What’s common between sports & commodity trade?

There is an old story about two hikers who encounter a tiger. One says: There is no point in running because the tiger is faster than both of us. The other says that it is not about whether the tiger is faster than both of us. It is about whether I’m faster than you. And with that he runs away. You guessed it right the person who ran was a commodity trader.

Traditionally while recruiting a commodity trader, one looked at the sportsmanlike traits. Surprisingly, in recent years, an increasing number of companies in the West are scrutinizing professional poker players to find talent and analytical tools, someone who has made a successful living as a poker player for a few years would more likely be a good trader than someone who hasn’t! 

The broader discipline of economics and finance has developed expertise that does take behavioral factors into account. There has been a perception shift in commodity trade from “value-based trading” to “price movement-based trading”, as a result of which, traders are no more thinking of rationality. One of the devastating myths perpetuated in commodity trade is a simplistic assumption about the behavior of people — a trader acts rationally to maximize the return. 

Investment bubble has demonstrated that traders are far from uniformly rational and the behavior of markets in general shows that behavioral factors of individual commodity traders are important for the profits and losses. 

You may often heard comments like “if the market goes down for three years in a row, it has to go up the next year!” or perhaps say it yourself ? That is ‘gamblers’ fallacy’ — a phenomenon which is very common amongst most commodity traders. 

It is normal for any commodity trader to frame the market race and hope to win by buying and selling commodities at the right time.

That doesn’t seem so hard... So what does this mean in practical terms? There are some of the companies in India who have employed technical analysts in order to take a contrarian position of the recommendations. No doubt with same data sets, same analytical tools, low depth and liquidity in the domestic market, the success rate of these companies have been much better than the others. The way people react and think in commodity market has more to do with the pressures’ rather than rational thinking. 

In India, the typical commodity trader no more fits the stereotypes which usually presented as ill-prepared, unsophisticated, unaware of the risks and undercapitalised.

It is seen that companies come and go but the traders dealing in a particular commodity line remains the same. Some of them are experienced, well-educated, financially sophisticated and well capitalised. Most of them seem to be in the area of odds against making profit; they continue to trade for the recreational reasons.

Published in The Economic Times    

Digital divide hampers growth of commodity mkts

Commodity markets and market yards used to be the physical locations where buyers and sellers met and negotiated. With the improvement in communication technology in 90’s, the need for a physical location has become less important as traders are transacting from remote locations over phone. 

The ‘E’ word in the commodity cash market seems to be the latest fad. E-products are creating sound bites rather than solutions. The solutions seem to hold more promise than they can actually deliver with the current technological reach to the masses. Internet presents physical cash markets with opportunities to increase efficiency through lower transactions costs but access remains a problem. While India has emerged as the second-largest mobile telephone market after China, in terms of computer and internet penetration India is still far behind. India has 5.1 internet users for every 100 people, which compares poorly with the corresponding figures of 39.2 and 28.5 for Brazil and China, respectively. 

Today a large majority of stakeholders in the commodity market are in the midst of the ‘digital divide’. It is not difficult to see broadband connections in the pockets of market yards of Rajasthan, Gujarat and Punjab. The commodity futures exchanges have helped in technology and digital penetration, though a majority of the physical cash market remains digitally excluded. Therefore, the growth of these commodity markets to the next level has remained elusive. 

Electronic trading makes transactions easier to complete, monitor, clear, and settle in the physical commodity space. All the considerations lead to compare a simple solution to avoid complex solutions. Such comparisons should also consider whether providing a low-cost system meets the basic needs, regardless of the use of         E-trading product. 

E-trading systems are typically proprietary software (E-trading platforms), running on COTS (Commercial off the shelf) hardware and operating systems, often using common underlying TCP/IP protocols. The emergence of electronic trading venues known as ‘Electronic Communications Networks’ (ECNs) in the late ‘90s made it possible for more entities to trade. ECNs and exchanges generally offer two methods of accessing their systems — GUI & API. GUI (Graphical User Interface) is which the trader runs on desktop and connects directly to the E-trading venues. API (Application Programming Interface) allows dealers to plug into their own in-house systems and then directly into the E-venues. From an infrastructure point of view, most exchanges provide “gateways” acting in a manner similar to a proxy, connecting back to the exchange’s central system. ECNs will generally forego the gateway/proxy, and their GUI or the API will connect directly to a central system, across a leased line. 

India ranks 43rd in a list of 133 countries, just behind China and Brazil according to the WEF’s Network Readiness Index. However, the standards on E-trading systems in commodity market with regards to authentication, encryption, transactions recording standard, pricing and slippage standard need to be created without much delay. Unless that is done and the ‘traffic rules’ are made, it would be a chaos on the E-trading highways of the commodity cash markets. 

Published in The Economic Times 

Implied volatility in commodities trade

Export populism in commodities is a phenomenon which is directly connected to the country’s backwardness profile. A mandi operator claims higher place among his peer group ‘for being a supplier to an exporter’ and exporter demands highest place of pride than his domestic counterpart in social forums. These are all ingrained in a false vanity that is often attached to international trade. 

