICING COMMODITY FUTURES

The process of arriving a figure at which a person buys and another sells a futures contract for a specific expiration date is called price discovery. The process of price discovery continues from the market's opening until its close and also free flow of information is also very important in an active future market. Futures exchanges act as a focal point for the collection and distribution of statistics on supplies, transportation, storage, purchases, exports, imports, currency values, interest rates and other relevant formation. As a result of this free flow of

information, the market determines the best estimate of today and tomorrow's prices and it is considered to be the accurate reflection of the supply and demand for the underlying commodity. Price discovery facilitates this free flow of information, which is essential to the effective functioning of futures market. We try to understand the pricing of commodity futures contracts and look at how the futures price is related to the spot price of the underlying asset. We study the cost - of - carry model to understand the dynamics of pricing that constitute the estimation of fair value of futures.

Investment assets versus consumption assets When we are studying futures contracts, it is essential to distinguish between investment assets and consumption assets. An investment asset is an asset that is held for investment purposes by most investors. Stocks, bonds, Gold and silver are examples of investment assets. However investment assets do not always have to be held entirely for investment. As we saw earlier silver for example, have a number of industrial uses. However to classify as investment assets, these assets have to satisfy the requirement that they are held by a large number of investors solely for investment. A consumption asset is an asset that is held primarily for consumption. It is not usually held for investment. Examples of consumption assets are commodities such as copper, oil, and pork bellies. We can use arbitrage arguments to determine the futures prices of an investment asset from its spot price and other observable market variables. For pricing consumption assets, we need to review the arbitrage arguments a little differently. We look at the cost – of – carry model and try to understand the pricing of futures contracts on investment assets.

The cost of carry model:-

For pricing purposes we treat the forward and the futures market as one and the same. A futures contract is nothing but a forward contract that is exchange traded and that is settled at the end of each day. The buyer who needs an asset in the future has the choice between buying the underlying asset today in the spot market and holding it, or buying it in the forward market. If he buys it in the spot market today it involves opportunity costs. He incurs the cash outlay for buying the asset and he also incurs costs for storing it. If instead he buys the asset in the forward market, he does not incur an initial outlay. The basis for the cost – of – carry model where the price of the futures contract is defined as:

F=S+C

……………………………… Eq (1)

Where F = Future price

C = Holding cost or carrying cost

S = Spot price

The fair value of future contracts can also be expressed as:

F = S (1+r) t

.…………………………… Eq (2)

Where: R = percentage cost of financing T = time till expiration Whenever the futures price moves away from the fair value, there would be opportunities for arbitrage. If F > S (1+r) t or F < S (1+r) t arbitrage would exit. We know that what is Spot price and what are future price. We should know that what are the components of the holding cost? The components of holding cost vary with contracts on different assets.

Sometimes holding cost may even be negative. In case of commodity futures, the holding cost is the cost of financing plus cost of storage and insurance purchased. In case of equity futures, the holding cost is the cost of financing minus the dividends returns. Equation – (2) uses the concept of discrete compounding, i.e. where interest rates are compounded at discrete intervals like annually or semiannually. Pricing of options and other complex derivative securities requires the use of continuously compounded interest rates. Most books on derivatives use continuous compounding for pricing futures too. When we use continuous compounding, equation – (2) is expressed as:

F = S erT

……………………………….. Eq (3)

Where: r = Cost of financing (Using continuously compounding interest rate) T = Time till expiration e = 2.71828 Let us take an example of a future contract on commodity and we work out the price of the contract. Let the spot price of gold is RS. 13763÷10gms. If the cost of financing is 15% annually, then what should be the future price of 10gms of gold one month later? Let us assume that we are on 1 Jan 2009. How would we compute the price of gold future contract expiring on 30 January? Let us first try to work out the components of cost – of – carry model. 1. What is the spot price of gold?

The spot price of gold, S = 13763/ 10gms. 2. What is the cost of financing for month?

e0.15 ×30/365 3. What are the holding costs? Let us assume that the storage cost = 0

F = S erT = 13763 e0.15 ×30/365

= 13933.73

If the contract was for a three months period i.e. expiring on 30th March, the cost of financing would increase the futures price. Therefore, the futures price would be F = 13763 e

0.15 ×90/365

= Rs 14281.58

Pricing futures contracts on investment commodities In the example above we saw how a futures contract on gold could be raised using cost – of – carry model. In the example we considered, the gold contract was for 10 grams of gold, hence we ignored the storage costs. However, if the one month contract was for a 100kgs of gold instead of 10gms, then it would involve non-zero holding costs which would include storage and insurance costs. The price of the futures contract would then be Rs.14281.58 plus the holding costs.

