Invest in commodities to maximise gains

Material Girl Madonna, may perhaps have been right in crooning that we are living in a material world, way back in 1985. With the prices of most commodities escalating in ’07, it looks like the lyrics have finally touched base.

“Commodities are so pervasive that you cannot be a successful investor in stocks, bonds or currencies without understanding commodities,” says Jim Rogers in his book ‘Hot Commodities’. And indeed, truth couldn’t have been any different. 2007 showed how wild gyrations in commodity prices can hit the bottomlines of companies, prompt governments to change trade policies and even make money for a truly diversified investor.

Several commodities like gold, crude oil, wheat, soya bean and palm oil hit all-time high price levels in ’07. Leading global commodity indices have generated faster returns (in some cases more than double) in the past one year, against gains made over the past five years.

For instance, the S&P Commodities index returned 32.5% last year, against a gain of only 11.7% over the past five years. In this edition, IG takes stock of the eventful year gone by and tries to peer into what ’08 holds for the hot commodity market.

The Agri Sector : The bullish performance in the past two years has ensured that agri-commodities won their due place in a fund manager’s portfolio. ’07 can clearly be called the year of agri-commodities, as prices of most commodities, including wheat, soya bean, corn, soya oil and palm oil, soared to more than 20-year highs. Barring sugar, most of the widely consumed commodities delivered handsome gains to their investors. Increased liquidity finally forced fund managers across the globe to discover undervalued assets in this sector.

Wheat: The prices of wheat — one the world’s most consumed grains — doubled to $10 per bushel in the past one year on the Chicago Board of Trade (CBOT). A fall in production in major producing countries, accompanied by rising demand, has been one of the major reasons for its meteoric rise. Besides the demand-supply mismatch, the role of hedge funds in pushing up prices cannot be undermined.

Global climate change has had an adverse effect on agri produce. Droughts in Australia and dry weather in the corn and wheat-growing belts of the US and South America have led to a fall in output of feed grains like wheat, corn and sorghum.

Economic prosperity in emerging economies gradually leads to increased consumption of starch-based items like breads and cakes due to the rise in purchasing power. Supply in these countries lags demand, fuelling the rally in wheat prices. To encourage production, countries like India have increased the minimum support price (or subsidy) of wheat to Rs 1,000 per quintal.

The situation isn’t likely to improve immediately, as it takes at least a couple of crop cycles for supply to catch up with the demand. Consequently, the rally in wheat is likely to continue this year.

Although trading in wheat futures has been banned in India, any rise in prices spells bad news for companies in the food industry, as wheat is an important raw material in most food products. Packaged food producers including Britannia, ITC and Nestle, for whom wheat and wheat-based products are the basic raw materials, face a direct hit on their bottomlines due to any big jump in wheat prices.

Source : Economic Times, 21 Jan 2008