Commodities could be anything starting from crops to gold. Investing in commodities is easy if you know how. We tell you all about it.
Commodities are a very lucrative investment option, unlike Fixed Deposits or Mutual Funds. The first process involved in commodity investing is choosing a commodity broker. Knowledge of the market is extremely important when it comes to commodity investing and your broker can help you trade right. The broker’s years of experience, country-wide network and testimonials of customers are some of the things you should look at before zeroing in on a broker.
Once you have chosen your commodity broker, you would need to undergo some formalities to start trading. Firs,t you will enter into an agreement for trading with the broker. You will need to fill forms that tell you about terms and conditions levied by the broker as well as the exchanges. Then you will need to fill in the Know Your Customer (KYC) forms. You will need to give details such as your PAN and bank account details.
Once you are done with this, you will need to deposit a margin amount with the broker before you start trading. A margin is a kind of protection amount which will come in handy in case your transactions start incurring losses. Generally, brokers accept margins in the form of cash, stock, Mutual Funds or Fixed Deposits. Some also accept bank guarantees. Ask your broker about the same. Now you are ready to start trading. But wait… unlike stocks, trading in commodities requires significant knowledge and expertise as volatility is higher. So, before you start trading it is important that you understand the trading process, the risks involved, nature of commodities and other details. Here’s a primer.
How much margin is applicable for commodity trades?
There is something called the initial margin that you deposit at the start of the trade. Later, based on the commodity price and volatility, you might need to put in an additional margin amount. Usually, margins are anywhere between 5% and 10% of your contract value and differs from one commodity to another. Commodity markets use the same system as equity markets to calculate margins. This system is known as the Value at Risk (VaR) system.
What is the minimum investment needed?
You could start trade for as low as Rs.1,500, everything will depend on the amount of margin needed to trade in the commodity of your choice. For instance, to trade in bullion (gold and silver), the minimum amount would work out to Rs.1,500 and Rs.2,100. This is assuming that the current price for gold is about Rs.30,000 for gold for one trading unit (that is 10 grams) and about Rs.42,000 for silver (one kg). Trading in agricultural commodities might involve a slightly higher amount. This would be dependent on the product as well as the exchange that you trade in. This is because agricultural commodities trade in measures such as kilos, quintals and tonnes and vary from exchange to exchange.
Do you need to take delivery of the commodity?
No. It is not compulsory to take delivery of the commodity. You could settle the transaction in cash. However, if you plan to deliver the commodity, you need to have the required warehouse receipts. All the commodity exchanges have both systems – cash and delivery. You could take delivery if you want the commodity or else you could settle in cash. You must notify your preference at the time of entering the trade.
Do you have to pay sales tax on all trades? Do you need a sales tax registration number?
Sales tax is applicable only if you opt for physical delivery of the commodity. The same is true for a sales tax registration number.
Is stamp duty applicable for commodity trades?
In case you opt for delivery, stamp duty will become applicable as per the prescribed laws of the state in which you trade. Stamp duty charges vary between Rs.200 – Rs.400 per crore worth of trades that you enter into. However, stamp duty is not applicable for contract notes issued in electronic form.
How will you receive the contract notes?
Every time you trade, you must be sent the contract note for it. You must get the contract note within 24 hours of the transaction. The contract note can either be electronic or in physical form, based on your preference. According to the Forwards Market Commission (FMC), electronic contract notes cannot be issued by the broker unless the client specifically opts for them.
What are the risks involved in trading in commodities?
Commodity trading is a pure margins game and, thus, involves high risk. You could end with huge profits (which is good) or huge losses (which might leave you bankrupt). Ask your broker about the various risks involved, including regulatory and counterparty risks.
Why should you have knowledge on commodities before you start trading?
Unlike equities and Mutual Funds, it is illegal to offer portfolio management services for commodities. Hence it is imperative that you learn what influences the commodity you would like to trade in, whether there are any seasonal patterns and the demand supply situation. Even though your broker will give you recommendations, you must have enough knowledge to assess them and take a call.
Where could you look for information on commodities?
Financial newspapers and magazines carry spot prices of commodities every day. They also will have articles on commodities. You could also subscribe to exclusive commodity magazines like commodityindia.com, which generally feature agricultural commodities and metals. Brokerages too come out with reports on commodities along with the outlook for the next 3, 6 and 12 months. The internet is another place you can find umpteen numbers of websites on commodities, their price movements and demand-supply info.
Investing in commodities can be rewarding if you do your due diligence. If you think commodities are too risky, better stick to Mutual Funds. Equity Mutual Funds can give you average returns of 12%-15% per year. Want to know more?