What Are Commodities and What is Their Role in the Stock Market?

In this article, we will discuss

• What are Commodities?
• The Different Commodities Traded in the Commodities Market
• A Deeper Understanding of the Commodity Market
• What are Commodity Derivatives?
• The Role of Commodities in the Stock Market
• Tips for Trading Commodities and Stocks
• Conclusion

The commodities market is a distinct section of the financial markets in India. Many traders — both beginners and those with years of experience — attempt to profit from commodity price changes. Commodity trading, particularly in the options and futures segment, is easier if you have access to advanced analytical tools like those offered by Samco Securities. In the Samco trading app, you can view the market depth, live market data, options chain, futures chain and any relevant events. This makes commodity trading easier because you have access to all relevant information.

In this article, we discuss the meaning of commodities, understand how the commodity market works and delve into the role of commodities in the stock market.

What are Commodities?

Commodities are goods that are used in various stages of production. Primarily, they are raw materials that are used as inputs for manufacturing other goods or providing different services. They are different from the finished goods sold to consumers for their end usage.

Commodities are primarily discussed in commerce rather than finance and trading. They are goods that are interchangeable with other similar goods. Despite certain differences in quality, they can essentially be substituted for their counterparts.

This concept of commodities in commerce also extends to the financial markets because such goods are often traded on commodity exchanges. Such organised trade is slightly different from physical markets, where you directly purchase the commodities from the seller for your end use.

The Different Commodities Traded in the Commodities Market

Commodities include various goods like agricultural products, metals, bullion, energy resources and more. The following goods are commonly traded in the commodity market in India.

• Bullion: Gold and silver

• Energy Products: Natural gas and crude oil

• Base Metals: Copper, aluminium, lead, nickel, steel and zinc

• Cereals and Pulses: Bajra, moong, wheat, chana, paddy, maize and barley

• Oil and Oil Seeds: Castor seeds, crude sunflower oil, groundnuts, refined castor oil, mustard seed, soybean, cotton seed oilcake, refined soy oil, sesame seeds, mentha oil and crude palm oil

• Fibres: Cotton wash oil, cotton and kapas

• Soft Products: Isabgol seeds, gur and robusta cherry AB coffee

• Spices: Jeera, turmeric and coriander

• Guar Complex: Guar seed and refined guar gum

As you can see, a fair number of products are traded in the commodity market. But how does the commodity market work? How does commodity trading take place between interested buyers and sellers in this market segment? Let us find out.

A Deeper Understanding of the Commodity Market

The commodity market consists of two main segments — spot markets and derivative markets. In spot markets, physical commodities are traded for immediate delivery and payment. These transactions involve the actual exchange of goods.

Derivative markets, on the other hand, trade financial contracts based on underlying commodities. They include futures, options and swaps. Derivative markets allow traders to speculate on commodity price movements or hedge against risks without handling physical goods. They provide liquidity and facilitate price discovery by influencing spot market prices. Both markets are interconnected though, with derivative prices often converging with spot prices at contract expiry.

What are Commodity Derivatives?

Commodity derivatives are financial contracts whose value is derived from an underlying commodity. These instruments allow you to manage price risks or speculate on commodity price movements without physically owning the goods concerned. The most common types of derivatives in the commodity market are:

• Futures Contracts: These are agreements to buy or sell a specific quantity of a commodity at a specific price on a predetermined date in the future.
• Options Contracts: These are agreements that give the holder the right to buy (in a call option) or sell (in a put option) a commodity at a specific price within a set timeframe. The options buyer is not obligated to buy or sell the commodity.

The Role of Commodities in the Stock Market

Commodities play a crucial role in the stock market because they influence various sectors as well as the overall market performance. Their prices often serve as economic indicators that provide direct insights into the supply and demand dynamics across industries. The profitability of many companies is directly tied to commodity prices — because they are either producers or consumers of these raw materials.

Commodity-producing companies — like those involved in mining, oil extraction and agriculture — have their stock prices closely linked to the commodities they deal with. Investors sometimes use these stocks as proxies for commodity exposure if they find them more accessible than futures markets. This relationship extends beyond producers and also affects the industries that rely on commodities as inputs.

The impact of commodity prices also ripples through the stock market in other ways. Rising prices can squeeze profit margins for companies that use commodities in production. This could potentially lead to lower stock valuations for such companies. Conversely, falling commodity prices may also boost profitability for these firms. This dynamic creates a complex link between the commodity markets and the performance of stocks across various sectors.

Commodities also serve an important function in portfolio diversification. Their typically low correlation with stocks and bonds can help reduce the overall risk in your portfolio. Many investors allocate a portion of their holdings to commodities or commodity-related stocks as a hedge against inflation and currency fluctuations. This is precisely what has led to the creation of various commodity-focused investment products.

Global events and macroeconomic factors can also significantly influence the relationship between commodities and stocks. Geopolitical tensions, natural disasters and trade disputes can cause large swings in commodity prices, which, in turn, affect the market performance of many companies. For example, conflicts in oil-producing regions may lead to oil price hikes that in turn benefit energy stocks while negatively impacting other sectors.

Currency fluctuations and the policies of the Reserve Bank of India (RBI) also play a major role in this relationship. Interest rate changes can influence commodity prices, particularly for precious metals often seen as safe-haven assets.

Tips for Trading Commodities and Stocks

If you want to participate in the commodity and the share market, here are some pointers to help you straddle both markets with relative ease.

• Diversify to Spread Your Risk

Diversify your portfolio across different commodities and sectors. This approach can help mitigate risk by reducing exposure to any single market or industry. You can also consider a mix of energy, metals, agriculture and related stocks to create a balanced commodity-focused investment strategy.

• Stay Informed About Global Events

It is also crucial to stay informed about global events and economic indicators. Geopolitical tensions, weather patterns and economic reports can all significantly impact commodity prices and related stocks. So, monitor news sources and economic calendars regularly to anticipate potential market movements and make informed decisions.

• Combine Technical and Fundamental Analysis

Use technical analysis alongside fundamental research for better clarity. For instance, you can combine chart patterns and technical indicators with fundamental analysis of supply and demand factors. This dual approach can provide a more comprehensive view of potential price movements in both commodities and related stocks.

• Use Stop-Loss Orders to Limit Risk

Implement risk management strategies like hedging and stop-loss orders. By setting predetermined exit points to limit potential losses on your trades, you can protect your capital and ensure that your emotions do not override your trading decisions — especially in volatile market conditions.

• Monitor the Impact of the Currency Market on Commodities

Consider the impact of currency fluctuations on commodity prices. Many commodities are priced in U.S. dollars, so changes in exchange rates can affect their values. Be aware of how currency movements might influence your commodity and stock investments, particularly in international markets.

Conclusion

This brings our guide on the commodity market to a close. As a retail participant, the best way to trade in this segment is to focus on commodity futures and options. If you are new to derivatives trading, ensure you have access to advanced tools like those offered by Samco Securities. This way, you can make informed rather than emotional commodity trading decisions.

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