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Wednesday, February 21, 2007

Commodity futures are not evil

My column in Business Standard today is about recent calls for a ban on commodity futures trading.


  1. This comment has been removed by the author.

  2. Thanks for such a great read. I howver am a bit confused about what you mention in the article:

    "When bad news about a future harvest comes in, the futures price goes up immediately. At this point, it is rational for private players to buy goods on the spot market, store them, and deliver them at future dates. These activities are the much-hated "hoarding"......

    When bad news surfaces about the future, this spot-futures arbitrage induces all the correct responses: spot prices go up immediately (thus shrinking present consumption); stocks are built up; and future prices are pushed down thus stabilising prices......"

    Kindly note that in the first para you mention that when bad news comes about future harvest, prices in futures market go up and in 2nd para you say that when bad news comes about future harvest, prices in futures market go up.....

    Isn't there a contradiction?

  3. Sorry if I confused you. Let me show the steps slowly.

    1. Bad news arises about a future harvest.

    2. Speculators process this news and buy futures; this drives up the futures price.

    3. This widens the basis between spot and futures to go to levels outside the "no-arbitrage band".

    4. Now there are opportunities for spot-futures arbitrage. The arbitrageur gets a locked-in fixed income return by (a) buying on the spot, (b) selling the futures and (c) storing goods for delivery at the future date.

    5. This tends to (a) drive up the price today, (b) push down the price at a future date because (c) stocks have gone up. All these are the "exactly correct" responses that you want to kick in when bad news about harvest date appears.

  4. One bigger issue apart from these futures markets, is the relevance of a spot market and the price determination process. If you visit any of the mandis is shocking the way the cartels decide the price of the produce.
    Would strongly recomend that you visit the lawrance road mandi in delhi.
    Further, never has the government ever bothered to correct the pricing mechanism in the mandis as it suits them ( they get around Rs 2500 crs from these mandis) . Futures are just being used as the political tool , its very unfortunate.
    Would be great if you can also read my pages at

  5. Mr. Ajay i too was disappointed when commodity futures were banned in future and the reasons you have given perfectly support my line of thinking. I feel that futures reduce the risk of producers from the losses and protects consumers from high prices in case of supply shortage to some extent.


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