NCDEX – indicative warehouse charges Commodity Gold Silver Soy Bean Soya oil Mustard seed Mustard oil RBD palmolein CPO Cotton - Long Cotton - Medium

Fixed charges (Rs.) 310 610 110 110 110 110 110 110 110 110

Warehouse charges per unit per week (Rs.) 55 per kg 1 per kg 13 per MT 30 per MT 18 per MT 42 per MT 26 per MT 25 per MT 6 per Bale 6 per Bale

The above table gives the indicative warehouse charges for qualified warehouses that will function as delivery centers for contracts that trade on the NCDEX. Warehouse charges include a fixed charge per deposit of commodity into the warehouse, and as per unit per week charge. Per unit charges include storage costs and insurance charges. We saw that in the absence of storage costs, the futures price of a commodity that is an investment asset is given by F = S erT Storage

Costs add to the cost of carry. If U is the present value of all the storage costs that will be incurred during the life of a futures contract, it follows that the futures price will be equal to

F = (S+U) erT

………………………………Eq (4)

Where: r = Cost of financing (annualized) T = Time till expiration U = Present value of all storage costs For understanding the above formula let us consider a one – year future contract of gold. Suppose the fixed charge is Rs.310 per deposit up to 500kgs and the variable storage costs are Rs.55 per week, it costs Rs.3170 to store one kg of gold for a year (52 weeks). Assume that the payment is made at the beginning of the year. Assume further that the spot gold price is Rs.13763 per 10 grams and the risk – free rate is 7% per annum. What would the price of one year gold futures be if the delivery unit is one kg?

F = (S+U) erT = (1376300 + 310 + 2860) e0.07 × 1

= 1379470 × e0.07 × 1 = 1379470 × 1.072508 = 1479493

We see that the one year futures price of a kg of gold would be Rs.1479493. The one year futures price for 10 grams of gold would be about Rs.14794.93. Now let us consider a three – month futures contract on gold. We make the same assumptions that the fixed charge is Rs.310 per deposit up to 500kgs, and the variable storage costs are Rs.55 per week. It costs Rs.1025 to store one kg of gold for three months (13 weeks). Assume that the storage costs are paid at the time of deposit. Assume further that the spot gold price is Rs 13763per 10 grams and the risk free rate is 7% per annum. What would the price of three month gold futures if the delivery unit is one kg?

F = (S+U) erT = (1376300 + 310 + 715) e0.07 × 0.25 = 1377325 × 1.017654 = 1401640.30

We see that the three – month futures price of a kg of gold would be Rs. 1401640.30. The three – month futures price for 10 grams of gold would be about Rs. 14016.40

Pricing futures contracts on consumption commodities We used the arbitrage argument to price futures on investment commodities. For commodities that are consumption commodities rather than investment assets, the arbitrage arguments used to determine futures prices need to be reviewed carefully. Suppose we have

F > (S+U) erT

……………………………… Eq (5)

To take advantage of this opportunity, an arbitrager can implement the following strategy: I.

Borrow an amount S + U. at the risk – free interest rate and use it to purchase one unit of the commodity.

II. Short a forward contract on one unit of the commodity. If we regard the futures contract as a forward contract, this strategy leads to a profit of F - (S+U) erT at the expiration of the futures contract. As arbitragers exploit this opportunity, the spot price will increase and the futures price will decrease until Equation (5) does not hold good. Suppose next that

F < (S+U) erT

……………………………………. Eq (6)

In case of investment assets such as gold and silver, many investors hold the commodity purely for investment. When they observe the inequality in equation 6, they will find it profitable to trade in the following manner:

I.

Sell the commodity, save the storage costs, and invest the proceeds at the risk –free interest rate.

II. Take a long position in a forward contract.

This would result in a profit at maturity of (S+U) erT – F relative to the position that the investors would have been in had they held the underlying commodity. As arbitragers exploit this opportunity, the spot price will decrease and the futures price will increase until equation 6 does not hold well. This means that for investment assets, equation 4 holds good. However, for commodities like cotton or wheat that are held for consumption purpose, this argument cannot be used. Individuals and companies who keep such a commodity in inventory, do so, because of its consumption value – not because of its value as an investment. They are reluctant to sell these commodities and buy forward or futures contracts because these contracts cannot be consumed. Therefore there is unlikely to be arbitrage when equation 6 holds good. In short, for a consumption commodity therefore

F ≤ (S+U) erT

………………………………………. Eq (7)

That is the futures price is less than or equal to the spot price plus the cost of carry.

CHAPTER – 4

CLEARING, SETTLEMENT AND RISK MANAGEMENT

Clearing and settlement Most futures contracts do not lead to the actual physical delivery of the underlying asset. The settlement is done by closing out open positions, physical delivery or cash settlement. All these settlement functions are taken care of by an entity called clearing house or clearing corporation. National Securities Clearing Corporation Limited (NSCCL) undertakes clearing of trades executed on the NCDEX. The settlement guarantee fund is maintained and managed by NCDEX.

