Is commodity trading the next big thing for retail investors?

The commodity markets are easy to understand, but the trading in the futures and options is entirely different from holding physical commodities.

The global economy is now experiencing the deepest recession since the Great Depression of the 1930s, with declining GDPs and increasing unemployment all around the world. Stock markets all around the world are facing large amounts of volatility and the whole atmosphere regarding the future outlook remains uncertain. Talking about the Indian stock market, the same situation prevails in the country as well. Due to high volatility and rising uncertainties, the retail investor is suffering the most during these times. Retail investors due to lack of proper knowledge stand to get the worst hit in times such as these. Due to this reason, they are looking for alternate investment avenues to park their fund.

The commodity market has been growing substantially since the past few years. The total turnover for the derivatives future segment increased to Rs 89.33 trillion in FY2020 from Rs 71.96 trillion in FY2019, registering a growth of 24.12% but retail investors’ participation still stands very limited. Commodity investments can help a retail investor diversify his portfolio into a different asset class apart from shares and bonds and enhance the overall returns of their investments. Through commodity investing, the retail investor can take exposure of all different asset classes and industries. In addition to this, commodity markets move separately from the share markets.

Inflation, which is also known as Rise in Prices, is one of the major reasons for the low real returns for retail investors. The prices of commodities generally rise due to inflation. Therefore, your commodity investments will reap a much higher return in scenarios where inflation is high. Investment in commodities, in short, is a hedge against inflation. The prices of commodities fluctuate significantly due to factors such as demand and supply, the occurrence of natural calamity, exchange rates etc.

Despite all the factors, commodity investing is still being considered as the next big thing for retail investors. Indian investors have till now focused on trading in the equity markets, while the world over commodity is bigger than equities. In addition to this, the trends in the agriculture sector especially are more secular. Commodity trading does not involve any fundamental analysis, rather it is a game of pure demand and supply. There are relatively very few variables which need to be monitored in case of commodity trading. In addition to this, commodity investments hold greater liquidity than other investments such as those in real estate. To help broaden the commodity derivatives market, market regulator Sebi had approved allowing mutual funds and portfolio managers to trade in this segment.

Commodity returns generally have a low or negative co-relation with the returns of other asset classes. Investors create a hedge against event risk such as natural calamity, war etc. This is the main reason why in times such as the Corona pandemic people are shifting their exposure to the commodity segment. A well-planned commodity investment is able to generate far more superior returns when compared with other asset classes.

Given the current scenario, the price of gold, which is considered as one of the safest types of investments, has seen a sharp rise. The fear of market uncertainties has forced investors to go for safer investment alternatives. Gold is considered to be a safe haven investment that does well when equities sell off. Apparently, base metals, precious metals and other energy-related commodities like crude oil have become a lucrative investment option for retail investors.

Given the facts, making investment in commodities seems like the next big thing for retail investors. But one should keep in mind that only investing in commodities is not the right decision to make in the current scenario. The commodity markets are easy to understand, but the trading in the futures and options is entirely different from holding physical commodities. Trading in commodity derivatives requires that an investor has sound working knowledge and a keen ability to make informed decisions. No doubt that commodity investment is a lucrative option, but an investment in commodities should be used in order to diversify one’s portfolio with a proper devised strategy in order to generate better returns and to hedge against inflation.

(By Jashan Arora, Director, Master Capital Services)

Disclaimer: The views expressed in this article are the author’s own.