The Hindu Business Line : Commodities as an emerging asset class

Commodities are becoming critical for fuelling India's economic growth. Investment in commodities not only has a balancing effect on the portfolio, but also acts as a natural hedge.

GOLD IS widely perceived as a hedge against inflation

As one of the world's fastest growing significant economies (GDP growth averaged 8 per cent last three years), India is finally beginning to get noticed by the world at large. Rising incomes, growing population (over one hundred crore or one billion growing at 1.8 per cent a year), soaring foreign exchange reserves (over $175 billion) and economic liberalisation policies make India an attractive destination for overseas investors and businesses. Indeed, India is emerging as an asset class. Growth is driven by domestic consumption and investment, plus gains from integration with the global economy through exports and capital flows.

An investment destination

Why is India an asset class? Strong performance of fixed income and equity asset classes, for one. Record FII flows demonstrate global investor interest in the country and its potential. Importantly, investors look for options so as to broadbase the investment basket. This is where India as an investment destination comes in. There are not many large countries that boast of roots of democracy, strong judiciary, population of 100 crore and economy growing at 8 per cent a year. What are the different asset classes available to investors? Fixed-income instruments and equities are popular. With limited supply and growing demand, real-estate is emerging rapidly as an asset class. Commodities are a new entrant into this category of investment options. Art too is catching investor fancy.

An asset class

The key features of an asset class are: Return; risk; and liquidity. Investors will have to have a clear picture of risks and rewards — what is called the risk-reward profile. Liquidity too is important. The ease with which one can trade the asset and transparency in trading boost investor confidence. The breadth and depth of the market will have an effect on liquidity and, in turn, price discovery and price risk management for market participants, without manipulation. The efficiency with which settlement takes place is another key motivator. Last, but not the least, is regulatory oversight. A strong regulator armed with adequate knowledge and authority to regulate the market and deal sternly with delinquencies will enhance investor confidence in the market.

Avenues for diversification

Interestingly, commodities offer excellent diversification possibility in asset risk management. Investment in commodities, in addition to others, not only has a balancing effect on the portfolio, but also acts as a natural hedge. Assessment of relative performance of various assets would show how well commodities perform. Even central banks eye commodities as part of diversification. Gold, for instance, is a wonderful example of a commodity that is widely seen as a safe haven investment and a hedge against inflation. The critical importance of crude or energy complex is beginning to be felt across the world. Commodities tend to outperform other asset classes when an economy is in an expansionary phase.

The major Asian economy, China, has been in an expansionary mode for some years now, and India has joined in. Indeed, the commodity market is bigger than the equity market in developed economies. With the increasing integration of the Indian economy with the global economy, economic interest in commodities is rising in India. Policies of liberalisation have resulted in dismantling of restrictions on internal and external trade. As a result, market opportunities have expanded considerably. Commodities are becoming increasingly critical for fuelling India's economic growth. For our country, there are six major areas of growth. These are: Food; education services; health services; clothing and apparel; housing, construction and infrastructure; and leisure and entertainment.

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