1. Clearing Clearing of trades that take place on an exchange happens through the exchange clearing house. A clearing house is a system by which exchanges guarantee the faithful compliance of all trade commitments undertaken on the trading floor or electronically over the electronic trading systems. The main task of the clearing house is to keep track of all the transactions that take place during a day so that the net position of each of its members can be calculated. It guarantees the performance of the parties to each transaction. Typically it is responsible for the following: ➢ Effecting timely settlement ➢ Trade registration and follow up. ➢ Control of the evolution of open interest. ➢ Financial clearing of the payment flow. ➢ Physical settlement (by delivery) or financial settlement (by price difference) of contracts. ➢ Administration of financial guarantees demanded by the participants. The clearing house has a number of members, who are mostly financial institutions responsible for the clearing and settlement of commodities traded on the exchange. The margin accounts for the clearing house members are adjusted for gains and losses at the end of each day (in the same way as the individual traders keep margin accounts with the broker). On the NCDEX, in the case of clearing house members only the original margin is required (and not maintenance margin), Every day the account balance for each contract must be maintained at an amount equal to the original margin times the number of contracts outstanding. Thus depending on a day's transactions and price movement, the members either need to add funds or can withdraw funds from their margin accounts at the end of the day. The brokers who are not the clearing members

need to maintain a margin account with the clearing house member through whom they trade in the clearing house. 1.1

Clearing banks: NCDEX has designated clearing banks

Through whom funds to be paid and / or to be received must be settled. Every clearing member is required to maintain and operate a clearing account with any one of the designated clearing bank branches. The clearing account is to be used exclusively for clearing operations i.e., for settling funds and other obligations to NCDEX including payments of margins and penal charges. A clearing member can deposit funds into this account, but can withdraw funds from this account only in his self-name. A clearing member having funds obligation to pay is required to have clear balance in his clearing account on or before the stipulated pay – in day and the stipulated time. Clearing members must authorize their clearing bank to access their clearing account for debiting and crediting their accounts as per the instructions of NCDEX, reporting of balances and other operations as may be required by NCDEX from time to time. The clearing bank will debit/ credit the clearing account of clearing members as per instructions received from NCDEX. The following banks have been designated as clearing banks. ICICI Bank Limited, Canarabank, UTI Bank Limited and HDFC Bank ltd 1.2

Depository participants: Every clearing member is required

To maintain and operate a CM pool account with any one of the empanelled depository participants. The CM pool account is to be used exclusively for clearing operations i.e., for effecting and receiving deliveries from NCDEX.

2. Settlement Futures contracts have two types of settlements, ➢ The MTM settlement which happens on a continuous basis at the end of each day

➢ And the final settlement which happens on the last trading day of the futures contract. On the NCDEX, daily MTM settlement and final MTM settlement in respect of admitted deals in futures contracts are cash settled by debiting/ crediting the clearing accounts of CMs with the respective clearing bank. All positions of a CM, either brought forward created during the day or closed out during the day, are marked to market at the daily settlement price or the final settlement price at the close of trading hours on a day.

•

Daily settlement price: Daily settlement price is the consensus closing price as arrived after closing session of the relevant futures contract for the trading day. However, in the absence of trading for a contract during closing session, daily settlement price is computed as per the methods prescribed by the exchange from time to time.

•

Final settlement price: Final settlement price is the closing price of the underlying commodity on the last trading day of the futures contract. All open positions in a futures contract cease to exist after its expiration day.

2.1

Settlement Methods: Settlement of futures contracts on the

NCDEX can be done in three ways. By physical delivery of the underlying asset, by closing out open positions and by cash settlement. We shall look at each of these in some detail. On the NCDEX all contracts settling in cash are settled on the following day after the contract expiry date. All contracts materialising into deliveries are settled in a period 2.7 days after expiry. The exact settlement day for each commodity is specified by the exchange.

When a contract comes to settlement, the exchange provides alternatives like delivery place, month and quality specifications. Trading period, delivery date etc. are all defined as per the settlement calendar. A member is bound to provide delivery information. If he fails to give information, it is closed out with penalty as decided by the exchange. A member can choose an alternative mode of settlement by providing counter party clearing member and constituent. The exchange is however not responsible for, nor guarantees settlement of such deals. The settlement price is calculated and notified by the exchange. The delivery place is very important for commodities with significant transportation costs. The exchange also specifies the accurate period (date and time) during which the delivery can be made.

Closing out by offsetting positions Most of the contracts are settled by closing out open positions. In closing out, the opposite transaction is effected to close out the original futures position. A buy contract is closed out by a sale and a sale contract is closed out by a buy. For example, an investor who took a long position in two gold futures contracts on the January 30, 2009 at 14402 can close his position by selling two gold futures contracts on February 27, 2004 at Rs.15445. In this case, over the period of holding the position, he has gained an amount of Rs.1043 per unit. This loss would have been debited from his margin account over the holding period by way of MTM at the end of each day, and finally at the price that he closes his position, that is Rs. 15445 in this case.

Cash settlement

Contracts held till the last day of trading can be cash settled. When a contract is settled in cash, it is marked to the market at the end of the last trading day and all positions are declared closed. The settlement price on the last trading day is set equal to the closing spot price of the underlying asset ensuring the convergence of future prices and the spot prices. For example an investor took a short position in five long staple cotton futures contracts on December 15 at Rs.6950. On 20th February, the last trading day of the contract, the spot price of long staple cotton is Rs.6725. This is the settlement price for his contract. As a holder of a short position on cotton, he does not have to actually deliver the underlying cotton, but simply takes away the profit of Rs.225 per trading unit of cotton in the form of cash.

