Chris Ugwu examines Commodity Exchange as an alternative investment window in a depressed equity market.
Investors’ new appetite to have their investment portfolio in the market diversified is no doubt occasioned by the continued depletion in the value of their shares at the equity market which seems to have defied all known intervention.
As an emerging market, experts had observed that the market needs to deploy gradually windows it wants investors to take position in, because the regulators still lack the requisite manpower and infrastructure to cope with diversified features.
It would be recalled that exept an economy like ours, other developed economies of the world usually have large diversified windows which have helped in no small way in contributing to the growth of their markets.
Much as Nigeria ’s Stock Exchange has been well-developed, as attested to by the international communities and other Stock Exchanges in the world, and with the sustainable bearish run which have caused many investors fortune, stakeholders in the Nigerian economy have stepped up the campaign for the diversification of the Exchange to accommodate the Commodity Exchange.
A commodity is a product, which trades on an Exchange. This includes cocoa, rubber, palm kernel, palm oil, coffee, hides and skin, gold, wheat, cotton, rice, corn, barley, rye, flaxseed, grain, sorghum, butter, eggs, potatoes, wool tops, fats and oil (including lard, tallow meal, groundnut oil, Soya bean meal oil, and all other fats and oils), cotton seeds, groundnut, Soya beans, Soya bean meal, livestock products and oranges, solid minerals and all other tangible goods and articles, except all services, rights and interest in which contracts for future delivery are presently being dealt with.
Commodity Exchange in Perspective
Giving an insight on what a Commodity Exchange entails, the former Chief Executive of the Nigerian Capital Market Institute (NCMI), Professor Uka Ezenwa, , said it is an organised market providing the necessary facilities for trading of commodities futures, options and other derivatives though registered and licenced brokers.
“All commodity contracts must specify price, contract terms, quantity, place of delivery and grade or quality. The price is usually denominated in a particular currency like the Unite State dollars, British Pound Sterling” etc,” Ezenwa said.
He noted that, another characteristic of the Exchange, is the contract term specifying the date or range of dates during which the commodity must be delivered, which becomes the effective contract date, adding that it also specifies the duration of the contract.
“The volume of the commodity to be delivered must be specified. For contracts between two parties, the point of delivery may be anywhere agreed, by both parties.
However, to meet an obligation on an organised Exchange, the delivery points must be those approved by the Exchange.
“Commodities vary in quality or grade as cocoa or cotton, due to variations in growing environments, handling and processing methods. The grade must be agreed upon by the trading parties and the prices adjusted to reflect quality,” he added.
Speaking on the three distinct markets in commodity Exchange, Ezenwa maintained that the cash market, the future markets and options market are the pillars around which the Exchange revolves.
“For the cash market, it further broken into spot market and forward market. The former refers to a cash market for physical commodity that is available for immediate delivery.
On the other hand, forward market is cash market in which a seller agrees to deliver a specific cash commodity to a buyer sometimes in the future. The main instrument is the forward contract, which can be defined as an agreement between two parties in which on settles the other at a specified future date.
Forward contracts, in contrast to futures contracts, are privately negotiated and are not standardised. Any transference or liquidation of the contract must be done with the mutual agreement of buyer and the seller,” Ezenwa noted.
The futures market is a forum where buyers and sellers enter into firm commitment to make and take delivery of specified commodities at some future date, at a price agreed upon by both parties. These commitments are legally binding and referred to as “Forward Contracts”. A future market is similar to a forward market because the contract is for delivery at a later date. However, traders in futures market are primarily interested either in managing financial risks through hedging or in pure speculation rather than in the actual exchange of the commodities. Contracts can be offset by financial transactions before its closing date so that no exchange of the physical commodity ever takes place.
Futures contracts are executed on organised Commodity Exchange(s). They are not between two ordinary individuals, but exist only between the buyer and seller of a contract and the Exchange or its representative, the clearing corporation.
Coming to the options market, it is basically an aspect of futures market. The main instrument is the option, which gives the buyer the right but not the obligation to buy or sell at an agreed price over some agreed period of time.
Commenting on this, Prof. Ezenwa acknowledged that some countries allow commodity options to be traded on organised Exchanges such as the London options market, adding that this contract cannot be used as collateral because of the underlying asset.
“There are two types of options contract: call option, which gives the buyer the right but not an obligation to purchase the underlying future contract at the strike price on or before the expiration date, and put option, which gives the option buyer the right but not an obligation to sell the underlying futures contract at the strike price on or before the expiration date.
