Stock prices of commodity-based companies are not always in sync with global commodity price trends. But that could change soon
It is when one studies inter-market relationships that it becomes obvious how distorted trading patterns in India often are. Some inter-market relationships should almost instantly translate into trading opportunities. A rise or fall in real interest rates immediately causes the inverse reaction in most equities. That is, rising interest rates lead to stock market sellouts while falling rates often result in rising stock market prices.
The financial sector is the most sensitive to this relationship while working capital intensive businesses also respond in a similar fashion. However, this apparently simple relationship can be masked by the effect of inflation.
This has been the case in India during 2001-02. While nominal interest rates fell during this period, inflation declined even more sharply. Thus real interest rates remained high and the relationship was not immediately apparent.
However, every nominal rate cut has resulted in a short-term move into the financial sector though this movement did not last as dropping inflation rates were discounted. Traders could bear this in mind but it can only be played over a very short-term period.
Another inter-market relationship that is often fairly obvious is the movement between commodity markets and companies that are either primary producers or secondary producers of the commodity.
In most cases, Indian commodity prices trend in the same direction as global prices. However there are distortions due to both price controls as well as customs duties, countervailing duties etc. The relationship is thus often distorted.
Take the case of aluminium and Hindalco for instance. If one charts the daily prices of LME (London Metal Exchange) Aluminium ingot versus the stock price of Hindalco, a positive relationship is visible. The stock shows amplified reactions, but it usually moves in the same direction.
The correlation is around 0.8, which is quite high. The difference can be explained by the duty differences and also the peculiarities of the specific company and trading environment etc. Thus one could usefully track the movements of aluminium on the LME if one wished to trade Hindalco.
A similar relationship exists between global steel producers with Tisco often lagging Kosco and US Steel in its movements.
But a similar relationship should exist between Sterlite and global copper price movements, given that Sterlite is primarily a copper producer. But a glance at the monthly chart of LME Copper prices versus Sterlite stock prices shows the enormous difference in amplitude of movements for Sterlite.
Sterlite has often rapidly changed direction and shot up and down while copper prices have been less volatile and shown a general downtrend.
The Sterlite stock has only a 0.1 correlation between its price movements and moves in LME Copper prices. The stock has been thus far more volatile and often moved in the opposite direction. It would be nearly useless to take position in Sterlite based on Copper price movements.
There could be several explanations for this. The stock has been under investigation during this period for manipulation by Harshad Mehta. The drama of the Balco takeover and its political fallout also caused sharp local fluctuations in the stock valuation.
Also, for the larger part of 1998-2002, Sterlite was valued as a telecom cable producer rather than just a primary copper manufacturer.
Now that Sterlite Opticals has been spun off, that factor should be less important.
A similar lack of correlated trend is visible in the sugar market.
Global sugar prices are easily available (at the worldbank site www.worldbank.org for instance) and well-aligned with Indian free market prices. This is natural because India is the biggest market for sugar and one of the biggest producers in the world.
Indian sugar producers do not immediately benefit from rising global prices because of rigidly controlled quotas. Indian mills don't have room to export at will and they have to sell a designated amount at government-controlled prices. Thus global price increases translate into massively lagged reactions on Indian sugar stocks.
But the sugar market is being gradually freed and a future market mechanism being set up. This could lead to a change where Indian mills' equity prices gradually align to world global prices.
Similarly there is a great deal of current distortion between global crude and NG prices and the movements of both Indian producers and refiners. In free markets, primary producers benefit from rising crude prices while refiners get larger margins from lower crude prices. This doesn't hold in India because of the Administered Price Mechanism (APM).
However, the APM will be removed in April 2002. Assuming the Indian market mechanisms align with worldwide global prices, global energy prices will be worth tracking. The profits of primary producers like ONGC and Indian Oil will align with crude/ NG prices while the profits of refiners such as HPCL, BPCL and Reliance should show a more inverse relationship.
Assuming more data was easily available, one could track several other inter-market relationships. Even in sugar and energy markets, Indian equity price moves should start aligning with global commodity prices as the distortions are being removed.
There will be ample profits available for the traders who can track the commodities and exploit this change in the relationships first.
