Introduction
Have you ever thought about how the prices of commodities, such as wheat, oil, and gold, are determined? Knowing how commodities are priced will help you better understand your financial decisions in India as an investor, a farmer, or a trader. In this article, we will tell you what commodity pricing means, why it is important to you, and how it works in India.
What Is Commodity Valuation?
Simply put, commodity valuation is to find the actual commodity price, the amount of money that a commodity, like rice, silver, or crude oil, is exchanged for in whatever market. Actual commodity value is not just some random number; it comes from applying several economic principles, primarily the interaction of demand and supply. For example, if you read that gold prices have risen to ₹1 lakh per 10 grams, you are seeing the valuation of a commodity in reflection of the market demand compared to supply.
This process is essential in India because commodities are traded in exchanges, including the Multi-Commodity Exchange (MCX) and the National Commodity & Derivatives Exchange (NCDEX). Commodities valuation provides fair and established pricing, based on production costs, world events and local demand, while guiding when to buy, sell and invest.
Why You Should Care About Commodity Valuation?
Knowing your commodity value allows you to navigate the market effectively and competently as an investor or trader in India. Whether considering gold as a hedge investment during inflation or following agricultural commodities like soybeans, understanding commodity valuations will allow you to identify the best opportunities. For instance, if you are a farmer, with proper commodity valuation, you can sell your crops to obtain fair market prices. For traders, it points out when a given commodity is potentially underpriced or overpriced, thus influencing their decisions.
Valuation also provides traders with transparency in the market. By identifying the current commodity valuation, you can see how things like drought conditions affecting wheat supply or sudden spikes in the price of oil affect current prices. By watching trends in these areas, you can identify the impact on commodity prices and predict price changes to forecast your price strategy.
How Is Commodity Value Determined?
Many factors contribute to the commodity value you see on exchanges.
1. Demand and Supply
Commodity value begins and ends with demand and supply. When a commodity has increased demand, such as copper, if a high demand occurs, but a stagnant supply, it has the potential to rise in price. On the other hand, when 'cotton' entered a tight market, supply was plentiful, demand wasn't often found, and market prices dropped. Your commodity value starts with demand and supplies every day.
2. Cost of Production
The cost of manufacturing, extracting or creating a commodity will impact its value. If the mining cost to pull silver from the earth begins to climb from labour, equipment costs, etc., the commodity value will climb. As a trader, you would notice that there are increases in MCX prices.
3. Weather and Events
We cannot ignore the fact that the weather plays a prominent role in India. In years that we face weak monsoon periods, rice production drops significantly. For rice, the commodity value rises solely due to the lack of supply. This, of course, does not apply to commodities that are not agricultural. If an investor is in agriculture-type commodities, it is essential to make an effort to track seasonal weather patterns and expectations.
4. Global and Local Events
Geopolitical tensions, such as trade bans, can interrupt commodity supply chains and impact commodity prices. For example, if the global oil supply is reduced, you will most likely witness an increase in crude oil on the MCX, impacting your portfolio.
5. Economic Factors
Economic factors such as inflation, currency changes and economic growth affect how much you are willing to pay for commodities. For example, during inflation, you may see the value of gold skyrocket as a safe investment.
Pricing Methods You Should Know
The pricing of commodities occurs in a variety of ways:
• Fixed Price: You negotiate a fixed price at the beginning of the sale that will not change due to market reasons.
• Ceiling and Floor Price: The exchanges develop ceiling and floor prices, so there is some flexibility.
• Variable Price: The prices are variable based on real-time supply and demand, as you'll see in the daily updates from the MCX.
• Floating Price: Floating prices are commonly used for volatile commodities such as oil and are based on averages over time, so there's less price jump or fluctuation.
Why is this important to you?
A basic awareness of how commodities are valued gives you the insight to make complex decisions, whether you are bull hedging against price fluctuation or buying for your implied profit. Engaging with these aspects allows you to forecast the market or make the appropriate decision. You will see the narrative behind those numbers when you check the price on MCX or the NCDEX.
Similar Reads: What is the meaning of Commodity? | What are traded in the commodity market? | Commodity trading risks and benefits