Risk management NCDEX has developed a comprehensive risk containment mechanism for its commodity futures market. The salient features of risk containment mechanism are: ✔ The financial reliability of the members is the key to risk management. Therefore, the requirements for membership in terms of capital adequacy (net worth, security deposits) are quite stringent. ✔ NCDEX charges an open initial margin for all the open positions of a member. It specifies the initial margin requirements for each futures contract on a daily basis. It also follows value-at-risk (VAR) based margining through SPAN. The PCMs and TCMs in turn collect the initial margin from the TCMs and their clients respectively. ✔ The open positions of the members are marked to market based on contract settlement price for each contract. The difference is settled in cash on a T+1 basis.

✔ A member is alerted of his position to enable him to adjust his exposure or bring in additional capital. Position violations result in withdrawal of trading facility for all TCMs of a PCM in case of a violation by the PCM. ✔ A separate settlement guarantee fund for this segment has been created out of the capital of members.

CHAPTER – 5

FUNDAMENTAL AND TECHNICAL ANALYSIS

Fundamental Analysis DEMAND AND CONSUMPTION OF GOLD Gold produced from different sources and demanded for consumption in form of Jewellery, Industrial applications, Government & Central bank Investment and Private investor, which has been worth US$ 38 billion on average over the past five years in world.

Total of world gold produced is mostly consumed by different sectors are Jewelers 80%, Industrial application 11.5% and rest of gold is used as investment purpose 8.5%. Considering the situation in India, the demand for Gold consumption is far more ahead than its availability through production, scrap or recycled gold. Where gold production in India is only 2tonnes, where demand is 18.7% of world gold consumption, which make India a leading consumer of gold followed by Italy, Turkey, USA, China, Japan. According to Countries wise demand, the following graph shows the demand in each country. Large part constitute by Jewelry consumption with 85.56% during 2004 by Indian consumers, who seem to spend a disproportionate percentage of their disposable income on gold and gold jewelry. Gold fabrication for domestic and international market, also formed large part of business in India with 527 tonnes of gold fabricated in India in 2004, making world largest

fabricator which is 60% more than its closest competitor Italy, Turkey, USA. But this Jeweler Fabrication is unable to generate much revenue, as most of its consumed in India (479 tonnes).

18.70%

In dia Italy 42.20%

11.10%

Turkey US China Japan Rest of world

8.50%

5.30%

7.30%

Consumption of Gold

6.90%

GOLD CONSUMPTION IN INDIA India consumed around 18% of world Gold produced. Even though it only contribute 1.6% of Global GDP. “Traditionally, Gold has been a good safety net for Indian households. However, the sharp rise in gold imports over the last three years when the rupee has started appreciating, inflation is relatively low, banking facilities are improving And economic can confidence has picked up, is surprising” say Market watchers.(Source: -Economic Times, Article, “ Forget sensex, the Gold rush is on”, July 18 ‘05) The demand is much that it consumed more than 1.5 times of US consumption of gold. Increasing by nearly 60% in 2003-04, but during this fiscal Gold imports increased by another 58%, with Import of gold and silver account around $11 billion consumption increased by 88% during March’05quarter.

Uses of Gold 1. Jewellery fabrication: The largest source of demand is the jewelry industry. In new years, demand from the jewelry industry alone has exceeded Western mine production. This shortfall has been bridged by supplies from reclaimed jewelry and other industrial scrap, as well as the release of official sector reserves. Gold's workability, unique beauty, and universal appeal make this rare precious metal the favorite of jewelers all over the world. India is the world's foremost gold jewellery fabricator and consumer with fabricator and consumption annually of over 600 tons according to GFMS. Measures of consumption and fabrication are made more difficult because Indian jewellery often involves the re-making by goldsmiths of old family ornaments into lighter or fashionable designs and the amount of gold thus recycled is impossible to gauge. Estimates for this recycled jewellery vary between 80 tons and 300 tons a year. GFMS estimates are that official gold bullion imports in 2001 were 654 tons. Exports have increased dramatically since 1996, and in 2001 stood at over 60 tons. The US

accounted for about one third of total official exports. Manufacturers located in Special Export Zones can import gold tax-free through various registered banks under an Export Replenishment scheme.

2. Industrial applications: Besides jewelry, gold has many applications in a variety of industries including aerospace, medicine, electronics and dentistry. The electronics industry needs gold for the manufacture of computers, telephones, televisions, and other equipment. Gold's unique properties provide superior electrical conducting qualities and corrosion resistance, which are required in the manufacture of sophisticated electronic circuitry. In dentistry, gold alloys are popular because they are highly resistant to corrosion and tarnish. For this reason gold alloys are used for crowns, bridges, gold inlays, and partial debenture. 3. Governments and central banks: The third source of gold demand is governments and central banks that buy gold to increase their official reserves. Central banks holds 28,225.4 tons, the holdings of Reserve Bank of India are only a modest 397.5 tons. 4. Private investors: Finally, there are private investors. Depending upon market circumstances, the investment component of demand can vary substantially from year to year.

