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Gearing towards a Strong Base

Rahul Oberoi/Money Today | Print Edition: May 2011

Interest of investors in commodity trading is continuously rising as it has various investment options which can outpace different other traditional investments. In the last one year we have seen that the price of silver has soared more than double from Rs 25,750 to Rs 55,655 per kg and that of gold has gained around 26% from Rs 16,335 to Rs 20,682 per 10 grams during the financial year ended March 31, 2011.

Investors who had got on to the precious metals bus, which include gold and silver, at the right time must be reaping good returns. Other than precious metals, market experts believe that a pack of base metals, which include copper, lead, aluminium, zinc, nickel and steel, is another option for investment. These metals, barring nickel, can also give you handsome returns in the long term. Money Today spoke to market experts about base metals and tried to find out why you should invest in them?

WHY BASE METALS?


The prices of base metals are related to their overall demand scenario. As base metals are mainly used in industrial and infrastructure related activities, their overall demand is dependent on global economic growth mainly. India being among the fastest growing nations it is obvious that the domestic demand for base metals will remain strong.

Tarang Bhanushali, assistant vice president research - India Private Clients, IIFL says, "Base metal is a space which can be used as a proxy play on the economic growth of major countries. A growing economy such as India would increase its investments in infrastructure which would lead to higher demand for the metal. Also, with supplies restricted, commodity prices are bound to move up as the pace in demand growth would beat increase in supply."

Other than good returns, having a direct stake in commodities can also protect your portfolio from soaring inflation. As a result, the loss from the rise in overall prices will be negated by the gains to your portfolio from the increase in commodity price.

WATCH OUT FOR...

Before investing in the metals pack you should have to look into macroeconomic factors, interest rate scenario and China's monetary policy actions as it is the biggest consumer of base metals.

"Prices normally tend to rise during positive economic data reporting from China. Also movements of currency impact its prices. Recently the interest rate hike by China have created fears of monetary tightening leading to expectations of demand slowdown for base metals in China and prices have fallen sharply from their highs," says Amarsingh Deo, head-commodities and currencies research, Aditya Birla Money.

"Japan would create fresh demand of metals for their redevelopment process in the long term."
Sumit Verma
Research Analyst, Geojit Comtrade
On the other hand, there are several headwinds which can interrupt the prices of base metals. Tapan Mishra, head-products at Ace Derivatives and Commodity Exchange says, "Unaccounted inventories in China are causing a distorted picture of actual total supply. Further, rising inflation and interest rates in major developed countries, because of recent jump in crude oil prices, is resulting in slowdown in growth thus affecting the demand for base metals."

FOR THE LONG TERM

As a result from the recent earthquake and tsunami in Japan, it seems that the prices of base metals are likely to remain subdued in the short term.

The global economy, markets and macroeconomic landscape have been trying to assess the impact of the devastating earthquake that shook northern Japan on March 11. Praveen Singh, research analyst for base metals, Sharekhan says "The Bank of Japan decided to inject around 70 trillion yen, or Rs 36.61 lakh crore, in the financial system to stabilise the market and thereby the Japanese economy. The global economy has surely taken a hit, in the short-term at least. It is estimated that the Japan quake could cut the growth rate of the emerging nations: for example China's growth rate could be lower by a 0.5 percentage point."

At present, China's gross domestic product is $4,909 billion, which accounts to nearly 7.92% of the world economy. Japan is the third largest commodity consumer in the world after US and China.

However, in the medium-to-long term, these commodities would see demand from Japan on rebuilding prospects since base metals are used in infrastructure building. Sumit Verma, research analyst at Geojit Comtrade says, "Japan's tsunami would create fresh demand of metals for their re-development process over medium to long term."

Tips to Invest in Base Metals
Jayant Manglik, president, Religare Commodities says, "Demand from China and other countries continue to support higher metal prices. Global growth in the last decade has driven base metals prices to periodic new highs for instance, during 2010-11, silver and gold have touched their all time closing high of Rs 55,950 per kg and Rs 21,087 per 10 grams on March 24, 2011 and March 7, 2011 on MCX, respectively. The recent policy of quantitative easing of governments worldwide has again ensured firm base metal prices. Like all commodities, base metals pricing is driven by demand and supply but during the period of high demand, like now, even small supply glitches can lead to spikes in prices."

INVESTMENT OPTIONS

Base metals such as steel, copper, nickel, zinc, aluminium and lead are trading on various commodity exchanges like the Multi Commodity Exchange (MCX) and the National Commodity & Derivatives Exchange (NCDEX). Let's take these commodities individually and try to understand how good they are from an investment point of view.

Copper: Copper, a key industrial metal used in housing and construction, is currently the most attractive investment avenue, due to the increasingly bullish supplydemand fundamentals. Another important reason for copper demand is the bullish sentiments over the launch of copper exchange traded funds (ETFs).

