Bears will make money, Bulls will make money, Pigs will get killed

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.

Published in The Times of India, Ahmedabad

Crash in commodities market may be temporary

© Copyright 2000 - 2009 The Hindu Business Line

M.R. Subramani Chennai, March 23

Last week, the commodities market witnessed its steepest weekly fall in the last five decades. Gold fell eight per cent, crude dropped 6.35 per cent and wheat prices in the US market slipped below the psychological mark of $10 a bushel. Most of the commodities that peaked late last month or early this month have come off with soft ones such as soyabean, wheat and crude palm oil slipping by over 20 per cent.

Does the fall signify the end of commodities boom? Not really, say analysts and experts. The trend actually is a fallout of the crash in equity markets. Funds are booking their profits in commodities so that they will have the necessary liquidity and can overcome any loss in equities, says Mr V. Shanmugham, Chief Economist of the Multi Commodity Exchange.

A shake-out

“It is also more of a long overdue correction,” he says. “The sell-out in the commodities is to add liquidity and this is seen as a shake-out. This will eliminate small players in the market, who would be forced to de-hedge their positions,” says Mr Shyamal Gupta, Head (Institutional Business) of Kotak Commodity Services Ltd. Analysts see the current phase as a temporary one where the commodities could see a fall for the time being, consolidate, and then rebound.

“What we are witnessing is a new orbital in commodities. The prices will recover and the players are likely to take them to a new level,” said Mr Gupta.

Recession fears

“Currently, fears of recession gripping the US are mainly driving crude lower. As a result, other commodities such as soyabean, crude palm oil and corn – all seen as alternative sources of crude oil – have crashed. Vegetable oils had found new peak levels as they were diverted for bio-fuels. Diversion of acreage to crops such as corn, besides the vagaries of weather, saw the wheat counter on boil.

“In between, fears of inflation and economic slowdown have seen the funds and players buy into gold. “Physical buying will have to be at higher levels after the markets rebound from this fall. Soft commodities will touch new highs,” said Mr Gupta. “Gold, on the other hand, belongs to asset class. Its glitter will remain and demand growth will keep crude firm,” he says. Increasing demand, especially from emerging nations, is seen driving the prices of commodities further up.

And Mr Gupta sums up the likely trend saying: “Commodities is the only avenue for funds to make money for sometime to come.” 

Concerns over agri productivity and yield remain

The clichéd phase coined by Benjamin Disraeli on statistics has been reinforced year after year through the economic survey. While the standards of reporting have been formalised in the corporate sector over the years, the statistics on the health & wealth of the nation is yet to find a reliable footing.

The QLI (Quality of Life) parameter has got lost in the maze of national statistics. Environmental concerns are yet not captured through statistics. The frequent change in the standards of reporting in economic survey by the policy makers has made the release of the economic survey a mere ritual and left the common man baffled with jargons.

The survey has projected a GDP growth of 8.7 % compared to 9.6 % during the last fiscal. However, the agricultural and allied sector's growth rate was projected at 2.6 % compared to 3.8 % during the last year. Concerns of productivity and yield shall continue to haunt. The allocation for the NFSM (National Food Security Mission) for the year 2007-08 is Rs 402 crore. Needless to mention, even after 50 years after Independence, 52% of the population still depends on agriculture, although its share in the GDP has gone down to around 18 %. In the midst of the chest thumping production of food grains figures we shall remain dependent on imported wheat and pulses. Concerns of Energy Security has not been highlighted at all.

Commodities futures business grew by mere 7.8 % in 2007 (in terms of the lots traded) against a growth of 76.3 % growth in 2006. The statistics have proven that the hype created about the growth in the commodities futures is a mirage. The growth is mainly contributed by the precious metals, Crude and base metals prices shooting up. The survey failed to point out that while price discovery was relevant for the domestic commodities, the current state of affairs pushed the market to be an instrument for speculation.

International referenceable commodities contribute almost 70% of the turnover whose prices are not discovered on the domestic exchanges. While almost a quarter of page is devoted to comparison of MCX Commodity futures exchange with other Indexes, the contribution of the exchanges for price discovery is ignored.

If "Optimism, but with caution as the watchword" for the FM then perhaps we should "Watchout" for his words on containment of Inflation. Even after banning Tur and Wheat futures last year with the assumption that the futures market has pushed the spot prices, the prices in the current year have not been reined. The ruling spot prices are up by 70% & 40% for Tur & Wheat respectively since the ban of futures.

Published in The Financial Express On The Economic Survey 2007-08

Commodity spreads: Less risky, less speculative

During the last week of December, while the entire commodity market was taking a breather, the domestic commodity exchanges came up with circulars on spread margins that may not only drive away the hedgers from the market this year but also derail the price discovery mechanism.

While the old saying “fake it till you make it” worked for a large number of myopic stances taken due to regulatory directions, this will certainly kill the physical market’s participation in the domestic exchanges.

Let us first understand the fundamentals of spread; spread is the simultaneous purchase of one futures contract and the sale of a different contract. The futures contracts can be different delivery months in the same commodity; or they can be two different commodities spread against each other. Or, they can be the same commodity traded on two different futures exchanges (currently, almost non-existent in India).

One might ask why people trade spreads when they can just as easily buy one futures contract and sell another one via separate transactions and hedge their risks. An important reason to place a spread order, rather than orders for the individual components of the spread, involves order-placing strategy.