TECHNICAL ANALYSIS Prices of the commodities in the commodity market fluctuate daily because of the continuous buying and selling of the commodities. Prices of the commodity prices move in trends and cycles and are never stable. An investor in the commodity market is interested in buying commodities at a low price and sells them at a high price, so that he can get good return on his investment. He therefore tries to analyze the movement of the share prices in market. There are

two approaches that we use for analyze the price of the commodities. One of these is the fundamental analysis wherein the analyst tries to determine the true worth or intrinsic value of the commodity when its market price is below its intrinsic value. The second approach to analyze the commodity is technical analysis. It is an alternative approach to study the commodity price behavior. Dow Theory Whatever is generally being accepted today as technical analysis has its roots in the Dow theory. The theory is so called because it was formulated by Charles H. Dow who was the editor of the wall street journal in U.S.A. Charles Dow formulated a hypothesis that the commodity market does not move on a random basis but is influenced by three distinct cyclical trends that guides its direction. According t this theory, the market has three movements and these movements are simultaneous in nature. These movements are primary movements, secondary reactions and minor movements. The primary movements are a long range cycle that carries the entire market up or down. This is the long – term trend in the market. The secondary reactions act as a restraining force on the primary movement. These are in the opposite direction to the primary movement and last only for a short while. These are also known as correction. For example, when the market is moving upwards continuously, this upward movement will be interrupted by downward movements of short durations. These are called secondary reactions. The third movement in the market is the minor movements which are the day – to – day fluctuations in the market. The three movements of the market have been compared to the tides, the waves and the ripples in the ocean. According to Dow theory, the prices of the commodities can be identified by the means of a line chart. In this chart, the closing prices of the commodities may be plotted against the corresponding trading days. The below diagram shows a line chart of closing prices of the

commodity in the market, The primary trend is said to have three phases in it, each of which be interrupted by a counter move or secondary reaction which would retrace about 33 – 66 % of the earlier rise or fall.

Primary trend and secondary reactions

Bullish Trend During a bull market (upward moving market), in the first phase the prices would advance with the revival of confidence in the future of business. The future prospects of business in general would be perceived to be promising. This would prompt the investors to buy the commodities. During the second phase, prices would advance due to inflation and speculation. Thus during the bull market the line chart would exhibit the formation of three peaks. Each peak would be followed by a bottom formed by the secondary reaction. According to Dow theory, the formation of higher bottoms and higher tops indicates a bullish trend.

Three Phases of bull market

Bearish Trend The bear market is also characterized by three phases. In the first phase the prices begin to fall due to abandonment of hopes. Investors begin to sell their commodities. In the second phase, the prices fall due to increased selling pressure. In the final phase, prices fall still further due to distress selling.

The theory also makes certain assumptions which have been referred to as the hypotheses of the theory. The first hypothesis states that the primary trend cannot be manipulated. It means that no single individual or institution or group of individuals and institutions can exert influence on major trend of the market. The second hypothesis states that averages discount everything. The third hypothesis states that the theory is not perfect. The theory is concerned with the trend of market and has no forecasting value as regards the duration or the likely price targets for the peak or bottom of the bull and bear markets.

Three Phases of a bear market

BASIC PRINCIPLES OF TECHNICAL ANALYSIS The basic principles on which analysis is based are as follows: 1. The market value of the commodity is related to demand and supply factors operating in the market. 2. There are both rational and irrational factors which surrounded the supply and demand factors of a security. 3. Commodity prices behave in a manner that their movement is continuous in a particular direction for some length of time. 4. Trends in a commodity prices have been seen to change when there is a shift in the demand and supply factors. 5. The shift in demand and supply can be detected through charts prepared specifically to show market action.

Line Chart

It is the simplest price chart. In this chart the closing prices of the share are plotted on the XY graph on a day to day basis. The closing price of each day would be represented by a point on the XY graph. All these points would be concerned by straight line which would indicate the trend of the market. A line chart is illustrated below.

Line chart of closing prices

Bar Chart It is perhaps the most popular chart used by technical analysts. In this chart the highest price and the lowest price and the closing price of each day are plotted on a day – to – day basis. A bar is formed by joining the highest price and the lowest price of a particular day by a vertical line. The top of the bar represents the highest price and the bottom of the bar represents the lower price and the small horizontal hash on the right of the bar is used to represents the closing price of the day. Sometimes the opening price of the day is marked as a hash on left side of the bar. This can be explained by taking 10 days silver, Gold & Crude oil prices.

