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Betting on commodities

Betting on commodities

Investors with a short- to medium-term outlook can book profits in metals and energy stocks now.

D.D. Sharma
D.D. Sharma

The revival in commodity prices in the past couple of quarters could be attributed to the replenishment of inventories by users, who refrained from big buying at the height of the credit crisis. This re-filling exercise by manufacturers to create sufficient inventories led to a sharp rise in commodity prices. The growing demand from China also helped the recovery. All stocks, including energy (oil & gas, coal), metals (ferrous, non-ferrous) and petrochemicals, rose during this period and have rallied by over 100%. The rally could also be due to speculative buying because of increased liquidity.

However, the rally in energy and metal prices may not sustain for long as the demand scenario for these is not too rosy. After replenishment in the past two quarters, not much of the incremental demand is visible to drive prices upwards. The demand from China and other big markets is also slowing down.

The recent data from large commodity consumers, such as the US, indicates that demand is not growing despite significant stimulus and historically low interest rates. Therefore, the outlook for commodity prices is not positive in the near term. Also, the demand for oil may not pick up enough to warrant a further rise in prices. Any delay in the global recovery will puncture the current oil rally. Another worrying scenario can be the withdrawal of the ongoing stimulus packages or monetary tightening as rising inflation warrants such a move.

Recent data indicates that inventories are now piling up at the London Metal Exchange, which is not a good sign for a further rally in metals. If prices of commodities keep rising, many high-cost capacities, which were rendered unviable earlier, could start production again and increase the supply levels.

The non-ferrous metal stocks have risen significantly from their March lows and the current valuations look expensive in terms of price-to-equity and price-to-book-value. These stocks are discounting a sustained rally in metals, whereas the current rally in non-ferrous metal prices may end any time due to the inventory build-up and slow global economic recovery. It’s the same case with energy products such as oil and coal.

Steel is the only metal showing a better trend, but a further rise in prices seems difficult. However, commodity prices will not touch the bottom they had reached in recent quarters. They will get support at much higher levels and consolidate till a real global economic recovery begins. So investors with a short- to medium-term outlook would be better off if they book profits in metals and energy stocks.

The outlook for precious metals and agricultural commodities is relatively better. Gold, in particular, is attractive for individuals as well as institutional investors. Buying gold could be a good way for individuals, mostly investors in the US, to diversify away from equity. It can also be a de-risking strategy for countries like China, which holds a significant amount of US treasury. Other central banks may also rebuild gold reserves to diversify the risk of holding US treasury.

D.D. Sharma is Senior Vice-President, Anand Rathi Financial Services.

Published on: Nov 05, 2009, 4:08 PM IST
Posted by: AtMigration, Nov 05, 2009, 4:08 PM IST