Is it time to bet on commodities? | Economic Times

Global liquidity, fuelled by central banks and governments, has lifted all asset classes. But funds have flown mainly into debt and equities. The debt market rally has taken more than 25% of the global investment-grade papers into negative yields— investors are paying interest to hold them. Similarly, the equity market rally has taken prices to new all-time highs.However, the rally in commodities is far from over. Prices rose smartly in 2020, but experts believe the rally will continue this year as well. Everyone agrees on the short to medium-term potential of commodities (metals, crude oil, agri products, cement, etc). “Commodities have seen a good rally, and the outlook remains strong for the next 3-6 months,” says Mahesh Patil, CIO – Equities, Birla Sunlife AMC. Some experts believe that this can be a long-term story too. “The commodities rally that started in 2020 is expected to continue in 2021 and 2022. The 2008-11 period saw strong recovery in commodities and with similar conditions, there could be a replay during the 2020-22 period,” says Sugandha Sachdeva, Vice-President, Religare Broking.Factors aiding rallyExperts say it’s time to shift a part of the portfolio to commodities for several reasons. First, commodities are coming out of a 12-year long downtrend. A breakout will take them to much higher levels. Second, liquidity continues to chase equities, especially the ‘new economy stocks’, pushing up their prices. Compared to commodities, equities have already crossed the 2000 dotcom bubble levels.The commodity index is out of a prolonged downtrend lineThe upside can be significant from current levels. 80186859Third, the demand slowdown due to the pandemic did not play out as feared. The increased demands from auto, consumer durables, etc. kept the base metal prices up. While the global economy suffered, the Chinese economy remained relatively stable. “Increased demand from China, the world’s largest commodity consumer, is the main reason for the spurt in commodity prices,” says Kunj Bansal, CIO, Karvy PMS. Since consumer-facing companies are expected to work overtime to meet the pent up demand, the demand for commodities will remain high.Commodity prices, compared to equities, are at multi-year lowsPrices could move up due to economic recovery and easy money policy. 80187049Fourth, we are living in abnormal times. A spurt in commodity prices would be inflationary. In the normal situation, central bankers would increase interest rates to control inflation. However, that is not what is expected in 2021. The US Fed has already said it will allow inflation to go above the target range in the short-term, resulting in a weaker dollar. A weak dollar is a standard recipe for further rally in commodities and the same is expected to play out now. Meanwhile, the dollar index has gone below 90 after a long time. “The dollar is expected to weaken further in 2021 due to continued loose fiscal policies,” says Patil.The US dollar index has gone below 90 markWeakening dollar is a standard recipe for a commodity rally. 80186867While the above factors will impact commodity prices in the short to medium term, the last and the most important factor that will impact it over the long term is the lack of new investments over the past few years. “Lack of investment in new capacities is the main reason for the commodity rally and due to this, increase in supply has lagged behind increase in demand. For example, China is not giving new capacity addition licences and this can change global supply-demand situation for commodities materially,” says Lalit Kumar, Fund Manager, ICICI Prudential AMC. The pandemic induced disturbances has also resulted in companies concentrating more on existing production facilities and not on new capacity addition and this is also delaying commencement of production from projects under implementation now.The outlookThere is good news for Indians and their love for gold. Gold does well in times of high inflation. This is why experts feel there is still steam left in gold, despite last year’s rally. According to them, the recent correction offers a good opportunity to add gold to one’s portfolio with a long term perspective. “While gold is in firm support zone at Rs 47,200-47,700, it will be stable even if prices fall to Rs 44,800. As long as gold remains above this zone, the long term structure looks positive and one can expect an upside move towards Rs 60,500 in the medium term. Gold prices can even scale Rs 65,000 during 2021,” says Sachdeva.While experts are bullish on gold, they are more bullish on other commodities, especially industrial commodities. “Going forward, other commodities are expected to do better than gold and we are more bullish on metals and mining,” says Kumar. The lack of new capacity addition will be visible more in industrial commodities and therefore, the demand-supply disconnect will be more obvious. The increased requirement for commodities, triggered by pent up consumer demand, is also putting pressure on them in the short term.Silver is getting the benefit of both its precious metal status and industrial metal status. Silver is the poor man’s gold and therefore, investors