Commodities hold promise as assets

One of the asset classes that holds promise in uncertain times such as this is ‘Commodity'. Commodity as an asset class is poised to benefit from the long-term structural growth factors, as well as external influences working to its advantage.

A key factor in favour of commodities is the increasing demand for natural resources where demand outpaces supply. As global population grows, and more people migrate from rural areas to urban locations, accessing a sustainable and secure supply of raw materials will become a priority for countries. This will lead to rapid industrialisation, as is being witnessed in India and China, thereby increasing the demand for commodities.

Even as demand increases, several impediments, including climatic change, impact their availability. Results from a study conducted on “Climate and Global Crop Production” reveal that from 1981-2002, global warming reduced the combined production of wheat, corn, and barley by 40 million metric tonnes per year. As supply constraints increase, commodity prices will rise.

PRESSURE OF INFLATION

Another factor that works in favour of commodity investing is inflation. As global growth rebounds, inflation-based pressures would increase. As is widely known, while equity has a negative correlation with inflation, commodities display a good correlation. This means commodity prices will rise with inflation, and thus act as a hedge.

While commodity investing does have its advantages, it also has certain limitations. One needs to be prepared to experience high volatility when investing in commodity.

In fact, the volatility associated with this asset class can be higher than that in the case of equity at certain times. Secondly, commodity displays very low correlation with some asset classes; however, this equation is becoming hazier, as commodity seems to be reacting to macro influencers similar to the rest of the asset classes, say equity.

The advantages outweigh the demerits, and it is important that one allocates at least a certain proportion of resources to this asset class.

INVESTING AVENUES

Investing in commodity has come a long way since markets operated purely on the basis of physical purchase and delivery. Today, investors have several options to take exposure to this asset class. Sophisticated investors can invest in Commodity Futures which is primarily an agreement between two parties to buy or sell the commodity at a future date at a pre-decided price. Similarly, one can invest in Commodity ETFs which either purchase and take a physical delivery of a commodity, or invest through the futures contracts. In India, regulations allow the purchase of only Gold ETFs, but eventually, more commodities will be included, thereby expanding the investment canvas for investors. Even as these options gain acceptance, several investors prefer to invest through the commodity stocks route. The underlying logic is that if the price of a commodity were to rise, the company engaged directly or indirectly with the business of manufacturing the commodity would also stand to gain.

For retail investors, the best option available is to adopt the Mutual Funds route, since it allows one to avail the expertise of a Fund Manager at a marginal cost. Mutual Funds invest in commodities either by investing in shares of specific companies, or through the ‘fund of funds' route, wherein a scheme invests in a master fund that is domiciled in a different country, most likely a resource rich nation. Commodity-focused mutual funds also enable an investor to mitigate risks, since the fund portfolio would comprise several commodity stocks.

(The author is Chief Executive Officer, Mirae Asset Global Investments (India) Pvt. Ltd.)

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