In the past few months, some agri-commodities traded in India’s commodity futures exchanges broke several records moving to record highs—this includes guar seed, guar gum, pepper, cotton seed oil cake and a few others.
The Guar seed February contract at NCDEX hit new record highs 11 times and hit the 4 percent permitted daily lower limit in the last 12 sessions defying all efforts by the exchange to curb volatility.
The Forward Markets Commission (FMC) which regulated commodity futures market in India has swifly swung into action and suspended suspended two of the five companies it had served with show-cause notices in connection with an investigation into guar trade apart from imposing higher margin limits and position limits.
Despite the several measures taken, volatility continues to create nightmares for traders and investors and no one knows why. In this interview with Sreekumar Raghavan of Commodity Online, Mr Kunal Shah, Head, Commodities Research at Nirmal Bang Commodities feels the introduction of options in commodities and an active electronic spot exchange can help in curbing volatility and help investors tide over uncterain market situations.
Sreekumar Raghavan: Do you think the present volatility in guar seed, guar gum, cotton seed oil cake, pepper is quite unprecedented, if so, why?
Kunal Shah: Yes, volatility in commodities such as pepper and guar seed is very high and there is more than one reason for the same. One of the major reasons is the depletion in carry forward stocks. There has been a constant decline in carry forward stocks of pepper and guar seed since the last five years. When inventories are low and there is a spurt in demand or a drop in supply, then prices tend to rise rapidly.
I believe that in commodity ‘shortage has its own importance’; a bull trend starts with shortage and then aggravates. Thus, we see a kind of humongous rise in the prices like we saw in guar seed, gum and black pepper. Wider participation and trading by corporates on the futures platform are also responsible for high volatility in commodities.
SK:Do you think more measures have to be taken to curb speculative activity now that guar seed, guar gum futures continue to hit upper circuit and volatility is seen in some other commodities such as pepper, chana, coriander, potato?
KS: Due to rising prices and volatility, margins on long positions were raised on guar seed and guar gum gradually over a period time. It is possible that traders who were short on these commodities were unaware of the structural changes in the demand for these commodities and were therefore blaming the system, which they should avoid. Most exporters seek to cover as much position as they can. And due to frequent circuits, hedgers faced a difficult time as they were not able to cover their short positions.
The Indian agriculture market is at a nascent stage and this phenomenon is quite common in a developing market. In the early 1990s, this trend was also visible in the Indian equities market. However, over a period of time, we have seen a lot of developments, including wider participation, increase in hedging tools and organized trades. A well-developed cash market, options to hedge positions and increasing participation by opening up of this market are some of the reforms that need to be undertaken on a war footing.
The Indian agriculture market is in need of urgent reforms such as amendment of the Foreign Contribution (Regulation) Act, 1976 (FCRA) and the implementation of the Goods and Services Tax (GST) Act, which when brought into effect will benefit the agriculture market a great deal.
SK: Do you foresee the possibility of imposing of suspension/ ban on these volatile commodities, if prices continue to swing upward? What message do you have to restore the confidence of investors?
KS: Banning or suspending trading in volatile commodities will not do any good to the market. A ban or a suspension is the last thing that a market participant would want now. In the case of guar gum, there was robust demand from the US and other middle east countries that are involved in the exploration of natural gas and horizontal drilling, in particular.
The US crude oil imports are falling as domestic oil production is moving up mainly from regions such as North Dakota where a massive exploration of shale oil and gas is taking place. US natural gas prices tested a 10-year-low on account of a massive surge in production.
Therefore, there is huge demand of guar gum from oil and gas sector. Unfortunately, in the absence of exact export numbers, it is difficult to monitor exports. Hence, neither the exchange, nor the regulator can control the demand for a commodity. It depends on whether the traders are understanding the dynamics of the underlying commodity or not. If a trader shorts a commodity just because it has run up too much and there is a strong demand even at an elevated price, then prices are bound to move up.
I think investors should try to understand demand and supply of a commodity and other dynamics, which affects the prices of a commodity and only then initiate their positions. They should not initiate a highly leveraged trade. They should have a stop loss in a trade (as you always have right to go wrong).
SK: Do you think introduction of options in commodities can to a large extent help market players to hedge risk better?
KS: Not only Options in equities, but Options in commodities too can help market players hedge their risks better. I am of the view that more than Options, a well-developed electronic spot market is the need of the hour as it will lead to better price discovery
