A well-developed and effective commodity futures market, unlike physical market, facilitates offsetting the transactions without impacting on physical goods until the expiry of a contract. Futures market attracts hedgers who minimise their risks, and encourages competition from other traders who possess market information and price judgment.
While hedgers have long-term perspective of the market, the traders, or arbitragers as they are often called, hold an immediate view of the market. A large number of different market players participate in buying and selling activities in the market based on diverse domestic and global information, such as price, demand and supply, climatic conditions and other market related information.
Allthese factors put together result in efficient price discovery as a result of large number of buyers and sellers transacting in the futures market. Futures market, as observed from the cross-country experience of active commodity futures markets, helps in efficient price discovery of the respective commodities and does not impair the long-run equilibrium price of commodities.
At times, however, price behaviour of a commodity in the futures market might show some aberrations reacting to the element of speculation and ‘bandwagon effect’ inherent in any market, but it quickly reverts to long-run equilibrium price, as information flows in, reflecting fundamentals of the respective commodity. In futures market, speculators play a role in providing liquidity to the markets and may sometimes benefit from price movements, but do not have a systematic causal influence on prices.
An effective architecture for regulation of trading and for ensuring transparency as well as timely flow of information to the market participants would enhance the utility of commodity exchanges in efficient price discovery and minimise price shocks triggered by unanticipated supply demand mismatches.