‘Take diversion' – invest in commodities too

Commodities have emerged as an alternative investment option today and make for a good tool to hedge against the spiralling inflation. The lure for commodities, however, isn't just limited to precious metals. It is slowly spreading to agricultural commodities too. But do commodities really fit a retail investor's portfolio? And is the futures market the only way to do it?

Dharmesh Bhatia, Associate Vice President-Research, Kotak Commodities , shares his views on commodity investing and gives a lowdown on the risks involved too. Excerpts from the interview:

Should retail investors invest in commodities?

Definitely, as commodities give diversification benefits. Gold and silver for instance do not have a high positive correlation with equity and hence help the investor hedge his portfolio against the uncertainties and the risks that are tagged with equity investments. On the returns parameter too precious metals have done well over the last few years and will remain upbeat in the medium term. Retail investors can consider investing 20 per cent of their portfolio in bullion.

Do you see a growing retail interest for commodity investment?

Yes certainly! When the commodity futures market was in its nascent stage, the majority of traders were only the ones with a very short-term investment horizon. This was because investors had little knowledge of the factors that impacted commodity prices. However, as the market has evolved, more retail investors are becoming informed about the commodities market. Extraordinary returns given by commodities such as gold, silver, crude oil and copper have also highlighted the investment potential of the commodity futures market.

What influences the price of commodities?

Commodities in which India is self-reliant i.e. those that are produced domestically see local demand-supply factors influencing price. This is true for a majority of the agri-commodities such as chana, guar seed, pepper, jeera etc. However, prices of imported commodities such as gold, silver, copper, crude oil and a few agri-commodities such as refined soya oil, crude palm oil etc. are decided by international demand-supply dynamics and developments on global economic front.

What is now driving price of the precious metals?

Global markets have still not completely revived from the recession. This uncertainty is spurring price of gold and silver, which are essentially safe-haven bets. As capital flies towards safety, we can expect to see this uptrend in precious metals for at least the next 6-8 months.

What are the options for investing in commodities? Should one necessarily take only the futures route?

Besides the commodities futures market, investors have the option of taking the ETF (exchange traded funds) route and the spot market (both through the physical commodity market as in the case of gold coins, as well as the electronic spot market through National Spot Exchange Limited). However, futures market offers the advantages of leverage, protection from counter-party default risk and guarantees the quality of the physical commodity delivered. These make it an attractive route for investing in the commodities market.

What are the risks in investing in commodity futures?

An investor in the commodities futures market is exposed to the risk of high leverage. In the futures market, broking houses generally let clients take a leverage position of up to 20-30 times the margin amount. But this at times may work to the disadvantage of the investor. An investor is at risk if he is highly leveraged in a volatile market. Futures market is advisable only for investors who are willing to take medium risk for high returns.

Unlike equities, commodities are very difficult to track. They have several global events influencing them. How can retail investors get a better understanding of the market?

In my view, commodities are not very difficult to track as the prices are basically impacted by the current and expected demand-supply scenario. Global events impact some commodities such as bullion, base metals and energy. And to understand this correlation an investor has to keep track of major global economic developments.

What is the process of starting to invest in commodities futures market?

A potential investor can contact any of the broker/members registered with an authorised exchange. He can start investing by depositing the required margin amount after completing the account opening procedure.

What are the commodities that a retail investor can look to invest in and how? Tell us the one will best fit a retail investor's profile.

A retail investor can start with an investment in gold. Commodity exchanges offer various alternatives. Besides the regular 1 kg gold contract, smaller contracts are available such as the 100 grams gold mini, 8 grams gold guinea and the recently launched 1 gram gold petal contract. I recommend gold to begin with, since the yellow metal has consistently provided about 20-25 per cent return year-on-year in the past 5 years. Besides it provides portfolio diversification. If interested in agri-commodities, one can consider soy bean, refined soy oil and chana.

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