The bull market in commodities, now in its fifth year, has produced a rally not seen in more than five decades. Copper five times over the past five years, gold more than quadrupled and oil tripled
Profiling: Unlike stock market, the commodities market has three main kinds of participants, Arbitrageurs, Speculators and Hedgers. If one has to participate in this market it is important to profile the participant. Internationally, the commodity index funds have done extremely well however, India does not offer any of these fund based solution to the investor class (due to regulatory reason) to participate on the commodities market hence the profiling become all the more important for protecting the interest of the participants.
How do Indians Benefit from Commodities Boom: The Indian market offers two options either participation through futures market or spot market. While cash and carry flourished initially however due to runaway prices, the govt sword and promulgation of Essential Commodities Act keeps hanging against the participants. Agriculture being on the concurrent list and each State having its own Agriculture Produce Marketing Act (APMC), the complications will necessarily evolve in the delivery, which is part and parcel of the spot trade.
Inflation Hedge & Global Indicators: Strong returns in commodities in 2008 are offsetting losses elsewhere for institutional investors’ portfolios and attracting a record level of fresh funds into the asset class. According to bankers in London and New York, fears over rising global inflation, robust fundamentals and the weakness of the dollar are other reasons for the strong interest. With stocks losing money, people had instead been buying bonds and in particular commodities, which have been stratospheric. Traders bought commodities as a hedge against inflation. High commodity prices guarantee upward pressure on inflation. But the slowdown predicted by stocks and bonds reduces commodity demand. So buying commodities to hedge against economic woes looks like a self-defeating strategy.
Volatility and Margins: No wonder, volatile trading conditions have become persistent in the commodity markets; yet activity in this sector is hardly slowing. Most recently inspite of market moving in favour of “longs” the volatility has caused huge margin call resulting in de-leveraging of positions by many. Since participation in commodities futures is leveraged the losses and profits are also leveraged.
Risk Appetite and Portfolio size: While stock market participants can rely on the market “tips”, this market requires deeper understanding of the underlying. Passive investment with small risk capital is possible in stocks however one requires a comparatively larger capital and active tracking of the market.
The success in this market will be in a disciplined approach to balanced portfolio creation with stop loss limits and proper assessment of the portfolio risk. Rather than having targeted prices the participants should have benchmarked profit with stop-losses triggers with unemotional attachment to the positions in the market.
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