Other than providing good returns, having a direct stake in commodities can also protect your portfolio from soaring inflation.
JP Morgan is among the first which has made a filing with US Securities and Exchange Commission for launching for Copper ETF. This has boosted investment demand in the industrial metal. In 2010-11, the price of copper surged 21% to Rs 428 per kg. However, experts are negative on copper for the short term. "Copper can fall to Rs 380 per kg in the short-term; but the metal is likely to rise sharply when Japan begins to rebuild its crippled infrastructure," Praveen Singh of Sharekhan added.

Lead: During the financial year 2010-2011, lead prices managed to gain around 26% on the back of strong demand from the battery industry. The principal consumption of lead is for lead-acid batteries which are used in vehicles, and in emergency systems as well as in industrial batteries found in computers and fork-lift trucks. Lead demand has managed to keep growing as demand for lead-acid batteries expands as more number of cars is being produced. During March 2006-March 2011, lead prices rose 130% to Rs 120.75 per kg mainly due to strong battery demand in China.

China is the biggest lead consumer and a large importer as well. Hence, its demand plays a crucial role in lead price movement. China's domestic lead consumption hit 3.64 million tones (mt) in 2010, up around 9% from 2009. "Demand for lead from China is expected to rise at around the same pace (9%), as China tries to slowdown its growth through monetary policy. Meanwhile, mine supply of lead is not abundant and scrap supply is tight, so prices will immediately respond to any sharp rise in auto sales numbers in China. However, global geopolitical instability and China rate hike fears will keep the markets range bound for short term," Aditya Birla Money's Amarsingh Deo added.

Over the long term, "We remain bullish on lead as supply from mines would be curtailed and demand from the automobile sector and the industrial battery sector is expected to remain robust," says Tarang Bhanushali of IIFL.

Aluminium: The price of aluminium is likely to remain strong on the back of robust demand from automobile sector in the long term.

"Growing economies would increased their investments in infrastructure, leading to higher metal demand."
Tarang Bhanushali
Assistant Vice-President, IIFL
However in the short term, market experts believe that we can see some correction due to increased political tensions in the Middle East North Africa (MENA) region. Also, Japan, Asia's biggest importer of aluminium, may cut down its imports as some of the factories are shut because of damage or power shortages.

During 2010-11, the price of aluminium on MCX gained 12.54% to Rs 116.20 per kg. "Aluminium price surged with demand from global market recovering. The auto sector has been one of the largest drivers of aluminium demand, especially in the United States and China. The short-term outlook for aluminium is mixed. The bearish sentiment is on the back of increased tensions in MENA region and spike in crude oil prices which threatens the global economic recovery. Overall, the long-term trend is bullish and we expect prices to continue their rally and see another 10-15% jump," Geojit's Sumit Verma added.

Nickel: Nickel has gained 4.39% in the financial year 2011 to Rs 1,175.10 per kg. Market experts believe that the metal has been moving up because of good demand from the stainless steel sector and supply concerns emerging from the mine strike in Vale, the Brazilian miner that owns the Voisey's Bay nickel mine. However, in the upcoming period it seems that the prices of metal can come under pressure. Kunal Shah, head-commodities research at Nirmal Bang Commodities says, "Outlook for nickel remains negative as the restart in production from the mines which were accounting for major supply concerns has put pressure on prices of nickel."

Zinc: Zinc prices witnessed a fall of 9% in the first half of 2010-11, but recovered in the second half finishing at Rs 104.65 per kg on March 31, 2011, lower by just 1.74% against March 31, 2010. "The sovereign debt crises in Europe, inflation fears in China, weak housing data in the US and excessive supply of zinc kept prices under pressure," says Sandeep Joon, senior research analyst for commodities, SMC Global Securities.

About the future prospects of zinc, Joon further says that zinc prices will remain firm in the near to long term as the casting and automobiles sector demand will keep its prices well supported. Japanese reconstruction and demand from emerging economies will give a further boost to the prices. Zinc prices may remain in the range of Rs 105-120 per kg in near term while it may touch Rs 140 per kg in long term in domestic market.

Steel: During the financial year ended March 31, 2011, steel prices rose by around 6% to Rs 30,600 per mt. Market experts believe that steel witnessed a rally due to decrease in the supply by China. "Steel prices have witnessed a rise last year as cutback of production in China coupled with rise in coking coal prices supported prices. In India, the price rally began in mid-December 2010 on the back of supply disruption of coking coal from Australia," Reena Walia, research analyst for base metals at Angel Broking.

Energy efficiency measures in China such as including rolling power cuts and assessing new projects for energy wastage -to try to meet its energy efficiency targets- affected steel production in 2010 have been lifted this year. This factor may help to ease the supply-side constraints but overall rise in input costs will continue to be a supportive factor for an upside in steel. "We expect the uptrend in steel prices to continue and expect steel to test levels of around Rs 29,500 per mt in the short-term and rise further to around Rs 31,000 per mt in the longterm period," Walia added.

As we have just entered into a new financial year, it seems that if you add some base metals, except nickel, in your portfolio it can help you to hedge against rising inflation. It could also help to generate good return by the end of the current financial year.

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