Commodities Outweighing Equities By Capitalheight – 01/12/10

Introduction-

 Gone are the days when you only needed to know about stocks and bonds to make money in the financial markets. With revolutionary changes taking place in the global economy and investment industry, you cannot afford to ignore commodities.

What are commodities? They are real assets that you and everyone in the world needs in life. Commodities are raw materials used to create the products consumers buy, from food to furniture to gasoline. Commodities include agricultural products such as wheat and cattle, energy products such as oil and gasoline, and metals such as gold, silver and aluminum. There are also “soft” commodities, or those that cannot be stored for long periods of time, which include sugar, cotton, cocoa and coffee.

The commodity market has evolved significantly from the days when farmers hauled bushels of wheat and corn to the local market. In the 1800’s, demand for standardized contracts for trading agricultural products led to the development of commodity futures exchanges. Today, futures and options contracts on a huge array of agricultural products, metals, energy products and soft commodities can be traded on exchanges around the world.

Commodities have also evolved as an asset class with the development of commodity futures indexes and, more recently, the introduction of investment vehicles that track commodity indexes. In this article, we will explain why investors might consider adding commodities to their portfolio, as well as some of the strategies for investing in commodities. Through this report, we are trying to explain how commodities are making their way to Investors portfolio and outweighing equities and bonds.

Commodity Market Scenario in India

The commodity derivative markets have been functioning in this country under the FCRA, which had entered the Statute Book almost half a century back in 1952. Since then the entire ecosystem of commodity markets the world over has undergone significant transformation, owing to changes in the trade pattern, trading methods and practices in both the physical and derivative markets, warehousing and transport norms, information and communication technology, and, above all, the growth of new risks, risk management instruments, and the entry of new institutional non-trade related market participants. That underlines the need for not only strengthening and expanding the scope of commodity derivative trading, but also regulating effectively such trading through restructuring the regulatory authority, and entrusting it with more regulatory and judicial powers, to ensure healthy and orderly development of markets, without any threats of manipulations, corners, and squeezes, besides avoiding unwarranted price volatility unrelated to the fundamental conditions of supply and demand.

Commodities trading is now a buzzword among the investor community in India, which is evident from the statistics that show how the trading volumes in commodities trading has been steadily rising over the years outshining the more popular and retail centric equities trading. The figures indicate that trading volumes generated in commodities have grown in a steady upward trend and much faster than that in equities during past couple of years.

Adding delight to the commodities investors, a recent estimation given by the commodities trading regulator, Forward Markets Commission (FMC) has indicated that average annual trading volumes in commodities would surpass Rs.90 lakh crore in the current fiscal from Rs.77.65 lakh crore recorded in 2009-10.

The FMC has also recently revealed that India’s total commodity futures turnover on four national and 18 regional exchanges during April 1 to 15, 2010 rose by 30% year-on-year at Rs.3.09 lakh crore. The turnover in the commodities grew by 48% in the fiscal year 2009-10 to Rs.77.65 lakh crore.

In India, investors showed an intelligent trend of investment in commodities as most of the investment flow went for high return yielding commodities like bullion, crude oil, energy and metals. Though, agricultural commodities too held a significant share in the total commodities trading volumes.

The Indian commodity bourses continued innovating investment products so as to create better investment avenues in commodities and introduced several new commodities for futures trading during 2009 that included almond, imported thermal coal, carbon credits and platinum, besides offering retail investment products in silver and gold investments.

It is seen that the large-scale participation in commodities market was primarily because of variety of investment products available across the exchanges and the trust involved with the store of value in commodities.

Indian stock markets have witnessed some of the horrifying crashes in past where crores of rupees of investors’ wealth was washed away keeping a large part of the trader community in a state of disarray. But with emergence of commodities markets, investors have found a mode of investment that involves lesser risk than equities and larger appreciation of investments in the shorter and longer term. Now, Investor has much broader option to invest in commodities, not only bullions but Agri commodity market is on fast expansion and with economies more consumer based in coming years they are meant to ripe good returns

 Obstacles in Commodities Trading

Despite having some significant benefits over equities markets, commodities trading have been limited to either large corporate, trading houses or high net worth individuals (HNIs). The reason being commodities trading involves large capital investments. The lot size in commodities would require huge amount of money at the initial investments. This restricts or rather discourages retail investors taking active participation in the commodities trading. Though, many of the commodity exchanges have offered several retail products as well, but the kitty is still limited.

