The Impact of Commodities on the Economy | Motilal Oswal

How Commodities Affect the Economy

In the past few years, the prices of commodities have shot up due to reasons best known to everyone. The world has been through a significant health crisis, literally compelling the shutdown of industries and raising demand for commodities produced by different industries across the world. From developed nations like the US to emerging countries like India, most economies are having to swallow the bitter pills of inflation. Therefore, there is little doubt about the way commodities and associated markets and prices affect the economy. They do affect the state of economies around the world and do so on a very large scale. If the share market today is affected by conditions of the economy, then commodities, which have a direct correlation to the condition of any given economy, cannot be ignored while assessing the economies of any nation. 

Commodity Shocks

Economies all around the globe are always influenced by the supply and demand of commodities, and simply, when there is more demand (due to any reason), prices rise, inflation takes sway, and the state of the economy generally sees a downturn. Various essential commodities like agriculture and energy have seen price increases in the recent past. This is largely because the world has faced a health crisis beyond comparison, and then witnessed the fallout of the Russia-Ukraine issue (which is more like a full-blown war). 

The health crisis had already caused a significant slowdown with an international economic upheaval and bottlenecks in supply chains, causing the slowing down of the production of goods and services. The share market today may be bouncing back, but it's slow. If you wish to open a demat account and invest in stocks, now may be the time to do it (although some prices of stocks are high), as you can invest reasonably well. Nonetheless, it is important to know how commodities influence the state of an economy because when they do, every citizen feels the brunt of any fallout or gain. 

Commodities and Markets

Besides equity, the financial markets of India offer many ways to invest your capital, diversify your portfolio, and ensure that your investment needs meet your financial goals for the short or long run. A popular way to invest today is commodity trading, and many individuals seek gains by engaging in commodity trading online. In the simplest terms, a commodity is any essential good that is used in commerce and can be interchanged with other goods of the same kind or bought and sold in commodity markets. In economies, the definition of commodities is crucial to be aware of as they represent the goods that are used for inputs in the production of goods and services (which may then be sold to individuals). Typically, in commodity markets, a commodity usually refers to raw material. What we commonly call a “commodity” is actually a finished product that is created from the commodity in question and which is sold to consumers. 

You can trade in commodities markets in India just as easily as you can subscribe to any upcoming IPO. The commodity markets in India are more than a hundred years old, but they were formally established via a legal mechanism for trading in 2003. As each country in the world is wholly reliant on raw materials for growth, commodities markets naturally have a pride of place in forging any country’s economic growth. The great bi-product of this is that investors can see profits along the way. 

The Commodity Market - What is it?

Everyone has some knowledge of the share market today, as stocks and shares are widely popularised just by their widespread engagement in most investors’ lives. Commodities markets are somewhat of an unclear subject to a lot of individuals who lack the knowledge of their importance. Resembling trading in company shares when you do so in the stock markets, you can buy and sell commodities in the commodities markets too. Commodities markets are financial markets which are broadly used by manufacturers, producers, and wholesale trading professionals as mechanisms for price discovery for a range of commodities. 

A Range of Traded Commodities

When any commodity that is essential to the production of certain goods and services in a country is in short supply, the commodity sees a rise in its price. This is because of the fact that demand for the commodity is high. Now, different commodities have essential roles to play in the production of goods and services in any given economy, and hence, with rises in price, the economy is also affected adversely. On the other hand, if there is much supply and a commodity’s price falls, this results in more buying of the commodity at lower prices. There are numerous commodities you can trade in India in commodity markets. 

Much as you trade in the stock market today, you have dedicated exchanges to trade in commodities. These let market participants purchase and sell commodities very easily online. In India, there are mainly three commodity exchanges which are operational presently - the Multi Commodity Exchange or MCX, the National Commodity and Derivatives Exchange or NCDEX, and the Indian Commodities Exchange or ICEX. 

What are the Traded Commodities? 

If you are an avid stock trader, you would be exposed to a range of stocks, or rather companies, to trade in across different segments of the industry in the share market today. If you wish to know how commodities affect the general state of the economy, you should delve into the area of commodity trading and be aware of the commodities available in particular sectors. This will give you an idea about why these prime commodities are vital to any economy’s goods and services production system. Here are the different commodities (across sectors) essential to the consumption by people and any economy thereof: 

  • Agriculture - Grains (rice, wheat, maize, etc.), Oils/oilseeds (castor oil, castor seeds, refined soy oil, crude palm oil, groundnut oil, mustard oil, cotton seed, etc.), Spices (pepper, chilli, cardamom, etc.), and Pulses (lentils/dal, peas, chana, etc.)
  • Material and Metal - Base Metals (aluminium, copper, zinc, tin, etc.), Bulk Commodities (iron ore, bauxite, steel, coal, etc.) and Others (chemicals, soda ash, earth metals)
  • Precious Metal - Gold, Platinum, Silver and Palladium
  • Energy - Natural Gas, Crude Oil, Brent Crude, Alternate Energy, etc.
  • Services - Oil Services, Mining Services, etc.

