Commodities spot and future markets in India: efficiency, integration, returns and risk

Abstract

The commodity futures markets in India are one of the fastest growing markets in the world today. The aim of this research is to help develop a better understanding of these markets, as also their relationship with global commodity markets. In order to do this, the thesis will be looking at four aspects pertaining to the Indian markets. The first is the efficiency of Indian commodity futures markets since the opening of the multi-commodity exchanges in 2003. The second involves the integration of the domestic commodity markets into the global markets. The third examines the macroeconomic influences on the commodity markets while the fourth part looks at the pricing in the spot markets in the light of spot price volatility.The two introductory chapters discuss the commodity markets that are studied later in the thesis. The agricultural commodities studied are castorseed, chana, guarseed, jeera, maize, soybeans and wheat. The prices for these commodities in this study have been taken from the NCDEX, which is the main agricultural commodity futures exchange. The non-agricultural commodities that are studied are aluminium, copper, crude, gold, lead, silver, tin and zinc. The prices for the nonagricultural commodities have been taken from the MCX. The exports and imports of the various commodities, besides the tariff levels and their implications, are also discussed. The production of the commodities (both domestic and international) is studied to understand the supply-side constraints of the respective commodities. The third chapter surveys the literature on the topics being studied to help the reader develop an understanding of the previous work carried out on each of these topics. The fourth chapter looks at the hypotheses, methodology and sources of data for each of the topics. Finally, the results are presented in the final chapter, which discusses their relevance and significance as well. With regard to efficiency, the study looks at futures and spot prices of the seven agricultural commodities and eight non-agricultural commodities described above, to understand whether the current prices fully reflect the information obtained from past prices. This is described as weak form efficiency. The daily spot and futures prices were obtained for each commodity since inception of trading from the respective exchanges. The time duration of the spot/futures price series was about three to four years (from 2004 to 2007), depending on when the trading started, for each commodity. Five forecasting horizons were taken for each commodity (one week, two weeks, four weeks, eight weeks and ten weeks). As most of the futures studied have a time duration of twelve weeks, these forecasting horizons cover the breadth of the lifespan of the futures studied. The spot prices vis-à-vis the nearest futures have also been tested. Unit root tests were conducted. Co-integration was used to test all those commodities and time-horizons for which the level of unit roots is the same for both spot and futures prices. The prices were then tested for efficiency and unbiasedness. Commodities such as chana, jeera and soybeans in the agricultural commodities, and copper, silver and zinc in the non-agricultural commodities were found to have efficiency for some of the forecasting horizons. Efficiency is seen to have a direct bearing on whether the markets are behaving optimally or not. The second hypothesis relates to whether MCX and NCDEX are integrated with the global commodity markets. Prior to the testing for international integration, the commodities have been tested for the domestic integration between the MCX and NCDEX markets. Next step was to check for co-integration between the main international markets for each commodity to ensure they are related. Finally, the international integration of Indian markets is tested in terms of the relationship of the change in domestic futures prices with the change in international futures prices, accounting for the respective exchange rates. Commodities have been classified for testing on the basis of contractual specification for futures contracts across international exchanges. The agricultural commodities that are tested are maize, soybeans and wheat; these are some of the main agricultural commodities that are traded internationally. The non-agricultural commodities that are tested are aluminium, copper, crude oil, gold, lead, silver and tin. Similarly, the spot prices have also been tested for integration vis-à-vis the relevant exchanges abroad. The futures and spot prices have been obtained from twenty different international exchanges, depending on the relevant exchange for each commodity. The final results show that for international exchanges, corn and soybeans are the agricultural commodities that show some degree of integration, for both future and spot prices. The copper and silver future price series of MCX show integration with international markets. In the spot markets, copper, silver, gold and crude oil show relatively high level of integration with international exchanges. The third hypothesis refers to the impact of the various macroeconomic indicators on the return of two different portfolios (viz. agricultural and non-agricultural). Macroeconomic indicators that have been used are change in money supply, inflation, change in index of industrial production, change in exchange rates and interest rates and also the MSCI (Morgan Stanley Capital International, a standard measure that incorporates changes in global macroeconomic environment for a relevant commodity/country) commodity index as a proxy for global macroeconomic indicators. These portfolios are classified on the basis of the level of international trading that exists in the commodities in the portfolio. The first is an agricultural portfolio comprising of chana, guarseed, jeera and soybeans. The second portfolio comprises of non-agricultural commodities such as gold, silver, copper and crude oil. The results indicate that the domestic macroeconomic indicators have a greater influence on the return for the agricultural commodities than the non-agricultural commodities. The latter are related more closely to the international economy. The final part of the research looks at the application of GARCH models to study volatility of spot prices. This is done after using ARCH LM-test to find out whether the ARCH effect is present in the time-series in question. Besides GARCH, various derivations such as Garch-inmean, E-Garch and Tarch were used to see whether there is any effect of spot price volatility on spot prices. Hence, the Garch modeling was undertaken for five forecasting horizons for each of the commodities, viz., one week, two weeks, four weeks, eight weeks and ten weeks. It was found that GARCH models are better applied to the commodities’ time series in the long-run (when greater number of observations are available) than the short run.

The thesis endeavors to cover new ground in terms of research undertaken and techniques employed for a large number of commodities traded on the national multi-commodity exchanges.As a result, there is a better understanding of price efficiency for Indian commodity markets than before. Furthermore, the sections on global integration, macroeconomic influences and spot price volatility shed light on the various factors that can influence the Indian commodity markets.