Emergence of Commodities as an investment class

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Emergence of Commodities as an investment class

• Prof. Deepak Ukidave
• Associate Dean ICFAI Business School, Mumbai

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• If stocks, bonds and commodities were part of
  the same family, commodities would be the sibling
  who never measured up, the black sheep the
  brother-in-law, perhaps, who got wiped out in
  soybeans. Commodities have never got the respect
  that they deserve, and its been something of a
  mystery to me why.
• - Jim Rogers, Commodity Investment Expert
  Creator of Rogers International Commodities Index.

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2004 Study Results

• Study titled Facts and Fantasies About
  Commodity Futures carried out by Yale School of
  Managements Centre for International Finance
  published the following results
• Since 1959, commodity futures have produced
  better annual returns than stocks and
  outperformed bonds even more. Commodities have
  had lesser risk than stocks and bonds, as well as
  better returns.
• During the 1970s, commodity futures outperformed
  stocks during the 1980s the exact opposite was
  true evidence of the negative correlation
  between stocks and commodities that is often
  noticed. Bull markets in commodities are
  accompanied by bear markets in stocks, and vice
  versa.
• Continued -

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2004 Study Results

• The volatility of the returns of commodity
  futures they expected for a 43 year period was
  slightly below the volatility of the SP 500 for
  the same period.
• While investing in commodity is one rational way
  to play a commodity bull market, it is not
  necessarily the best. The returns of commodity
  futures examined in the study were triple the
  returns for stocks in companies that produced
  those commodities.

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Commodities as an alternative investment class in
21st century

• Viable alternative to equity, real estate and
  other
• traditional forms of investments owing to
• Better returns
• Less risky
• Less price volatility due to few factors
  influencing commodity prices
• Less sluggish than bonds
• Good way to diversify a portfolio of stock
  bonds
• Continued -

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Commodities as an alternative investment class in
21st century

• Twentieth century was witness to three long
  commodity bulls (1906-1923, 1933-1953,
  1968-1982), each lasting an average of seventeen
  years and we are living in the middle of another
  such bull period which started in 1999. By
  nature, commodity bull markets last for a longer
  period than stock market bull periods. This
  presents all the more reason to be excited about
  the real things - Jim Rogers (Hot Commodities).

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Commodity Market Beneficiaries

• Farmers/Producers
• Processors
• Traders
• Manufacturers
• Wholesalers
• Retailers and end-users.
• All these participants in the commodities trade
  are benefited to a large extent due to changes in
  technology, communication networks and a number
  of value-added services provided by
  multi-commodity exchanges.

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Research Framework

• Research Question
• Have commodities emerged as an alternative
  investment class ?
• Hypothesis Testing Research Methodology
• Macro economic analysis of demand, supply, price
  movements of certain select commodities traded on
  the exchange. For example, gold which has hit 28
  year high spot price in European trade,
  subsequent to rupee strengthening against the
  dollar in last 6 months.
• Continued -

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Research Framework

• Study of hedging strategy in commodity futures
  used for effective risk management in select
  commodities like gold, ferrous and non-ferrous
  metals.
• Comparison of price volatility of various
  commodities traded on commodity exchange
  platforms for a period of three years.
• Study of recent trends in the commodity markets,
  including real challenges faced by the investors
  while investing in the worlds best market
  profitably .
• To identify critical dynamic issues / intricacies
  which need to be addressed to ensure further
  thrust and efficiency of commodity markets.

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Commodity Future Increasing Farmer Participation

• In India, 60 of the population dependent upon
  agriculture.
• Farmers are now assured better price for their
  produce (fair price discovery). Hence, they are
  no longer required to sell below cost of
  production in distress.
• Market determined price information available to
  the farmers enabling them to plan their
  production schedule.
• Inculcates competitive spirit among farmers to
  cultivate quality produce and among the traders
  for quality production and output.

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Commodities Futures Market Other Benefits

• Price risk management through hedging strategy,
  wherein, price risk that is inherent in a spot
  market is offset by taking an equal but opposite
  position in futures market.
• Enable the exporters to hedge their price risks
  (risk arising from volatility in foreign exchange
  rate movements) and improve competitiveness. In
  fact, with rupee strengthening against the
  dollar, export firms can now go in for more
  proactive hedging strategies, such as entering
  into forward and option contracts or exotic
  derivative products.
• Enables manufacturers to predict domestic prices
  that are likely to prevail in future, so that
  they can ensure that their market share is
  protected even with free entry of imports.
• Hedging would cut down the discount rate in
  commodity lending thereby enabling commodity
  traders to get easy access to credit.

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Future of Commodity Markets

• National online exchanges started operating since
  2003.
• Future trading in commodities permitted from 2003
  thereafter remarkable growth in volumes traded
  in the commodity market.
• Just passed nascent stages of their growth story.
  
• Phenomenal turnover achieved by commodity
  derivative exchanges in India.
• Increase in volume by more than 25 to Rs.27.39
  lakh crores for 2006-2007 period within just four
  years.
• Investor community in India has finally started
  taking notice of commodity markets.
• Bright future ahead emerging as a new hot
  market for the future.