Commodities saw a stupendous rise last year. While oil shot up by 80 percent, zinc rose by over 87 percent
Commodities have caught the eye of investors again with some registering a stupendous rise last year. Zinc rose by over 87 percent in one year, while oil and copper shot up by 80 and 33 percent respectively. Gold increased by 8.85 percent. For investors, while an ongoing uptrend is a morale booster (and certainly, last year’s performance does tick that box), they may, however, require more indicators to be genuinely interested in the commodities spectrum, especially with trading volumes dwindling as a fallout of demonetisation. So, before someone considers the investment prospects of commodities, they would look at two things: First, the attractiveness of other assets, and second, the trading and regulatory environment.
Most of the stellar performances of commodities in the last one year have come on the back of steep falls in the previous years, exaggerating the present rise. This would mean that the 20 percent gain achieved by Nasdaq and DAX or the 12 percent gain of Sensex does not pale much in comparison considering the run-up in the previous years. In fact, Dow recently hit the psychological mark of 20,000, suggesting that the Trump rally has legs. This comparison is important as equity continues to remain a favourite asset class for a majority of investors.
But it is not only equities that have threatened to take the wind out of commodities’ sails. For example, while measures by the government to curb fiscal deficit reduced gold imports, gold sovereign bonds gave additional reasons to look away from physical gold or gold futures. The rising appeal of debt and bond markets has meant that commodities as an asset class have been posed a genuine threat, especially during a period when investors have been generally risk-averse. But things may be changing.
In the US, the new government has already kindled expectations of fiscal expansion, which have not only sparked equity market rallies, but also whetted the appetite for commodities. Further, with this, the expectation of higher inflation and higher interest rates in the US has also gone up, which foretells a bear market in bonds. Meanwhile, in India, fiscal deficit and inflation are under control, giving room for further rate cuts, but demonetisation has left banks flush with funds. This means it is not as much a question of cost of funds as it is of a demand offtake, suggesting that the central bank may not be overly enthusiastic in easing rates much. We have also seen property registrations falling post-demonetisation, and it is fair to assume that funds diverted from non-essential property purchases could get diverted to equities or commodities. Lastly, recent economic data shows that growth had been slowing down even before demonetisation was rolled out. Even without incorporating the impact of demonetisation, the Reserve Bank of India had lowered the GDP to 7.1 percent from 7.6 percent. This could suggest that equities could at best see a slow and acute angled rise rather than vertical.
The second angle is that of confidence in participation, especially in the backdrop of the National Spot Exchange Limited fiasco. In addition, while global commodities have suffered from higher transaction costs due to the imposition of the Commodity Transaction Tax, agricultural futures have been upset by the abrupt suspension of a few contracts. The merger of the Securities and Exchange Board of India (Sebi) and the Forward Markets Commission seeks to iron out the regulatory inefficiencies and could help in attracting the hedgers back into the fold. So, along with a single regulator, we will also move towards better price dissemination, movement of goods and a unified market, with the rollout of GST and increase in digitisation.
The good performance of commodities has come on the back of steep fallsSebi has also sought to amend the Securities Exchange and Clearing Corporation to clear ambiguities and a discussion paper inviting comments on settlement and pricing of options, too, has been issued. The plan to introduce options in commodities has invited criticism over fears that participants may not fully understand the product. This is not without truth. In fact, even though equity markets have seen option volumes soaring, the main attraction of the instrument has been the low investment required and the common investors are usually buyers employing a single-legged approach, suggesting it is normally speculative interest rather than hedging or thematic interest that constitute the chunk of equity option volumes.
(This story appears in the 03 March, 2017 issue of Forbes India. To visit our Archives, click here.)