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5 easy steps to making money in commodities
Deepa Krishnan in Mumbai
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September 29, 2005 10:54 IST

Deciding on your investment plan for the year may not always be the easiest of tasks. If you had enough of riding the stock markets and don't fancy debt, here is an opportunity to do something different.

Commodity markets are offering an annualised return of anywhere between 18 per cent and 24 per cent. In comparison, debt markets are offering returns in the range of just 8-10 per cent.

According to Rajiv Nair, deputy general manager, Karvy Commodity Broking, "The commodity markets are still at a nascent stage and offer the best returns on arbitraging - locally as well as internationally."

He said once the markets mature, returns will automatically settle at lower levels. Once mutual funds and foreign institutional investors are allowed to trade in the markets, volumes will rise, but returns for individual investors will stabilise.

So, if you are thinking of taking the plunge, it is a good time now. Nair suggested a five-pronged strategy to invest in commodity markets.

The Cash-and-Carry Arbitrage: This is the easiest form of arbitrage, where the investor has to buy the commodity in the spot market, and sell it in the futures market. This is largely successful in gold and silver, and is also popular among various agricultural commodities.

Calendar Spread: This is done between futures contracts. The investor buys the near month contract (ex: October gold) when prices are low, and sells in the forward month contract (December gold) when prices rise, or sell the positions in the near months, and purchase the forward months contracts.

This trading is popular in gold, soya, silver, crude, chana, urad, jeera, and chilli. Spread between commodities with high correlation: Here, examples are gold and silver, gold and crude etc.

Inter-exchange arbitrage: This is popular among liquid commodities like gold and silver, where the arbitrage can take place between the Indian exchanges and the foreign exchanges, where contract specifications are similar.

Trading calls: Here, the trading is largely dependent on the direction of the trade. A good mix of commodities and disciplined trading will ensure that the investor makes money on the commodity markets, Nair said.

While the ratio of profit and loss may vary, if an investor were to park Rs 25 lakh (Rs 2.5 million) in commodities using these strategies, of which Rs 20 lakh (Rs 2 million) through the four arbitraging strategies and Rs 5 lakh (Rs 500,000) in trading calls - taking data from the last quarter -- he would earn a return to the tune of 5-6.5 per cent during the period.

The investor, at any given time, is likely to make at least three times the profit for every loss that he incurs - that's a 3:1 ratio of profit and loss.

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