started chasing silver once gold prices began hitting the roof. Since around half of the silver demand comes from the industrial sector, particularly from photovoltaic solar panels, any pick up in industrial demand is also positive. These factors helped silver to outperform gold in 2020 after years of underperformance. “Due to increased industrial demand, silver will continue to do well compared to gold and the gold/silver ratio is expected to come down further to 60,” says Praveen Singh, AVP, Fundamental Research – Commodities & Currencies, Sharekhan Comtrade. “Since new US President Joe Biden is committed to green energy, the demand from solar panel will increase. This may push silver prices to around Rs 77,000 per kg levels in the medium term and it could embark into uncharted territory towards Rs 85,000 per kg by the end of the year,” says Sachdeva.The gold-silver ratio is fallingDue to industrial demand, silver should continue to outperform gold. 80186947Experts are neutral on crude oil. “Opec is producing below its full capacity and crude is expected to remain range-bound due to this spare capacity now,” says Singh. Supply from shale fields may also increase once crude oil prices start stabilising at higher levels. Emergence of alternative fuels are also a threat for crude oil. “Crude oil may remain range bound and we don’t see a big jump in oil from current levels because the energy demand can get diverted to alternative fuels,” says Patil. Structural shifts, like increased use of electric vehicles, power stations shifting from diesel to natural gas, etc will also keep future crude demand in check. This shift towards clean energy is helping natural gas with increased demand.The way aheadSince investing in commodities can be a different ball game, investors need to take extra precautions. “Commodity prices are volatile and therefore, investors should restrict the exposure to around 20-25% of their portfolio. Since around 10-15% of that will be occupied by bullion, keep only the remaining portion for other commodities,” says Bansal. Before jumping in, investors should also note that commodities have already rallied in 2020 and therefore, should rein in their return expectations in coming years.Commodity rally can continue till 2022Due to pent up demand, industrial metals are expected to well in 2021. 80186965While it is easy to buy and store gold and silver, investing in other commodities is not that easy and therefore, the next step should involve deciding how to buy commodities. What investors can do is to buy them in the commodities futures market and roll them over on a regular basis. However, the amount required is high. For example, the lot size of copper on MCX is 2,500 kg and the total cost works out to Rs 15.41 lakh (based on 5 January price of Rs 616.50). Though you can trade in futures market with margins—paying only a portion of the contract value—this increases the risk. “Only high-risk investors should get in through the commodity exchange route and that too with a clear risk management strategy,” says BansalSince far month contracts usually are costlier than near-month contracts, you also have to bear the rollover costs. While crude is still in ‘rollover only’ mode, commodity exchanges like MCX is allowing delivery in other commodities. That means, taking delivery and keeping it in warehouses is one way to avoid rollover charges and headaches associated with it. However, you have to bear the warehouse charges. Also, make sure that you keep delivered goods only in exchange designated warehouses. “If you keep the delivered goods only in exchange designated warehouses, there won’t be any issues when you give delivery,” says Singh.While directly buying commodities is difficult, investors can use the companies that mine or manufacture them as proxy to benefit from the commodity rally. For example, the upstream oil sector-major ONGC can be a proxy if you are bullish on crude oil. Similarly, you can buy companies that manufacture cement, steel, copper, etc. instead of buying these commodities directly. Most metal stocks have rallied due to rally in metal prices. While this may look easy, investors need to consider several other factors like its cash flow, debt level, etc, also while buying stocks. However, experts feel that the risk in this segment is low now. “The current commodity rally and the resultant increase in margin and cash flows will help several commodity companies to deleverage and rectify their high debt problems,” says Patil. In addition to increasing earnings potential, this deleveraging exercise may also help companies to get better valuations from the market.Most metal stocks have done wellInvesting in commodity manufacturers can be a proxy for commodity play. 80187013The top 5 commodity fundsThis is the best option for investors who want to avoid commodities or direct stocks. 80187038Rising commodity price led inflation is going to be a threat in coming years. While this is good for commodity companies, what about commodity users? It depends on whether they are able to pass on the additional costs to consumers. Since it will be difficult for several consumer facing companies to do so, they may come under pressure.