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Gaining from the non-correlation

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Devangshu Datta New Delhi

Global commodity indices show all commodities taken together have appreciated six per cent (dollar terms) in the past year. The basket of food items has risen 12 per cent, crude oil is up over 10 per cent and precious metals have risen over 20 per cent. Base metals are, however, down six per cent.

Global GDP growth has been weak in this period. Equity performance has been negative. That is reflected in the falling prices of industrial metals. The rise in crude oil prices is explained by the continued political turmoil across Arabia and North Africa. Gold and silver have risen due to currency weakness and volatility.

 

The rise in food staple prices is less easily explained. This normally occurs when there's scarcity (due to poor weather, perhaps) or the demand is increasing, due to rising incomes. Both factors could be responsible. Despite slowing global GDP growth, significant populations in India and China are moving up past the poverty barrier.

For an investor, the non-correlation between commodity and equity performance is interesting. In theory, one should be able to use this lack of relationship to hedge, by judiciously mixing asset allocations. In practice, this isn't easy, not in India.

Speculating in physical food staples is impractical. You can choose a basket of food commodity futures, take positions and roll over as required. Keeping track of those positions, margins, etc, is challenging. Also, the government often plays spoilsport and arbitrarily bans futures trading, restricts exports, etc, when food prices escalate.

It is possible to speculate in precious and industrial metals, and across the energy value chain. The precious metals' bull run may still have some distance to cover, since it's inversely related to currency stability. There were large corrections in September. But the uptrend still seems intact.

The demand for industrial metals will remain weak till global GDP growth starts a recovery. The share prices of Indian metal producers could be sold at disproportionately higher amounts, because of reforms in the mining and land acquisition Acts and stronger environmental measures.

The energy chain is the most difficult to assess, but potentially the most rewarding. The prices of crude oil, gas and coal, all trend in the same direction. As and when the West Asia-North Africa situation resolves, global GDP might start recovering. Demand will rise to ensure crude prices don't correct down once there's political stability.

Unfortunately, price controls make for huge distortions in the domestic energy markets. Taking advantage of what could be a long-term bull market in energy may be difficult, given the policy distortions. In the long run, however, this industry shouldn't lose.

The author is a technical and equity analyst

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First Published: Oct 06 2011 | 12:49 AM IST

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