The Hindu Business Line : An emerging asset class

Commodities as an asset class has delivered strong returns in the last two years with prices of commodities across segments - bullion, metals, agricultural products, crude, chemicals - at multi-year highs. Commodity markets have been on a revival path after a long slump period. In India, the fervour in the commodities markets has been high and second only to equities.

India has a long history of organised trading in commodities. However, the players in the commodity markets have been by and large, either, producers and major users of commodities or traders. The commodities space has never offered a serious option as an asset class to the general Indian investors.

The lack of standardised format of trading, limited depth and deficiency in transparency were serious limitations curbing growth of commodity markets. The absence of a regulatory framework to support mutual funds and such other institutional structures is also stunting growth. It is relevant that participation by high networth individuals and retail participation in equities and more particularly in fixed income had received a big boost with the setting up of mutual funds.

Turning point

The setting up of the three national multi-commodity exchanges was a turning point that put in place a robust trading platform. The streamlining of services by warehouses and banks have also facilitated better linkage between the spot and futures markets. As a result, there has been a rapid growth in trading volumes and deepening of commodity markets. Daily trading volumes have topped Rs 10,000 crore. The upturn in the commodity cycle, meanwhile, has attracted savvy investors to commodities as a means of diversification of the asset portfolio. These investors have traditionally focused on only equities and fixed income instruments for want of investment alternatives that afforded adequate comfort levels.

Outperformer

Commodities generally outperform other asset classes in an expansionary phase and deliver extra-ordinary returns within short periods. In the past, in the absence of robust commodity markets, investors have been forced to take the sub-optimal, proxy route of investing in stocks of commodity companies. Now investors can get a direct, undiluted play through commodity exposure. Since the Indian economy is on a high growth path with sustained, strong demand envisaged for commodities, going forward, commodities are likely to increasingly figure in the asset allocation of serious investors. Commodities exhibit low correlation to equity and fixed income instruments and, therefore, provide a natural hedge to the portfolio. Commodities thus provide a balancing and sobering effect on the portfolio.

The outlook for commodities is positive given that the uptrend in the demand for a wide range of commodities driven by the high industrial growth in China and India is likely to continue. The upward pressure on commodity prices is likely to be exacerbated by supply side constraints due to widespread closing down of facilities world-over during the slump period prior to the current boom as well as geo-political tensions impacting crude supplies.

Gold rush

A commodity that merits special mention is gold thanks to its differentiating attribute as a quasi-currency and a safe haven asset. The dollar, the traditional currency and asset class of last resort is steadily losing its sheen, weighed down by the ballooning twin - deficits in the US.

The striking negative correlation of gold to the dollar means the yellow metal is likely to gain at the expense of the UScurrency. The broad consensus on prospects for the US currency, going forward, continues to be negative. This means the gold-rush and uptrend in gold prices is likely to continue.

(The author is associated with BNP Paribas. The views expressed are his own and not that of his organisation)

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