An ancient Chinese curse translates as "May you live in interesting times". We are doing that, thanks to the bursting of the Chinese stock market bubble. The collapse of Chinese equity markets has triggered big selloffs in other markets and underlined the weakness in demand for a range of basic commodities. Metals, fuels, cotton and plastics have all gone South. There has also been turmoil in the forex market, with Emerging Market currencies down in the wake of heavy FII selling.
The Indian stock market indices have been badly hit. There is an additional complication in that this is settlement week. Hence, we don't know if the Nifty support below 7,700 is solid, or just driven by short-covering. Nor do we know if the rupee has a stable floor in the zone of Rs 66.25-66.75/dollar. The cautious trader might wish to wait for the next settlement before playing these trends.
Some trends in the commodity markets should be more reliable in the long-term. Unfortunately, most of these are negative, which means that efficient exploitation may require taking short positions, with leverage.
Demand across a basket of commodities, such as represented in Bloomberg's 22-commodity Index, will remain low until China's prospects improve. That in turn, depends on global demand improving since China's demand is driven by its manufacturing exports. This is a chicken and egg situation.
However, if commodities are low in price, industries which use those commodities, can cut costs. Hence, demand for products can be stimulated by passing on cost savings. Eventually that can lead to a recovery in the commodity itself. But it is a long process. Demand could get weaker and prices could fall further before there's a pick up.
One classic industry where these upstream-downstream effects have been visible for a while is energy. Crude, coal and gas have already fallen to multi-year lows and prices could continue falling. In this case, upstream players like ONGC, Cairn and OIL will take a beating as realisations drop. Refiners and marketers - IOC, HPCL, BPCL, Essar Oil, etc, will see higher profits as costs drop.
There will be more projects planned in the power sector and transport using gas. City gas distribution should see more activity, along with pipeline development, meter manufacturing, etc. So, there are a lot of potential gainers, and losers, as well.
In basic metals, there are many Indian manufacturers. There are iron and steel players, aluminium and copper players, zinc players, etc. Their power costs come down and that's a massive component of total cost. But realisations also drop a lot. We have seen shareprices of metal majors hitting 52-week lows. The downtrends here could continue. There is also the real fear that China will export steel at lower prices that domestic industry just cannot match.
Unfortunately, downstream industries are suffering from low demand so there are no immediate, obvious beneficiaries from lower metal prices. Construction for example, could see serious cost reductions because it uses a lot of steel. But the government will have to apply stimulus in terms of pushing infrastructure projects along. Similarly, automobiles could benefit from lower costs but this doesn't necessarily mean stronger auto sales volumes, given question-marks about demand.
Commodities themselves are easily traded on commodity exchanges, where futures contracts are available. The trends in most cases look set to continue down for months - the cycles tend to be long. However, taking short positions in highly leveraged contracts involves very careful calculation of stop-losses and position sizes. Enter such positions only if you are confident about handling those aspects of trading.
The author is a technical and equity analyst
