Commodities

Spot and derivative markets in commodities can coexist; Here's how

Updated : January 30, 2020 12:49 PM IST

Commodity derivatives markets and spot markets complement each other in bringing stability at the macroeconomic level. The value of futures markets arises from their ability to discover cash prices at a future date and thus provide agents with a means of managing the risks associated with trading in a commodity. In an efficient commodity market, the futures price will perfectly converge with the spot price at the time of contract expiry.

From a transparent price discovery mechanism to the absence of counterparty risk and the trust generated by regulations and regulatory agencies, spot commodity exchanges fill in the gap existing in financialisation of any market ecosystem. Financialisation impacts risk sharing in markets with financial investors providing liquidity to hedgers. The development of physical markets has usually been followed by the expansion of the financial market where market participants can hedge their risks. In fact many Asian countries, such as Turkey, China and UAE have set up world class physical infrastructure for refining, storage, transport, trading and financing of commodities such as gold and base metals, to cater to the high and increasing demand for these commodities in the region. These institutions support the development of both spot and derivative markets of these commodities. Spot and futures commodity exchanges and related infrastructure set up by these countries appear to have greatly enhanced the efficiency of their commodity markets by way of efficient price discovery, quality assurance and active retail participation.

Turkey – A well-developed gold markets ecosystem

Turkey’s extensive gold market is a key component of Turkey’s overall economy. From mining to refining, through exchange spot and futures trading, and an active gold import and export trade, the Turkish gold market is a model of a vertically integrated market. Turkey leads the way in gold monetisation and standardisation of gold business. In fact Turkey, like India, has a similar gold consumption pattern among its citizens. It is the world’s fourth largest gold consuming nation and is also noted as a high gold ‘hoarding’ nation. Policy enablements in Turkey have made Borsa Istanbul and the Precious Metal Market (BIPMM) within it one of the most successful gold trading platforms.

The salient features of the gold exchange platform are:

PMM offers both derivatives and spot market products.
PMM has a large participant base consisting of banks, currency offices, precious metal brokerage houses, precious metal producing and marketing companies, etc.
PMM conducts spot trading of gold, silver, platinum and palladium on an electronic platform in both ‘standard’ and ‘nonstandard’ quality metals.
Banks are not only permitted to trade, but gold held at the Exchange are even allowed as part of their SLR requirements.
There are no taxes on gold traded on the PMM.

Thus, based on experiences such as Turkey’s, it is apparent that the successful development of the commodity economy must be associated with development of organised and standardised exchanges offering spot and derivatives trading. Improving price discovery, linking retail participants to markets, reducing transaction costs, institutional development and increasing overall growth pattern in the economy are some of the known benefits of developing commodity exchanges which can effectively link the spot and derivatives arms of commodity markets.

This is a partnered post.