Benefits of Commodity Exchange Market
Commodity investing was initially received well only by a few sectors investing in commodities were first restricted to the trade and exchange of commodities meant for regular and day-to-day use. However, the awareness in the subsequent stages has brought all sectors into the manifold of commodity investing and has enabled speedy movements, transfer and transaction of goods and services in most of the advanced countries.
Explaining the objectives of Commodities Exchange, aside helping to deepen the activities of the capital market with the introduction of new products, Ezenwa reasoned that it would increase the earnings of the producers by reducing the effects of price volatility, provides a basis for risk management and serves as mechanism for effective pricing.
The benefits of a commodity exchange include market price discovery as well as access to information concerning commodities traded on the commodities Exchange, which are available to brokers in advance of trading i.e. quality, location and time of delivery, thus facilitating pricing.
The futures markets help to determine the best prices. All bids and offers are aggregated and the prices at which the trades are executed, determined the best, current market price. In addition, the prices are publicly disseminated and therefore provide an easy way to determine a product or instrument’s fair price.
Another benefit of the Commodity Exchange, as enumerated by Ezenwa in his book, Commodity Exchange: What you should Know, is that just as in banks and stock markets, the Commodity Exchange is essentially an institution for mobilising investment, through the activities of hedges and speculators. “The speculators in the commodity Exchange risk their capital in the expectation of making profit. By supplying the capital, the speculators help to create liquidity in the market,” he said.
According to the Chief Executive Officer, Modus Market Concepts Limited, Mr. Brian Ojukwu, “as an investor your chances of risks are very less if you choose to invest in commodity. Therefore the gains from commodity investing will be helpful for you to balance other losses due to other financial instruments in your portfolio. The chances of risks are lower because commodity investing primarily deals with diverse items. Moreover, when the contracts are entered for a future date at the current time, you can exercise reasonable care and see to it that the chances of risks are reduced or nil”.
Ojukwu noted that the performance of commodity market could be monitored by analysing the performance of bond and share market because in most cases a commodity market will perform well when the others don’t perform and vice versa.
He said it was possible to easily predict the prices and make the contracts by considering the ups and downs in other markets which according to him, a prerequisite for this is that the assets in the commodity market should not be correlated with the stock and bond markets.
Abuja Commodity Exchange and Crisis of Confidence
The Abuja Securities & Commodity Exchange(ASCE) was originally incorporated as a Stock Exchange on June 17, 1998. It commenced electronic trading in securities in May 2001 and was converted to a commodity Exchange on August 8, 2001 and was brought under the supervision of the Federal Ministry of Commerce. The conversion was premised on the need for an alternative institutional arrangement that would manage the effect of price fluctuations in the marketing of agricultural produce which had adversely affected the earnings of farmers since the abolishment of commodity Boards in 1986. Attempts to establish a Commodity Exchange and Futures Market in the country dates back to 1989 when an Inter-Ministerial Technical Committee was set up at the behest of the Central Bank of Nigeria to look into how a Futures Exchange for agricultural commodities could be established to address frontally the agro-commodity marketing problems.
But since the Exchange was set up, it has neither been able to engender the growth of commercial farming and the growth of the agriculture sector nor serves as a veritable platform for farmers, agro-commodity processors and merchants to mitigate the inherent risks in agricultural production and marketing.
Concerned about the negative impact the absence of an active commodity exchange is having on agricultural commodities trading in the country, the Central Bank of Nigeria (CBN) recently called on the federal government to allow it take over the Abuja Securities and Commodities Exchange (ASCE) to help it deliver on its mandate.
The CBN governor, Sanusi Lamido Sanusi, who was speaking at the opening of a two-day stakeholders’ conference on Nigeria’s Incentive-based Risk Sharing System for Agricultural Lending (NIRSAL) in Abuja, said if properly positioned through adequate funding and clarification of its corporate governance policies, the Exchange could provide the platform for trading in agricultural commodities.
According to Sanusi, following the dissolution of the country’s commodity marketing boards in 1986, commodity merchants had exploited the dearth in the coordination of the small holder farmers’ produce, thus creating a disconnection between primary producers, processors and marketers operating in silos.
He said the break in the commodity value chain among these stakeholders had to be bridged through the establishment of vibrant and viral producers, processors and marketers along each value chain, to boost their incomes.
According to reports, since trading started on the floor of the Exchange, the largest single transaction it recorded was 716 metric tons of cowpea worth about N26, 597,065 traded on September, 2006.