11 Days Highest, Lowest and Closing prices of Silver Highest Price 18358 18432 18208 18193 17990

Lowest Price 17204 18000 17953 17975 16941

Closing Price 18200 18129 18062 18014 17060

17345 17203 17200 17116 17778 17380

16837 16884 16900 16500 16556 17001

17124 17062 17061 16770 17422 17203

Bar Chart

10Days Highest, Lowest and closing prices of Gold Highest Price

Lowest Price

Closing Price

12030

11779

11903

11990

11780

11885

12100

11924

11997

12200

12080

12141

12820

12225

12797

13155

12830

12941

13226

12785

13105

13288

13004

13145

13192

13000

13051

13179

12985

13125

Bar Chart

10Days Highest, Lowest and closing Prices of Crude oil

Highest Prices

Lowest Prices

Closing prices

2485

2446

2474

2555

2448

2515

2582

2480

2507

2559

2438

2461

2559

2475

2496

2519

2482

2484

2470

2340

2360

2501

2300

2360

2374

2291

2348

2410

2289

2317

Japanese Candlestick Charts The Japanese candlestick chart shows the highest price, the lowest price, the opening price and the closing price of the commodities on day – to – day basis. The highest price and the lowest price of a day are joining by a vertical bar. There are mainly three types of candlesticks, like the white, the black and the doji or neutral candlestick. A white candlestick is used to represents a situation where the closing price of the day is higher than the opening price. A Black candlestick is used to represents a situation where the closing price of the day is lower than the opening price. A White candlestick indicates a bullish trend while a black candlestick indicates a bearish trend. A doji candlestick is the one where the opening price and the closing price of the day are the same. This can be expressed below by taking prices of silver, Gold & Crude oil i.e., (opening, closing, high, low) 19Days Prices of Silver

Open 21725 23075 23481 23100 23625 23400 23555 22950 22664 21950 21954 22279 22526 21976 22051

High 23225 23634 23703 23806 23876 23885 23850 23196 22775 22600 22480 22838 22526 23444 22488

Low 21000 23000 22800 22933 22987 23100 22621 22354 21780 21803 21954 21916 21583 21344 22050

Close 23052 23422 22890 23755 23625 23810 22930 22936 21861 22189 22170 22640 21922 21976 22424

Japanese candlesticks

10Days Prices of Crude oil Opening Price

Highest Prices

Lowest Prices

Closing Prices

2446

2485

2426

2474

2460

2555

2448

2515

2568

2582

2480

2507

2491

2559

2438

2461

2500

2559

2475

2496

2519

2519

2482

2484

2460

2470

2340

2360

2354

2501

2300

2360

2374

2374

2291

2348

2289

2410

2219

2317

10Days Prices of Gold Opening Price

Highest Prices

Lowest Prices

Closing Prices

11880

11980

11779

11880

11890

11890

11880

11885

11925

12100

11924

11997

12127

12200

12080

12141

12437

12820

12225

12797

12955

12955

12930

12941

12868

13226

12785

13105

13102

13288

13004

13145

13192

13192

13000

13051

13055

13179

12985

13125

CHART PATTERNS: When the price bar charts of several days are drawn close together, certain patterns emerge. These patterns are used by technical analysts to identify trend reversal and predict the future movement of prices. The chart patterns may be classified as support and resistance patterns, reversal patterns. 1. Support and resistance patterns: Support and resistance are the price levels at which the downtrend or uptrend in price movements is reversed. Support occurs when price is falling but bounces back or

reverses direction every time it reaches a particular level. When all these low points are connected by a horizontal line, it forms the support line. In other words, support level is the price level at which sufficient buying pressure is exerted to stop the fall in prices. Resistance occurs when the commodity price moves upwards. The price may fall back every time it reaches a particular level. A horizontal line joining these tops forms the resistance level. Thus, resistance level is the price level where sufficient selling pressure is exerted to halt the ongoing rising in the price of a share. If the scrip were to break the support level and move downwards it has bearish implications signaling the possibility of a future fall in prices. Similarly, if the scrip were to penetrate the resistance level it would be indicative of a bullish trend or a future rise in prices.

45Days Highest, Lowest and Closing Prices of Gold Highest price

Lowest Price

Closing price

12088

12012

12050

12411

12200

12312

12383

12281

12332

12200

11962

12141

12820

12225

12797

12955

12930

12941

13226

12785

13105

13288

13004

13145

13192

13000

13051

13179

12985

13125

13199

13157

13172

13134

12640

12720

12727

12467

12636

12640

12451

12507

12600

12375

12403

12421

11981

12104

12193

12110

12134

12487

12175

12326

12430

12221

12385

12798

12374

12752

12973

12660

12845

12915

12690

12839

12851

12820

12830

13021

12800

12913

12974

12863

12960

13288

12968

13196

13276

12835

12960

12919

12671

12748

12797

12737

12757

13118

12816

13047

13235

13016

13084

13205

12907

13111

13500

13023

13357

13447

13380

13417

13825

13609

13660

13677

13392

13462

13690

13375

13646

13800

13670

13763

13730

13515

13580

13590

13552

13572

13582

13216

13351

13450

13116

13394

Support and resistance levels

\ 2. Reversal patterns: The trends reverse direction after a period of time. These reversal can be identified with the help of certain chart formations that typically occur during these trend revaesals. Thus reversal patterns are chart formations that trend to signal a change in direction of the earlier trend. Head and shoulder Formation: The most popular reversal pattern is Head and Shoulder formation which usually occurs at the end of a long uptrend. This formation resembles the head and two shoulders of a man and hence the name head and shoulder formation. The first hump known as the left shoulder is formed when the prices reach the top under a strong buying impulse. Then trading volume becomes less and there is a short downward swing. This is followed by another high volume advance which takes the price to a higher top known as the head. This is followed by another reaction on less volume which takes the price down to a bottom near to the earlier downswing. A third rally now occurs taking the price to a height the head but comparable to the left shoulder. This rally results in the formation of the right shoulder. A horizontal line joining the bottoms of this formation is known as the neckline. This head and shoulder formation usually occurs at the end of the bull phase and is indicative of a reversal of trend. After breaking the neckline the price is expected to decline sharply.

