Investing in direct stocks requires a lot of research; feeder funds are better.
Rise in commodity prices has been in the news for quite sometime now. While it may be worrying for end-users of these commodities, investors would be reaping rich gains.
If one considers the top-traded metals at the London Metal Exchange (LME), these are copper, aluminium, lead, zinc and nickel. And except zinc, all the others have been rising steadily. But financial experts wouldn’t advise investors to enter the commodity market directly. It is primarily because investments need to be done through future contracts in the Multi-Commodity Exchange or Bombay Metal Exchange or National Commodities and Derivatives Exchange.
Another option is direct stocks. “As a rule of thumb, primary producers benefit from the rising price because it positively impacts their margins. End-users, however, suffer,” says Arun Kejriwal, founder, Kejriwal Research and Investment Services.
For instance, aluminium is trading at $2,489 a tonne at LME — up over 11 per cent since April last year. Investors who followed Kejriwal’s strategy and invested in Hindalco are reaping benefits. The stock price is up 30 per cent.
But there are complications as well. “External factors such as government polices and inflation, or even company-specific factors such as debt servicing impact the stock price,” says Amar Singh, head-research, commodities and currencies, Aditya Birla Money.
For instance: Copper prices are up by over $2,000 a tonne in the past eight months to a lifetime high of $9,484 on January 11, 2011. But the Hindustan Copper stock almost halved from Rs 535 in April last year to Rs 298 in January, 2011. Analysts say the prices fell on expectations that the follow-on public offer will be done at a much lower price.
The third option is through mutual funds or feeder funds. But the options are limited. Feeder funds invest in commodity stocks in foreign countries. SBI Magnum Comma fund is one mutual scheme which invests in stocks that produce commodities in India. In case of international feeder funds, some options include DSP BlackRock World Mining fund, ING-Optimix Global Commodities and Mirae Asset Global Commodity Stocks. In the last one year, these schemes have returned 20.71 per cent, 12.29 per cent and 4.23 per cent, respectively (as on January, 2011).
In case of gold, there are two mining funds — DSP BlackROck World Gold Fund and AIG World Gold Fund. These two schemes have returned 19.19 per cent and 20.70 per cent on an annual basis, respectively, as on January, 2011.
Financial experts prefer this option for retail investors because of the complexity in commodity markets. As Gaurav Mashruwala, a certified financial planner, puts it, “Playing the commodity cycle is like timing the market. And, retails investors with limited knowledge cannot do it effectively.” Ideally, one could put 10-15 per cent in these schemes.
While one aspect of investing in commodities consists of looking at producing companies, the second part is to gain from user companies. The situation here is trickier. “In the current market conditions, end-user companies will be hurt the most and should be avoided. Even if the company is the market leader and can pass on the price rise, it may suffer due to lower demand for its products,” says Raamdeo Agrawal, co-founder and director, Motilal Oswal Financial Services.
When a commodity cycle reverses, user companies may see their margins increase because there may not be a reduction in the retail prices in tandem with falling raw material prices. But timing the start or reversal of cycle is impossible, at least for the retail investor. “Timing the cycle is impossible and one doesn’t know for how long it will last. If you are playing on it, follow it closely to ensure you benefit,” Ambareesh Baliga, vice-president, Karvy Stock Broking.
Due to these complexities, retail investors are advised to stay away from these stocks, or at least have a long-term view to mitigate risks.