The Highlights of Commodities and Commodity Markets in India

By now, you have a fair idea of the reason why commodities are important to the Indian economy and the Indian people. The commodity market in India could be said to be more important than the share market today, as it holds much value for the economy and the citizens of India. Individuals earn their living through commodities, and investors make profits through them. Apart from this, commodities make up crucial ingredients for consumer goods and thereby serve the purpose of the operations of various sectors in the economy of the country. Some features of the commodity markets and commodities will give you a clue as to why commodities hold significance for an economy:

  • The Discovery of Prices - Commodities markets in India permit transparency when attempting to discover authentic prices of commodities like spices, cotton, pulses, etc., and hence, give producers of goods information about pricing too. This ensures that commodities are not sold to intermediaries at cheap rates, preventing losses. 
  • Standards of Quality - Commodities and commodity markets have stringent policies related to commodity quality in terms of those traded on exchanges when you partake in commodity trading. Such policies are the cause of the superior standards of commodities in terms of their quality. The availability of superior quality commodities throughout the length and breadth of India benefits suppliers and end users (customers). 
  • Hedges Against Loss - The extractors of several commodities, like farmers, find a perfect way to mitigate loss through commodity markets. Selling futures and options contracts in commodity markets ensures that these individuals receive fair prefixed prices for their commodities despite any potential price changes. This, in turn, ensures the smooth running of production and fosters good economic practices. 
    • Portfolio Diversification - The stock market today can offer you many avenues of portfolio diversification. However, commodities and trading in them can give you even more diversification in a financial portfolio. Savvy investors know that commodities hold an inverse relationship with the prices of bonds and equities. Therefore, any investment in commodities can act to safeguard capital in case the bond and/or equities markets plunge. The more investors invest in commodities, the more the economy is positively affected by such investment. 
  • The Leverage Factor - While engaging in commodity trading, leverage can be effectively used with commodities futures contracts. You must deposit a margin with your broker, and this lets you execute a significant transaction with a lesser amount of capital. 

What Role Do the Commodity Markets Play in India? 

The realisation that commodity markets and commodities are pivotal to the economy of India will only come if you know what role commodities and their markets play. Basically, any country’s growth and development, whether you are referring to India or any other nation, is dependent on the economy. In turn, the economy has to rely on a steady inflow of commodities and reasonable price points to safeguard the interests of its own citizens. You should be aware that commodities and their markets play roles through the following: 

  • Security of Food - Commodities are the primary ingredients in the food supply chain of any country. The commodity markets play a significant role in ensuring that food suppliers are protected against price fluctuations. Through the markets, it's possible for suppliers to lock prices in through futures contracts. This maintains stability in prices and ensures that an adequate supply of food is received by citizens of the country. 
  • Infrastructure in Agriculture - In India, which is mainly dependent on farming for its basic food supply, farmers are often found suffering due to an inadequacy in infrastructure after their harvest periods. Although a large quantity of commodities is produced, the total lack of appropriate storage facilities, transport, etc., forces farmers to incur losses. Commodities then become scarce, and the demand for certain commodities may increase, forcing price increases in the economy. However, the commodity markets let farmers prosper and earn profits, and therefore, there is an attraction for investment in the agricultural sector. This brings more capital into the economy on a larger scale. The share market today is not the only place to earn profits in the long term, as commodities can offer investors profits too. 
  • Organised Platforms - Previously, before commodity markets existed, farmers and other commodity suppliers relied primarily on middlemen for the sale of products. Middlemen were thus placed in positions of power, forcing suppliers to accept any amounts that they offered them. In the present day, commodity markets assure suppliers of an organised method of doing business. Platforms to trade in commodities are more structured and rule-based. Adequate prices are realised, and this attracts more suppliers to the markets. More trade takes place, and the economy prospers with this. 
  • Commodities as an Asset Class - In the stock market today, you can find a plethora of companies to invest in. These include companies that produce raw materials such as commodities too. However, the commodities exchanges also give investors the chance to trade and invest in commodities directly. As more investment takes place, the economy sees inflows of cash and propers along with investors. Investors have gradually realised that it's worth investing in commodity markets to diversify portfolios. This has led to the overall growth of the markets and the sector of commodities in the Indian economy. 
  • Control of Volatility - Commodities are bought and sold through commodity markets. Through futures contracts in the commodity markets, the probability of risk due to price shifts can be lessened to a substantial degree. As risk is adequately distributed, high levels of volatility are avoided. 