Head and shoulder formation

Highest, Lowest and closing prices of Silver Highest prices 16834 16987 17380 17649 17790 17572 17688 17690 17320 17200 17290 17118 17458 17649 17790 17572 17890 18095 17950 17901 18737 18500 18729 17963 17990 17844 17690 17580 17550 17649 17790 17672 17890 17410 17508 17320 17200 17190 17118 17158

Lowest Prices 16800 16556 17001 17238 17471 17211 17234 17548 17100 16803 17215 16800 16653 17238 17471 17211 17509 17700 17378 17721 18002 17975 18113 17987 17990 17740 17500 17480 17440 17238 17471 17211 17509 17410 17246 17100 16803 17050 16800 16653

Closing prices 16825 16898 17203 17536 17612 17465 17600 17610 17210 17010 17229 16915 16998 17536 17612 17465 17763 17886 17721 17792 18372 18329 18663 17580 17825 17773 17600 17543 17490 17536 17612 17465 17763 17410 17403 17210 17010 17110 16815 16998

MATHEMATICAL INDICATORS Commodity prices do not rise or fall in a straight line. The movements are unpredictable. This makes the investors difficult for the analyst to measure the underlying trend. We can use the mathematical tool of moving averages to smoothen the unpredictable movements of the commodity prices and highlight the underlying trend. Moving Averages: moving averages are mathematical indicators of underlying trend of price movement. There are two types of moving averages (MA) are commonly used by the analyst. 1. Simple Moving Average. 2. Exponential moving average. The closing prices of the shares are generally used for the calculation of moving averages. I.

Simple moving average: An average is the sum of prices of a

Commodity for a specified number of days divided by the number of days, in a simple moving average, a set of averages are calculated for a specified number of days, each average being calculated by including a new price and excluding an old price. In the below table the first total of 67022 in column 3 is obtained by adding the prices of the first five days, i.e. (13611+13124+13124+13433+13730). The next Total of 67448 in column 3 is obtained by adding 6th day and deleting first day price from the first total i.e. (67022+14037-13611) this process is continued. The moving average in column 4 is obtained by dividing the total figure in column 3 by the number of days i.e. 5. Calculation of gold price Five days Simple Moving Average Days Close Prices(Rs) Total prices of 5 Days 5 Days Moving Avg(MA) 1 13611 2 13124 3 13124 4 13433 -

5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

13730 14037 14037 14283 14283 13140 13145 13405 13247 12742 12742 12742 12600 12277 11976 12050 12099 11940 12050 12312 12332 11962 11962 11962 11603 11841 11841 11841 11841 11753 11766

II.

67022 67448 68361 69520 70370 69780 68888 68256 67220 65679 65281 64878 64073 63103 62337 61645 61002 60342 60115 60451 60733 60596 60618 60530 59821 59330 59209 59088 58967 59117 59042

13404.4 13489.6 13672.2 13904 14074 13956 13777.6 13651.2 13444 13135.8 13056.2 12975.6 12814.6 12620.6 12467.4 12329 12200.4 12068.4 12023 12090.2 12146.6 12119.2 12123.6 12106 11964.2 11866 11841.8 11817.6 11793.4 11823.4 11808.4

Exponential Moving Average(EMA): It is calculated by using the

Following formula: EMA = (Current closing price – Previous EMA) × Factor + Previous EMA Where

Factor = 2/n+1 and n = number of days for which the average is to be calculated. Calculation of 30 days gold price of Five – Day EMA

Days

Closing price

EMA

1

13611

13611

2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

13124 13124 13433 13730 14037 14037 14283 14283 13140 13145 13405 13247 12742 12742 12742 12600 12277 11976 12050 12099 11940 12050 12312 12332 11962 11962 11962 11603 11841

13450.29 13342.61 13372.44 13490.44 13670.8 13791.65 13953.79 14062.43 13758.03 13555.73 13505.99 13420.52 13196.61 13046.59 12946.07 12831.87 12648.76 12426.75 12302.42 12235.29 12137.85 12108.86 12175.89 12227.41 12139.82 12081.14 12041.83 11897.01 11878.53

Factor = 2/ n+1 = 2/ 5+1 = 2/6 = 0.33 The EMA for the first day is taken as the closing price of that day itself. The EMA for the second day is calculated as EMA = (closing price – Previous EMA) × Factor + Previous EMA = (13124 – 13611) × 0.33 + 13611 = 13450.29 EMA = (13124 – 13450.29) × 0.33 + 13450.29 = 13342.61 If we are calculating the five day exponential moving average, the correct five day EMA will be available from the sixth day onwards. A moving average represents the underlying trend in commodity price movement. The period of the average indicates the type of trend being

identified. For example, Five day or Ten day average would represent the short – term trend; a 50 day average would indicate the medium term trend and a 200 day average indicates the long term trend. The moving averages are plotted on the price charts. The curved line joining these moving averages represent the trend line. When the price of the commodity intersects and moves below or above this trendline, it may be taken as the first sign of trend reversal. Sometimes, two moving averages – one short-term and the other long term are used in combination. In this case, trend reversal is indicated by the intersection of the two moving averages. .

