Madan Sabnavis: Commodity Shopping in 2010
adan Sabnavis, Chief Economist, National Commodity & Derivatives Exchange.
His call: Global recovery will boost demand for metals, crude oil and agricultural commodities.
His investment idea: A layman should take a long-term view to reduce risk; non-farm products are easier to track over the long run.
Commodities in the Indian context have progressively become an exciting prospect for investors as they could be positioned somewhere between boisterous equities and the more conservative government securities in the pecking order of returns. They have received a boost in the last five years on account of the idiosyncratic commodity cycles which at times have yielded returns of over 75 percent on products such as copper, furnace oil, spices and pulses. Commodity prices are driven by fundamentals rather than sentiment. While this appears to be assuring, it is actually difficult to judge commodity trends due to their complexity.
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Madan Sabnavis, Chief Economist, National Commodity & Derivatives Exchange | |
Prices were subdued during the first half of 2009 since the world economy’s attention was focussed on the financial sector as overall growth had slowed down. Crude and metal prices declined and stable farm output kept prices in balance. However, with the global economy staging a recovery earlier than anticipated, prices of crude and metals have started moving upwards. This has caused renewed interest in commodities which will probably remain through 2010. If the expected U-shaped recovery becomes more like a V-shaped one, then the commodity cycle could look good in the years to come.
Commodity price trends can change all too suddenly. A transport strike, frost, unscheduled holiday or a roadblock can cause disruptions in supplies that can move prices in a certain direction, only to be reversed when normalcy is restored. Therefore, one needs to understand the difference between a disturbance or shock and a fundamental. Lower area sown or crop damage is an irreversible event while breakdown of vehicles or non-availability of fuel in a mandi centre is a one-day distortion. Knowing and interpreting these events is the major challenge of investing intelligently in the market.
A layman should ideally take a longer term view to reduce risk because short term variations need to be understood very clearly before entering the market. Cash and carry is just not possible given that contracts end in physical delivery. This means that an investor must enter and exit at the right time. Long-term contracts are not yet available in India and the farthest contract doesn’t exceed six months. Therefore, it is all the more important to be better informed before entering the market as one will be dealing with a single-season outlook.
Presently the Indian regulatory system does not allow for Indians taking positions international exchanges. But on account of globalisation, the correlation between global and domestic prices has tended to get closer. This holds quite clearly for bullion, crude and metals (over 90 percent) where price setting takes place on international exchanges and India is a price taker.
But in agriculture, too, this bond has thickened for global products like soya (80 percent), corn (60 percent), wheat (60 percent) and sugar (80 percent). In fact, India’s influence on global prices can be gauged from the fact that whenever the government had reckoned imports of wheat and sugar, global prices started moving up in anticipation. In other products like spices, where India is the price setter, investment decisions are based on domestic considerations.
In 2010, maybe the world will get on a higher growth trajectory leading to an increased demand for commodities, especially metals. To begin with, supplies will be available but countries have to start investing in capital to meet these future demand requirements. Crude oil would once again be in demand as the hype around bio-fuels has melted presently and higher growth would necessarily mean greater demand for oil. At the same time growth in population, higher income and changing consumer preferences to value-added food products will keep demand for agricultural products buoyant.
Can one take a guess at the commodity cycle in future? It is a tough call because there are two sets of factors at work. The first is that inflation is always positive (most of the time) which means that prices must rise over time.
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