Investing across asset classes is a way to reduce your portfolio risks. Technically, this is called diversification. Diversification is a great tool to seek stability in a portfolio’s returns. Many a time, the idea of earning very high returns blinds traders to inherent risks. Consequently, they take very high exposure in an asset class, and any unfavourable movement in that asset class can wipe out the entire investments. This tendency can be avoided. For this, investors must be ready to learn and go beyond their comfort zone. They must understand the importance of investing in varied asset classes to save their portfolio from eroding fast.
In India, given the low percentage of people who invest, investing in equities seems like the only viable option after fixed deposits and insurance. But there is another asset class: commodities. It is quite peculiar that commodity markets in India are not yet fully developed. In large developed markets, commodity markets are bigger than equities markets. This is a sign that investors want diverse investment options in developed markets. So, a natural question that arises is: Is commodity trading in India profitable? And if it is profitable, why is it not developed and become bigger as seen in developed markets? Here is a low-down on this:
Even though equities attract high attention, commodity markets are also big and are growing in India. More and more investors and traders are trading in commodities. And the reason is simple and clear: they are making profits. Let us understand how trading in commodities can be profitable in India.
Real commodities real profits
Commodities are used in all walks of life. The demand for and supply of commodities keep changing and they also change their prices. Unlike some imaginary factors, underlying commodities have real value in use and value in exchange. They get consumed and add value to our life. If you get an idea of the demand supply factors that impact commodity prices, then you can make decent risk-adjusted profits by trading in commodities.
Variety
Commodities are a well-diversified asset class. There are precious metals, industrial metals, agri-commodities, energy and other commodities within this asset class. Each of these has its own fundamentals and its price changes accordingly. You can trade in many such commodities and earn from low-correlation trades. This brings down risk and improves risk-adjusted return of your portfolio.
Global asset class
Commodities are used across the globe. They may be mined in one part of the world but may be consumed all over. This helps in efficient price discovery. Commodity prices cannot be manipulated for long. Participation of users, producers and speculators make this asset class very efficient. Even if you are trading in India, you benefit from global movements in commodity prices.
Relatively less complex
Two companies working in the same sector offering similar products may be offering different profit numbers to their respective shareholders. Their cost structure and capital structure may differ from each other. They may be operating in different geographies. There may be off-balance sheet risks associated with each one of them and they won’t be the same. Their management’s efficiency may differ. There may be corporate governance issues, which may throw up a negative surprise.
Unlike this, commodities remain the same across the globe. Gold does not change from one country to another. Foreign exchange differences and local duties may change the prices a bit. But beyond that, there are a finite number of things to watch out for.
Most commodities are relatively easy to track as compared to share prices of companies in a sector. If you are planning to invest in companies across sectors, then there is much more work involved.
Demat trading
Trading in commodities on commodity exchanges has its own distinct advantages. Commodities are bulky goods in most cases. Hence, the physical market is unattractive as it calls for storage, transport and insurance costs, among others. Trading commodities on an exchange helps you avoid all these costs if you plan your trades carefully. Exchanges also offer many derivative instruments that serve the needs of large and small traders. This helps a lot as it brings down costs and considerably improves liquidity. It, in turn, makes commodity trading profitable in India.
Trade in both directions
While trading in commodities, one can initiate trade in both directions, up and down using derivatives. One can go short if one has a bearish view on the price of an underlying commodity. Similarly, one can go long if one is bullish on the prices of an underlying commodity. Traders with a very short-term timeframe can make the most of this strategy by changing their positions as trends change.
Margin-based trading
To make trading profitable in commodities one needs to employ capital as low as possible. The use of derivatives to trade commodities in India can help you trade large quantities using relatively less funds. The reason being that the margin money required for derivatives trading is lower than trading in the spot market. Low margin requirement in select products helps even small traders begin trading in commodities. Careful use of margin for trading commodities in India can make it a profitable enterprise.
Diversify
It is possible to build another income stream if one understands how to trade in commodities. The commodities market functions beyond market hours of stock and currency markets in India. Many day traders in stocks and currencies can supplement their income by trading in commodities in India. One can also learn about investing wisely in equities by looking at price movements of commodities. During inflation, the price of a commodity goes up. It becomes difficult for a company which uses that commodity to produce goods to pass on the increase in price to consumers. The profitability of such companies is impacted and their earnings may fall. Hence, in such a situation, one could buy a commodity instead of a company heavily dependent on it.
Longer cycles
Commodity cycles typically last for years. These are generally longer than what is seen in equities. If you get the cycle right and position your trades accordingly, then there is a fair chance that you will make money in commodities.
These factors give a clear idea that trading in commodities can be a profitable idea. But experts say that only disciplined traders make money in commodity trading. This is because of the wide range of commodities available in markets. Studying and understanding the demand-supply situation of commodities requires a considerable amount of discipline.
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