Commodities have been traded for monetary units for a long time. In the initial days of trade and commerce commodities were exchanged for commodities itself. It is the oldest means of trade and commerce and is still practised on the commodity trading exchange in India. To simplify the commodity trading, mutual fund AMCs provide commodity mutual funds which use commodities to garner gainful returns for the investors. The commodities are exchanged with monetary units in order to generate profit in commodity mutual funds.
- What is a Commodity?
- How are Commodities Traded?
- What is a Commodity Mutual Fund?
- Top Performing Commodity Funds
- How Does Commodity Mutual Funds Work?
- Types of Commodity Funds
- Benefits of Investing in Commodity Funds
- Benefits of Investing in Gold Through Mutual Funds
- Who Should Invest in Commodity Funds?
What is a Commodity?
A commodity is a raw material which has an economic value that has been either extracted from earth or available in natural raw form. It is an asset which has been traded for money or different commodities for many centuries in India. Due to many reasons like foreign invasions, natural calamities, government policies etc, commodity trading practices have declined. However, even in the present day, directly or indirectly, every individual plays a part in commodity trade.
Commodities exist in their natural form and no extra value can be added or removed by the producer. However, the quality of the raw material can be different for every commodity but these are generally priced equally. Commodities are mainly divided into two subcategories depending on the method which has been used to extract the raw material.
- Agri Commodity - This is the agriculture-based commodity which have been grown by farming. Commonly traded agriculture commodities are Corn, Beans, Rice, Wheat, Chana, Castor, etc.
- Non-Agri Commodity - This is the commodity which has been extracted from earth or occurs naturally. Commonly traded non-agriculture commodities are Metals, Gold, Crude Oil, Natural Gas, Eggs, Cattle etc.
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How are Commodities Traded?
Commodities in India are traded on the officially registered commodity trading exchanges. There are six major commodity trading exchanges in India, namely:
- Multi Commodity Exchange – MCE
- National Commodity and Derivatives Exchange – NCDE
- National Multi Commodity Exchange – NMCE
- Indian Commodity Exchange – ICE
- Ace Derivatives Exchange – ACE
- The Universal Commodity Exchange – UCE
In India, investment in commodities is done through futures and options. A future contract is an agreement to buy or sell any specific quantity of the commodity at a fixed price at a predefined time and date in future. An option is a contract between a buyer and seller in which the buyer buys the right to buy or sell the shares of a stock or commodity at a predetermined price within a fixed period of time. Trading in options can be risky and inconvenient for laymen. This is where the commodity mutual funds are advantageous.
What is a Commodity Mutual Fund?
A commodity fund is a mutual fund where a fund manager handles the investment in the commodities. Based on how the chosen commodity performs in the market, the returns are generated to the investors. Investing in a commodity fund is much better than investing in the commodities directly as the fund manager who handles the investment of the fund is a professional and has the experience to deal with the commodities. Majority of the asset management companies in India have launched commodity funds which trade only with gold as gold acts as a hedge against inflation and is highly appreciated in India.
Top Performing Commodity Funds
How Does Commodity Mutual Funds Work?
The performance of commodity mutual funds is directly dependent on the performance of the commodities in which the fund manager is investing the pooled corpus. If the price of the commodity increases and the profits are booked by the fund manager by investing at the right time, the gain is divided equally among each unit owned by the investors. Any fluctuations in the price of the commodity directly affect the NAV of the commodity fund. There are different risks and benefits of investing in commodity mutual funds.
Types of Commodity Funds
Commodity funds have various sub-categories depending on the investment strategies and investment objective.
Natural Resource Funds :These funds invest the corpus in the companies or organisations which have a business associated with natural resources such as minerals, petroleum, oil, gold, etc. The performance of these funds is directly dependent on the price of commodities with which the business is associated.
Basic/True Commodity Funds :These funds are called basic because the commodities are directly bought by the pooled corpus of the fund. These funds mostly invest in naturally occurring commodity like metals.
Future Funds :These funds are considered as riskiest commodity fund as these are subject to significant fluctuations according to the market rates. The fund manager of a future fund takes a call on future trading. The NAV of these funds can depreciate sharply but can also deliver significant gains if right calls are made.
Combination Funds :As per the name, these funds follow a combined strategy of investing in commodity futures and basic commodity. The commodity future possesses high risk while the basic commodity investing controls the volatility.
Index Funds :The index commodity funds are passively managed mutual fund in which the investments are directly used to buy commodity on the standard prevailing rates based on the benchmark.
Benefits of Investing in Commodity Funds
- The Flexibility of Investment Objective
Commodity mutual funds can fulfil short term as well as long term goals. Commodity futures can be used for different tenure to fulfil the investment objective in a convenient manner.
- Hedge Against Inflation
The prices of most of the commodities rise at par with the inflation rate or global market alteration. Investment in commodities act as a hedge against inflation as the investments in commodities provide protection against decreased purchasing power of a currency due to inflation.
- Protection Against Market Fluctuations
Investment in commodities can reduce the volatility of the portfolio as whenever the equity market is on a downfall, the price of the commodities rise similarly when the equity is on the rise, commodities fall. Hence the investments in commodity balance out the fluctuations in the market.
Commodity funds are less prone to fluctuations, unlike equity funds. These funds can overcome market risk and tend to move slowly. The risk associated with the commodity mutual funds is mostly due to geopolitical activities. For example, if a country imports gold from another country and the relationship between both nations is declining, it is likely to affect the prices of the gold.
- Diversification of Portfolio
Adding a commodity fund to the portfolio can increase the diversification in the portfolio. The diversification can reduce the risk associated and can promote consistent growth regardless of the market conditions.
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Benefits of Investing in Gold Through Mutual Funds
In India, gold is not only treated as a metal commodity for investment but is also worn as an ornament. Most of the Indian families have been buying gold and passing it on to their next generation as a treasure or property. However, incidents of gold theft and snatching are quite common. Apart from this, buying physical gold has a risk of depreciation in the value due to making charges and the purity can also depreciate over time.
To avoid these risks and limitations on gold investment, the investments can be done in a much safer and more beneficial manner through gold commodity mutual funds which are commonly known as gold ETF (Exchange Traded Funds). Investments in gold through Gold ETF can be a much convenient, safe and profitable for the investors. The buying and selling in Gold ETFs have no extra charges and gold can be bought with the periodic investment of amount as low as Rs 500 every month.
Who Should Invest in Commodity Funds?
Investing in the commodity mutual funds requires an understanding of the products and material where the fund is investing. As the commodity market can be highly influenced by the market conditions, the investors must equip themselves with the functioning trends of the commodity markets to make a better decision. These funds are highly subject to market fluctuations and hence do not ensure fixed or guaranteed returns. The investors must be careful of the risks associated and understand the functioning of the commodity mutual funds comprehensively. New investors should take the assistance of an expert for a better investment experience, the commodity funds must be chosen by those who have their investment objective in line with that of the fund.
For a layman, it could be perplexing to analyse the behaviour of commodities and the effects on commodity due to any geopolitical event. To enjoy a fruitful investment experience, take the assistance of financial experts at MySIPonline who have the professional expertise to examine the trends of the commodity in the present as well as future market conditions. The experts can give a unique solution to achieve a certain financial objective for every investor.