The Hindu Business Line : Commodity equation with equity

The entire commodities complex is now the focus of attention not only of entrepreneurs (producers, consumers) and investors but also of policymakers, including central banks. Investment in commodities exerts a balancing effect on the portfolio as it provides a natural hedge against possible decline in the value of other assets.

Hedge against inflation

Gold, for onehas performed commendably in the last four years with impressive year-on-year rise in prices. Indeed, even central banks are said to be eyeing commodities as part of their diversification plan. For instance, Asian central banks together hold foreign exchange reserves totalling over $2 trillion, with China alone accounting for $1 trillion. In last two-three years, we have often heard, for instance, China's central bank wanting to park a part of its reserves in gold.

There is also the strong likelihood that in future, central banks or institutions with large funds would, in addition to gold, look at crude for asset diversification. Crude is increasingly becoming a strategic asset for producers and consumers with energy security today perceived as critical. Importantly, commodities tend to outperform other assets in expansionary phase. There is a positive correlation between global economic growth and commodity consumption. When growth drives demand, there is positive effect on commodity prices. It is often said that equity and commodity markets move in opposite direction. It is true, but to a limited extent and under circumstances. For instance, geopolitical concerns would pull the stock market down, but prove positive for energy and metals because of the potential for supply disruption.

However, a slowdown in global economic growth will pull down both markets. In India, strong GDP growth in the last three years has propelled the stock market higher even while boosting the commodity market.

Equity and commodity markets

There is clear linkage between equity and commodity markets. Changes in commodity prices do impact the share prices of companies, whether commodity producers or consumers. For instance, a rise in steel prices would be positive for producers but not for consumers.

For savvy investors, a study of the linkage would open up a window of excellent investment opportunity. Positions held in one market can be hedged through positions in the other.

Taking the above example of steel, if prices were set to rise, an investor could go long on commodity steel. At the same time, he could go long on steel producers' scrip as higher prices would prove positive for the topline and bottomline of producers. As higher steel prices would hurt consumers, he could go short on steel consumers' scrip. This example can be extended to commodities such as base metals, sugar, cotton and so on.

In the developed economies, commodity markets are bigger than equity markets. Not in India. But looking at the impressive growth of trading volumes on nationwide commodity futures exchanges here, it is only a matter of time before we catch up with the developed world.

So, there could be absolutely no doubt the emergence of economic interest in commodities. The huge demand surge for food, fibre, metals and energy is seen creating newer opportunities in the marketplace. Currently, supply growth clearly trails demand growth.

Commodity consumption

There is every likelihood that India may go the China way in commodity consumption. China is not only a big producer and consumer of commodities, but also a huge mover and shaker of the global commodity market, with large volumes of foreign trade in energy, metals and agricultural commodities. India's foreign trade volumes may not exactly match that of China, but would expand rapidly over the next 10-15 years.

Economic liberalisation is seen driving India's growth. Internal and external trade controls have largely been dismantled. Licensing requirement and restrictions on storage, movement and credit access have been done away with. Today, the Indian commodity market is freer than ever before.

More Stories on : Investments | Commodity Markets | Young Investor

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Commodity equation with equity

Mid-caps will outperform large-caps by a margin of 30 per cent

Gold: Not always a bright idea

Index Outlook

Short 'em