Will the stagnant demand in commodities encourage hedging?

The market may be responsive to fundamentals rather than any momentum trading

The commodity market, which had defied gravity during the last few years, is showing signs of slowing down.

It is not a breather but a shift to a bear cycle.

No doubt the “investors” have vanished and the herd mentality has gone out.

The standard explanation during the period of price surge was that the booming demand, particularly from China, was clashing with stagnant supply of energy, metals and agricultural produce. Talks of stagnant or falling demand are now in the favour.

The bull phase saw “weight of the money effect” where the participants took positions so large compared to overall position that they could move the prices.

However, with money becoming scarce for such activity, the market is likely to become more responsive to market fundamentals rather than any “momentum trading”. Even an oilseed trader who would have tried his hand on the trends of the gold or crude market during the last few years will increasingly restrict himself to core business by avoiding such daredevil acts.

During the past decade, “financialisation” of the commodity market had almost destroyed the information flow of the physical market adjustment mechanism. Commodities which became “basket of assets” will now be viewed more for its uniqueness and S&D (Supply & Demand) gaps.

Businesses involved in the origination, processing, merchandising, trading, handling, storage and shipment of commodities will get a flip compared to the companies who were promising investors with short terms large returns.

The acceleration and amplification of the price movement which was witnessed in the market during the last several years have come down substantially during the last six months in almost all the commodities.

The changed scenario would also encourage the long term hedge requirement of physical players in the futures market who need not be worried about frequent variation margin calls.

Companies in the physical commodities domain are likely to react to such situations by consolidating specialisation and getting back to the fundamentals of business.

As the saying goes often in commodity market “Bears will make money. Bulls will make money. Pigs will get killed” would be proven correct once again.

Published in Business Line on  March 27, 2014

Why commexes should offer incentives to encourage growth

Sops can be given in an innovative way to expand the footprint of the futures market

Commodity exchanges collect transaction charges from its members according to the average daily turnover in a slab-based system.

The recent decision of the Forward Markets Commission to give freedom to commodity exchanges to fix different transaction charges is a landmark one.

Transaction charges

The flexibility to fix the transaction charges is leading to a situation where it has sparked competition among the exchanges to grab market share in the already shrinking futures pie. Instead of using the freedom to attract more participants in their fold from different parts of the country, exchanges are looking to grab each other’s shares.

The non-agri-exchange is vying for the share in the agri space and vice-versa. This freedom to set transaction fee could be used more innovatively used to give a fillip to better geographic participation which is now concentrated mainly in the western parts of the country. If the exchanges try to do the same thing, they may not succeed.

However, if exchanges expand the network by broad basing participation that go beyond the cities and bring more and more players, there will be space for more growth.

Incentive programmes

The incentive programmes of the exchanges can enable non-penetrated geographies where knowledge and usage of the futures market is low.

Participants from these geographies can be charged a discounted fee for qualified products. Under such schemes, existing market participants are not included unless they specifically inform the exchanges about the efforts made under the programme. This will prevent misuse of incentives by the members.

The incentives apply only to electronic trades that are done by qualified registered traders in accordance with exchange policies. The participants will be eligible for discounted fees during the announced period provided they satisfy the minimum quarterly volume requirements.

CME, which is the world’s largest exchange, offers a number of such incentive programmes directed at different parts of the world.

The incentive programmes offer fee waivers or reductions to new traders from locations where the exchange has yet to make inroads. There is also an Emerging Market Programme that covers the world outside the 20-most developed economies.

The New Trader Incentive Program (NTIP) provides fee waivers for new traders associated with proprietary trading firms and trading arcades located in approved countries. Qualified registered traders can obtain fee waivers for trades of qualified products in accordance with the announced policies.

The NTIP is designed to encourage the development of new traders with no experience.

The mobile phone industry underwent a metamorphosis when it changed from call-based tariff to usage-based tariff.

The commodity futures market is yet to see a change from a value-based fee structure to a transaction-based fee structure …which may prove to be a game changer.

Published in The Business Line on March 12, 2014