Commodities and their markets play a crucial role in the economy, directly affecting economic growth and influencing the agricultural sector (a large part of the Indian economy) in a positive way. 

In the News

In recent news reports, the Reserve Bank of India has stated that the Indian economy might just escape an international inflation trap, provided some moderation in the prices of commodities seen in the previous weeks continues. Along with this, an ease in the pressure of supply chains could go a long way in curbing growing inflation. If you are involved in commodity trading, you must be aware that the Reserve Bank of India (RBI) has declared that inflation has already reached a peak in India and is on its way down. Although investors and other citizens may be feeling the inflation pinch still, there is some respite to be had with positivity in the RBI’s “State of the Economy” announcement. 

How India will Escape Inflation

The RBI expects that India will be out of the inflation loop, only gradually moving ahead, by the second part of 2022-2023. Currently, there is an abundant supply of commodities, and if this is maintained, India’s road ahead can be one that is free from inflation. The Reserve Bank of India may well be optimistic, but is this the reality on the ground? In the US, the rate of inflation shot up to 9.1%, recorded as a 41-year high, in June 2022. India has reported a minor drop from 7.04% in May 2022 to 7.01% in June 2022. The RBI has clearly stated that, since the global atmosphere is riddled with hostility, constant monitoring of the broadening of portfolio outflows and trade deficits must be conducted. 

Commodities Play a Key Role

As mentioned earlier, India is mainly an agricultural nation. In terms of commodities in India, the agricultural sector is enormous. If you are busy trading in the share market today, it's high time you turn your attention to commodities also. Due to India being an agriculture-dependent country, India also relies on the southwest monsoon for its timely and abundantly necessary crop yield. Positively speaking, the latest news of the southwest monsoon revival has led to renewed crop sowing activity and encouraged hope for a bountiful harvest. Thus, in terms of agricultural activity, rural demand may catch up with spending in urban areas soon, consolidating a much-needed recovery of the economy. 

External Forces, Internal Prices

June 2022 marked close to one hundred days since the Russia and Ukraine crisis began. It also marked the time when India witnessed rising prices and the ugly head of inflation rising. The invasion began, and the prices of several essential commodities rose, especially sugar, wheat, oil and mustard oil. These rises were terrible enough to warrant some serious concern. However, the soon-to-follow exponential increases in crude oil exacerbated a situation that was already spiralling downwards. The global economy was badly hit too and is still marred with the banner of inflation. 

Nonetheless, India is now set to witness some bright days ahead. India’s consumers and chief policymakers are cheering a sharp slump in international commodities like palm oil. This could well result in some months of low levels of food inflation. Practically every staple dish in the Indian diaspora uses oil, and cooking oils have tumbled to very low levels as supplies rise. It is important to note, whether you are interested only in the stock market today or not, that India is the biggest buyer of edible oils in the world. It relies on imports of oil to satisfy 60% of its overall oil requirements. The cost of palm oil has dropped to a whopping 40% now. 

Internally, inflation-busting strategies by our very own government may prove to curb inflation at the root. Measures to give the economy a lift include curbs on exports of sugar and wheat, thereby protecting and encouraging a rise in the domestic supply of these commodities. In a wise move, officials have effectively also cut taxation on some petroleum products and edible oils, and this has lowered food prices that fall into half of the consumer price baskets of the Indian economy. 

Rise and Fall

As prices on the global front slip and slide, domestic costs are bound to fall. In the retail segment, prices of oil have dropped by 8%. You may have noticed that diesel prices at pumps have also dropped by above 7%. The declining prices of oil, sugar and wheat may signal and encourage the reduction in prices of other commodities too. However good this news may appear, the RBI has refused to dilute its fighting stance against inflation. The country’s bank claims that risks still remain, as a weak rupee has to be taken into consideration as this could undercut any advantage of low commodity prices. 

The Clear Picture

If you are interested in investing and balancing your portfolio, commodities may be a good way to go. The share market today can offer you great returns, but so can commodity markets. 

Any country’s economy is highly reliant on its commodities for the strengthening of its economy. India is not to be left out in this aspect as commodities affect all aspects of life for investors and citizens alike. For example, in terms of certain commodities, such as precious metals like gold, India doesn’t produce this. It has to depend on exports of gold to meet its demand within the country. If gold prices surge internationally, India has to spend more to buy the same amount of gold to meet its demand. This may put a dent in its economy. For the present moment, the Indian outlook looks like it is improving. With a steep decline in global input costs and agricultural rates, domestic prices may soften up too. 

While you ponder on how and what to invest in, you can open a demat account with any reputed broker, one like Motilal Oswal. This is just your first step in the investment world, as this lets you trade and invest in the stock market. If you wish to subscribe to an upcoming IPO, you can do this too, plus consider commodity markets for an equitable portfolio. 

 

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