Investment in commodities expected to remain strong as supply conditions look tight.
As fears of a possible implosion in Europe and recession in the US started looking real, the belief was that slower global growth would result in commodity prices cooling. The same became stronger with the Federal Reserve refusing to give any indication on a third round of quantitative easing (QE3). The flow of money into commodities may have slowed for now, but it is not down meaningfully.
According to a report on global commodities by Citi, investment in commodity markets eased to $432 billion in July 2011, down nearly four per cent from the high reached in April, although it did record a slight rise of 1.8 per cent from June. Compared to a year ago, flows remain strong, up 48.5 per cent annually.
The lion’s share of the recent decrease in invested funds has been due to a fall in commodity prices (particularly copper and oil) rather than outflows, says the report.
While the pace of inflows may slow somewhat, commodities will continue to attract investments as the demand scenario remains robust in emerging economies like India and China and adverse currency movements will make this asset class a good hedge, claim analysts.
In addition to the investment demand, the demand dynamics are in favour of commodities such as coal (thermal and metallurgical), steel and iron ore. For starters, India and China are likely to drive demand for thermal coal in the world markets. China is already seeing power outages as a result of rising demand and a slowdown in creation of fresh generation capacity. While a slowing Europe may not consume too much thermal coal, this may well be offset by Germany consuming more coal after shutting its nuclear plants. Supply is expected to remain tight for metallurgical coal, too, which will keep long-term prices at $200/tonne.
According to Citi, in the longer term, “there are only a few potential sources of new hard coking coal supply; two of the most important being Mozambique and Mongolia”. Iron ore supplies are also expected to remain tight till 2014, believe analysts, which will keep prices high. No prizes for guessing that with prices of both coal and iron ore staying firm, power and steel prices will reflect this trend, too.
Given that the inflation juggernaut continues to roll in India for a host of factors, what seems apparent is that the central bank will find little support from the world commodity markets. Rising raw material prices have contributed significantly to the non-food manufacturing inflation and this may continue.
Going forward, there may be little respite from this pressure. And, if QE3 is announced, commodity prices will rise further, worsening inflationary expectations in India. External factors such as commodity prices have played a big role in ratcheting up inflation and RBI needs a new trick to deal with this known unknown.
