The Hindu Business Line : Looming risk of rising crude prices

THERE has been a smart rally in equities over the past couple of months, with mid-cap stocks at the forefront. The large-cap stocks joined the rally at the end. The rally has been driven by liquidity boosted by FII participation and robust corporate profit growth.

During this period, the price of crude oil has been on a relentless upward trend that was interspersed with declines that lasted only for a short period. Crude prices have ended the week that just ended on a bullish note, in excess of the $55 a barrel. The concerns regarding rising crude prices have started to take a toll on equities, as the US markets closed sharply lower. European as well as several Asian markets, too, ended on a similar note.

Crude prices could reach higher levels over the next few months as the winter season in the northern hemisphere gets under way.

Although the price of the basket of crude relevant for India is ruling at a much lower level than $55, the effect of higher crude prices is bound to affect the profitability of a swathe of companies, especially in the manufacturing sector, as costs of energy, fuel and transportation could start to spiral.

Even if the Government decides to limit the price increases by seeking recourse to further cuts in excise and customs duties, and requiring oil companies to bear an even greater part of the burden, profitability and growth rates could be affected as growth rate of the global and the Indian economy slows down. Market sentiment could also be influenced in a negative manner if liquidity in global markets dries up and a flight to safe assets and safer currencies set in.

Investors as such should consider adopting a cautious approach to buying equities, by staggering investments over a period of time, and partial profit booking on deep-in-the-money positions, may be appropriate. This could mitigate any downside risk that could envelop the markets due to the bullish trend in crude prices that is driven by a combination of robust demand and speculative activity.

The positive aspect of the crude prices story is the likely boom in construction activity in the Gulf countries. This could be an opportunity for companies such as Larsen & Toubro and Voltas, which have executed several projects in the region that could serve as a reference point for bagging more orders, and Gujarat Ambuja Cements, which appears well set to capitalise on the sharp spurt in cement prices in export markets.

The latter's earnings numbers for the July-September quarter have been buoyant with a fillip from exports as well as higher domestic prices, and there could be a further scaling up over the next few quarters. There are others that could benefit from the anticipated construction boom.

For now, we prefer the stocks of these companies, which have an established presence, higher efficiency levels that could compensate partially for rise in input costs and limited downside risks as large-cap stocks. Stock-specific recommendations of Business Line, however, will take precedence over this broad-investment strategy.

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