Oscillators: Oscillators are the mathematical indicators calculated with the help of the closing price data. They help to identify overbought and oversold conditions and also the possibility of trend reversals. These indicators are called oscillators because they move across a reference point. Rate of change Indicators (ROC): It is a very popular oscillator which measures the rate of change of current price as compared to the price a certain number of days or weeks back. To calculate a 7 day rate of change, each day’s price is divided by the price which prevailed 7 days ago and then 1 is subtracted from this price ratios ROC = (Current price / Price ‘n’ period ago) – 1 Let’s take an example of 30 days Gold price.

Calculation of 30 days gold price of 7 – day ROC Days

Closing Price

Closing Price 7 Days ago

Price Ratio

ROC = ratio - 1

1

13611

2

13124

-

-

-

3

13124

4

13433

5

13730

6

14037

7

14037

-

-

-

8

14283

13611

0.049371832

9

14283

13124

1.04937183 2 1.08831149

10

13140

13124

0.001219141

11

13145

13433

12

13405

13730

13

13247

14037

14

12742

14037

1.00121914 1 0.97856026 2 0.97632920 6 0.94372016 8 0.90774382

15

12742

14283

16

12742

14283

17

12600

13140

18

12277

13145

19

11976

13405

20

12050

13247

21

12099

12742

22

11940

12742

23

12050

12742

24

12312

12600

25

12332

12277

26

11962

11976

27

11962

12050

28

11962

12099

29

11603

11940

30

11841

12050

0.08831149

-0.021439738 -0.023670794 -0.056279832 -0.09225618

0.89210950 1 0.89210950 1 0.95890411

-0.107890499

0.93396728 8 0.89339798 6 0.90963991 8 0.94953696 4 0.93705854 7 0.94569141 4 0.97714285 7 1.00447992 2 0.99883099 5 0.99269709 5 0.98867675

-0.066032712

0.97177554 4 0.98265560 2

-0.028224456

-0.107890499 -0.04109589

-0.106602014 -0.090360082 -0.050463036 -0.062941453 -0.054308586 -0.022857143 0.004479922 -0.001169005 -0.007302905 -0.01132325

-0.017344398

The ROC values may be positive, Negative and also be zero. An ROC chart is shown below where the X – axis represents the time and the Y – axis represents the values of the ROC. The ROC values oscillate across the zero line. When the ROC line is above the zero line, the price is rising and when it below the zero line, the price is falling. Ideally, one should buy a commodity that is oversold and sell a commodity that is overbought. In the ROC chart, the overbought zone is above the zero line and the oversold zone is below the zero line. Many analysts use the zero line for identifying buying and selling opportunities. Upside crossing (from below to above the zero line) indicates a buying opportunity, while a downside crossing (from above to below the zero line) indicates a selling opportunity. The ROC has to be used along with the price chart. The buying and selling signals indicated by the ROC should also be confirmed by the price chart.

MARKET INDICATORS: Technical analysis focuses its attention not only on individual commodity price behaviour, but also on the general trend of market, Indicators used by technical analysts to study the trend of the market as a whole are known as market indicators. Technical Analysis Vs Fundamental Analysis: Fundamental analysis tries to estimate the intrinsic value of a commodity by evaluating the fundamental factors affecting the economy, industry and company. This is a tedios process and takes a rather long time to complete the process. Thecnical analysis studies the price and volume movements in the market and by careful examining the pattern of these movements, the future price of the commodity is predicted. Since

the whole process involves much less timeand data analysis, compared to fundamental analysis, it facilitates timely decision. Fundamental analysis helps in identifying undervalued or overvalued securities. But technical analysis helps in identifying the best timing of an investment, i.e. the best time to buy or sell a security identified by fundamental analysis as undervalued or overvalued. Thus, technical analysis may be used as a supplement to fundamental analysis rather thanas a substitute to it. The two approaches, however, differ in terms of their databases and tools of analysis. Fudamental analysis and technical analysis are two alternative approaches to predicting stock pricebehaviour. Neither of them is perfect nor complete by itself. Technical analysis has several limitations. It is not an accurate method of analysis. It is offen difficult to identify the patterns underlying commodity price movements. Moreover, it is not easy to interpret the meaning of patterns and their likely impact on future price movements.

REFERENCES Books: •

Security Analysis And Portfolio Management - S.kevin

E – Books: •

Ncfm module for commodity market

•

COMDEX Educational series

•

Investors Educational series

•

Nair C.K.G. (2004): Commodity Futures Markets in India: Ready for Take Off”? www.nseindia.com

Websites: •

www.geojit.com

•

www.bseindia.com

- Angel commodities

•

www.mcx.com

•

www.kitco.com

•

www.ncdex.com