Secondly, the knowledge requirement for commodities trading is again a constraint for the common investors. Unlike equities market, commodities trading requires not deep but at least some understanding of the domestic and global economy, monsoon, consumption and government policy.

However, it cannot be ruled out that an investor can accrue gains in equities merely by speculating. There too knowledge about company operations, government policy with regard to sectors and taxation and more importantly understanding of the overall business. But looking at the large-scale participation of retail investors in 2008, when IPO subscription had almost become a common man’s hobby, the Indian equities markets proved easier and more convenient for the retail investors.

But, India’s retail investment strength cannot be ignored, especially, when the commodities trading is trying to set its foundation firm among the investors here. In order to address this thriving untapped investors’ strength, many commodity bourses have started putting in efforts to develop investment products that can attract large number of retail investors but as long as the knowledge and the extent of initial capital investments are concerned, commodities trading seems to be a cup of tea of a select.

Why Invest in Commodities?

There are lots of good reasons to invest a portion of your portfolio in commodities, but the most profound may be very simple: We are running out of stuff. We have to dig deeper to find oil, mine more dirt to find copper, knock down more mountains to find anthracite. For a long-term investor, it’s tough to do better than own necessities that are growing scarcer. As you go about your day, observe how often you use, in some form, essentials such as natural gas, corn, wheat, rice, cotton, wool, copper, gold, silver, sugar, coffee and cocoa. Commodities (also referred to as natural resources) are necessary for everyone on the planet. And, today there's growing global demand for natural resources that every investor should be aware of. Never before have commodities been in such great demand worldwide at a time when supplies are extremely low. It will take many years for this supply-and-demand imbalance to improve. This means opportunities for you, that is, rising commodity prices worldwide.

Investing in commodities is not the risky business as many people imagine. It's amazing how many investors believe that stocks are safer than commodities. Commodities have historically had more attractive returns and less risk than stocks. We’ve heard about the importance of diversifying (ad nauseam), and commodities will also help diversify your portfolio. Commodities historically have shown a very low correlation to equities and can lower your portfolio’s volatility. Agriculture goods, livestock, metals, oil, and gas are the foundation of the global economy and their prices typically move in different directions than stocks and bonds. Natural resources also offer a hedge against a falling dollar, since they tend to get more expensive as the greenback loses value. “Commodities will do wonderful things” to round out a portfolio. Recent research, such as that done by the Yale School of Management's Center for International Finance, sheds some very interesting light on this asset class. Their study showed that by diversifying an investment portfolio with stocks and commodities, it can have less risk than a portfolio that is 100% invested in stocks.

Often people will shy away from investing in natural resources, such as gold, silver, oil and sugar, because they think it's complicated to invest in them or they believe it takes a lot of money to invest in these real assets. That used to be true but no longer is. There have been big changes in the last few years in the investment industry that now give any investor easy and inexpensive access to this asset class. It's easier than ever to invest in natural resources.

For example, you can invest in some commodities funds with just a few hundred dollars. Many people, including experienced investors, simply do not understand the magnitude of investing in these real assets and as a result are not taking advantage of the amazing global commodities boom of our time.

But at the end of the day (or at least the fiscal year) you want to make money, and investing in commodities could boost your returns. This appears to be a propitious time to get in. The recent massive global economic collapse resulted in a crash in commodity prices, but the world will be growing again. Already, industrial production and retail sales — key gauges for commodities demand — have started rising. And commodity prices, which move early during economic rebounds, have headed up. Copper, for example, has doubled in price in 2009. Commodity prices have been driven higher by a number of factors, including increased demand from China, India and other emerging countries that need oil, steel and other commodities to support manufacturing and infrastructure development. The commodity supply chain has also suffered from a lack of investment, creating bottlenecks and adding an “insurance premium” and/or a “convenience yield” to the returns of many commodity futures. Over the long term, these economic factors are likely to support continued gains in commodity index returns.

Conclusion

Investor interest in commodities has soared in recent years as the asset class has outperformed traditional assets such as stocks and bonds. The performance of commodities as an asset class is usually measured by the returns on a commodity index, such as the Dow Jones-AIG Commodity Index, which tracks the return from a passive investment in 19 different commodity futures contracts. Over the five-year period ended March 31, 2006, the Dow Jones AIG Commodity Index has returned 10.6%, versus 2.6% for the S&P 500. Commodities are a distinct asset class with returns that are largely independent of stock and bond returns. Therefore, adding broad commodity exposure can help diversify a portfolio of stocks and bonds, lowering risk and potentially boosting return.

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