Commodity Shopping in 2010 : Forbes: Jan 21 2010

Commodities could sizzle again in 2010 if global growth returns. They could offer the alert investor, ever ready to track key changes real-time, a happy hunting ground
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.
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 mlayman 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 takeBut 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.

The other set of factors is product specific in the sense that one has to choose the product to invest just like the individual scrip in the equity market. The moot question is which are the ones that would provide high returns on investment? Again, this is not an easy one to answer as individual product prices would be driven by their own fundamentals which have to be analysed individually. The value of the dollar is important for gold while US stocks of crude will continue to provide hints on the price. Crop prospects can never be known in advance in the country or the rest of the world.
In that case how does an investor go about using this market? When it comes to farm products there are seasons, and a crop out of season would not generally see much interest as the hedgers, which is the class that initiates trade, would be missing. Investing in this segment means conjecturing the supplies expected in the country as well as in the rest of the world. While such information is available, one needs to really track them on a real time basis. A rebel attack in Nigeria can send the price of crude upwards while a flood in Andhra Pradesh can ruin the chilli crop for the entire season.
Non-farm products are probably easier to track over the long run as we get some sense of the trends of growth prospects in the developed world. Investments in farm products would still be a challenge as it was observed this year, where it was only in late September that it was agreed officially that there was a drought. In fact, prices started moving at a quicker pace once this announcement was made.Therefore, given that this market is still new and less understood, the uninitiatedmust make a thorough study of the factors that guide prices. The key risk is failing to understand the commodity and blindly following a price direction. The second risk is getting caught in a relatively less liquid contract where one cannot exit easily. One could get caught being forced to make or take physical delivery in case one cannot exit or roll over before expiry.
As far as speculative bubbles go, it is theoretically true that it holds in any market. However, in the commodities markets, prices have generally followed fundamentals and there has not been any such bubble or even deviation from what is expected. In fact, the futures markets have given several early warning signals on the state of final harvest as in wheat and sugar. Hence, if one does one’s homework and operates, one can take judicious decisions.
There is need to step in with caution and be prepared to get one’s feet wet, much like Macbeth’s: Letting ‘I dare not” wait upon ‘I would,’ Like the poor cat i’the adage.”