In the controlled regime, the successful exporter had to manage the ‘babudom’ to leverage the incentives and subsidies of the government. However, market orientation brought about a change in the profile of the exporters. The established players have moved out and the less established players have moved in. The moot point is whether one makes money by exporting commodities? 

Free play of the market can be seen nowhere more dominantly than in exportable commodities like soyabean de-oiled cake (DOC) and coffee market. In both these commodities, one rarely finds a back to back parity. So, how does one make money — thru positional calls? lower interest & logistical cost or by sheer luck? 

Coffee and soyabean are the largest traded commodities in international exchanges. Implied volatilities for these commodities have been creeping up steadily over the course of past two decades and now appear a more permanent feature in their markets than was the case in the past. A detailed examination of the past underscores just how volatile these markets have become and how volatility has persisted. Since the beginning of 2006, implied volatility have frequently spiked to levels well beyond 30% in these commodities, reaching well over 60% at times. The more divergent are traders’ expectations about future prices: the higher the underlying uncertainty and hence the implied volatility of the underlying commodity. 

Does volatility matter? Prices of derivative commodities that are observed today of commodities which are traded in the major global exchanges are determined by underlying expectations and uncertainties about such expectations, pertinent to the market and the commodity. Hence, implied volatility, as reflected or inferred by the prices of derivative contracts, is an important component of the price discovery process and is a barometer as to where markets might be headed. 

Markets are failing under the pressure of oligopolistic powers. The companies that process and ship agricultural commodities are growing in size as they decrease in numbers. Empirical evidence shows that a growing disconnect between prices paid by the consumers and prices received by the producers. International Commodity Agreements, Buffer Stocking and government intervention have failed in past. 

In addition to seeking ways to increase stability in commodities market the government needs to re-think that in a market oriented economy, how can one limit the exposure to commodity price volatility and mitigate the detrimental effects of commodity wild price swings. To quote Friedman, “governments never learn. Only people learn”. 

Published in The Economic Times

India Commodity Year Book

Launch of India Commodity Year Book 2011

(L to R) Dr. Hanish Kumar Sinha, Head - Commodity Research, Mr. K. Sankaranarayanan, Head – Risk, Compliance & Technology, Sanjay Kaul, MD & CEO, NCMSL. Shyamal Gupta, Chief Business Officer, NCMSL 

There was a long felt need in the commodity world for a handy reference book covering the entire gamut of commodities with special reference to their role, relevance and price movements in the Indian markets. Also, statistical information on production, growth, demand-supply and price movements of different commodities over the last 8-10 years, at one place, was difficult to find in the published literature on commodities in India. It is in the background of such a situation that the Commodity Year Book 2009 published by National Collateral Management Services Limited (NCMSL) comes in as a gap-filler. This was repeated on 2010.

Here’s another regulator in farmers’ name

India has a unique distinction of creating monoliths in the name of farmers yet the objective is to provide a better support function to established financial institutions.

As long as there is a public acknowledgement of this fact, there is nothing wrong in creating better systems. The tagging often in the name of the farmer is done to gain legitimacy.

The most recent initiative in this space was the creation of a regulator by the name of WDRA (Warehousing Development and Regulatory Authority). The WDRA Act 2007 came into operation on October 25, 2010, almost after three years since the bill was passed by Parliament. The regulator’s mandate is to put in place a negotiable instrument in the name of warehouse receipts (WHR). The main challenge shall be to create a foolproof network wherein this instrument is not used in the manner in which a large corporate house had done previously (issuance of multiple physical shares with the same number) or the fraudulent use of bank receipts by Harshad Mehta for leveraging in the stock market.

With the increasing “financialisation” of the commodity market, the laws and governance initiatives of the government seem to have remained etched in archaic classical economics of demand-supply and individualism. Institutionalised DEF (desire, expectation and fear) has now taken over the individual’s role in commodity markets. Price manipulation and leveraging are not anymore a businessman’s individual prerogative but are achieved through well-designed plans of policy manipulations and systemic loopholes. The new regulator is expected to bring a much-desired foresight in an environment of governance myopia.

While promoting instruments for pledge & collateralised struc ture in the commodity market one needs to take into considera tion the financial ramifications of these instruments. In the current legal structure, the ministry of consumer affairs may not be well-equipped to handle a financial instrument of this nature and the equipment are available elsewhere within the country. Without direct access to the ministry of finance and RBI, WDRA may not be constrained to access a regular financial information flow, talent and resource pool.

On the “farmers welfare account”, needless to mention, a majority of Indian farmers produce a lot size which is nonremunerative to be funded by financial institutions after considering the overall transaction cost and credit delivery cost. Therefore to make a case out of WHR that the instrument is going to help in preventing distress sale and shall give better access of credit to farmers is a more of a public relations exercise which is hard to be consumed even with a pinch of salt.

The chances are that in order to achieve economies of scale for credit delivery, we might see a new financial intermediation option and not a direct credit delivery. If an instrument of such great importance gets notified (if at all) in the Negotiable Instrument Act, then can we restrict it to only “agricultural produce” that will be the death sentence for the instrument (WHR) or will that be a solitary confinement? 

Published in The Economic Times