Retail investors are turning to the commodities market as an investment option. Rising commodity prices have resulted in these giving better returns than equity markets.

However, precious metals such as gold and silver are the only bets in this space for retail investors.

Both the metals have had an unprecedented run, marking several new all-time highs over the past months. While one-year returns from gold stand at 19.52 per cent (as on June 1, 2011), silver returned 91 per cent.

Moreover, returns from agricultural commodities like tur dal,wheat and base metals like copper, zinc, aluminum, lead, nickel and tin have recorded higher returns than the equity markets.

While the Multi-Commodity Exchange's (MCX) agri index is at 26 per cent and at 25 per cent for copper, returns from Nifty are at 11.67 per cent annually.

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However, commodity experts say only short-term trades take place in agricultural commodities and base metals.

Most retail investors who are looking for diversification should consider the commodities market. But, financial planners advise capping the investible amount at 10 per cent of the portfolio.

Also, stick to gold and silver rather than agri or base metals. Agricultural commodities are more likely to be impacted by local events, in contrast to gold and silver, which follow global cues.

Direct investment in the agricultural commodities market would mean keeping track of a lot of variables like the commodity's crop cycle, its main market, etc.

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This may not be easy for someone not in the commodity business. Without adequate knowledge, chances of making losses are high. An indirect option would be much easier. So, investors could invest in companies having exposure to these commodities.

If you still want to invest in this space, derivatives are an option. You can buy future contracts through MCX (for trading in international commodities) and the National Commodities and Derivatives Exchange for agricultural commodities.

Both exchanges have high volume.

If you are interested in gold and silver, you can also look at National Spot Exchange's e-series in gold.

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The quantity of gold bought will reflect in your demat account, which is different from the demat account for equity trading.

The same can also be turned into physical gold, if needed. This service will, of course, come at a charge. There are various lot sizes.

The National Spot Exchange allows exchanging e-gold units into coins or bars of 8 gm, 10 gm, 100 gm and 1 kg.

The National Spot Exchange has also introduced e-series for silver and other commodities. Investments in gold can also be done through gold exchange-traded funds, which are traded on both NSE and the BSE.

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Or, you could invest in gold funds launched by fund houses. You should also consider the tax angle. Income from derivative trading is considered as business income and is added to your income, taxed according to the applicable tax slab.

Short-term capital gains tax for e-gold and e-silver comes into force if the units are sold within three years. After three years, 20 per cent long-term capital gains (LTCG) tax is applicable.

Both ETFs and gold funds are taxed like debt funds, with the LTCG tax applicable after one year. Buying physical gold over a stipulated amount (assets over Rs 50 lakh) will attract wealth tax.