When you trade the spread, you lock in the price differential between the “legs” of the spread, often by specifying the exact differential. If you try to trade the spread by placing two different market orders, for instance, many things could happen between the time you place your order and the time both orders are filled. 

Thus, a single-spread order can be more predictable and less risky than multiple individual orders. Almost a decade ago, the R.V. Gupta Committee Report had recommended about spread: “So long as anticipated physical exposure levels appears prima facie to be reasonable, it would be unduly restrictive to bar the firms concerned.”

Internationally, the spread trade margins are continuously being reduced. Comex had cut the spread margin on September 7 to between 56 per cent and 76 per cent. Internationally spread hedges are being promoted to cover price risk. The recent circulars will create not only volatility in margins but also expose the futures market to unnecessary cash flow volatility, thus creating market distortions.

While the exchanges are trying to embark on a VaR-based margining system for individual futures contract, the revised calculation of the spread-based margining and the ambiguity in calculation (not based on VaR) leaves a lot to be desired.

Strategies of the Hedgers

Spreading strategies assume that both the long and short contracts used in the spread are affected by the same economic circumstances. As a result, prices of the long and short are expected to move generally in sync. If, for some reason, the prices of the two futures do not move together, then an opportunity to book profit by physical players may arise.

If the hedger believes that current price relationships between related futures contracts are out-of-line, then he or she would buy the relatively under-priced contract and sell the relatively overpriced. If the two contracts move back to the expected price relationship, then the hedger protects the profit.

Physical traders, by doing spread trading, reduce speculative activity in the futures market. For example, if the nearby futures contracts for maize are gaining in price relative to the deferred contracts, this generally indicates more demand or less supply, or both. It’s a strong signal that fundamentals are bullish and prices may well move still higher.

However, if the nearby maize futures do not gain on the deferred during an upmove, the trader may deduce that the recent price advance has been technical in nature and not backed by bullish fundamentals, and that a sell-off may be close at hand. Thus, the spread trading helps in the “price discovery” — the foremost function of the futures market.

It has been said that most spread traders rely heavily on fundamental analysis when employing their spread trades,

Spread trading in futures markets does not get a lot of attention among speculative traders. This is because of the complexity that tracking and analysing some spreads can entail. Many hedgers do employ this method of trading because it can be less risky and less expensive than trading straight futures contracts.

Spread trading usually involves less risk than trading straight futures. Because storable commodities have “carrying charges,” spreads rarely go beyond a certain level that is known to hedgers. This means a trader can initiate a spread and know to a fairly certain degree how much risk is involved. There are some spreads that do involve higher volatility, such as inter-commodity spreads; however, these are non-existent in Indian conditions.

Spread and physical market

In the grain business, the difference between two contract months of the same commodity (i.e. maize) represents the carrying charges or the cost of holding the commodity for a period of time.

Carrying charges are determined by the cost of interest and storage when physical commodities are held in store. (not necessarily in the exchange approved warehouse).

Grain traders monitor spread relationships very closely as the relative difference between various contract positions determines the handling margins or profitability of their involvement in marketing grain.

When using spreads, the hedgers hope to protect profit by changes in the spread (difference) between the two contracts. The hedger is looking for either a widening or narrowing of the spread relationship over time. Spreads are used when the difference in prices between the long and short contracts is considered to be "out-of-line".

Commodity-Product Spreads

A commodity-products spread comprises a long position in a commodity against short positions of an equivalent amount of the products derived from it, or vice-versa. A well-known example of a commodity-products spread is the so-called soybean crush, which involves going long on raw, unprocessed soybeans again short positions in soybean products – soybean meal and soybean oil.

The soybean crush gets its name from the fact that when soybeans are “crushed” in processing, two products are made, meal and oil. A “reverse” crush is a spread in which soybean futures are sold and soybean oil and meal futures are bought. Traders undertake the crush (or reverse crush) when the price relationship between processed and unprocessed soybeans is different from what they expect.

Risk management tool

Spread hedges are considered to be a less risky and often less expensive way in which to participate in the futures market. Spread trading is more complicated than outright trading and requires a higher degree of sophistication on the part of the trader. By monitoring the relative strength between various contracts and between different markets, one will be better able to select the appropriate pricing and risk management strategies when developing the marketing plan.

In conclusion, spreads, when used by physical market players and hedgers, can be a key tool to managing the risk in a position while maintaining a profit potential as spread hedges are less sensitive to market direction predictions of the individual contracts and it may be easier to predict market relationship patterns than price direction.

Published in The Business Line 25 Jan, 2008

Entities with short term perspective will get wiped out

In the Chinese calendar, 2008 is known as the year of Rat. In India, Rat is associated with Lord Ganesha, who is widely revered as the remover of obstacles. If the commodity futures market needs anything - it is the removal of obstacles of growth. This year will probably witness a large number of removals of structural impediments by the existing sectoral order and overall structural business adjustments rather than any drastic policy change by the govt.

Demand for commodities from emerging economies is incredibly strong and incredibly resilient, given the high prices. Given the limited growth in supply across most markets crude, gold and grains prices will still have to increase substantially from the current levels to slow down the healthy demand growth from emerging countries.

On the corporate side, commodities price momentum will spur mergers and acquisitions, like the one seen in case of BHP-Rio Tinto. The logic is to focus output in fewer hands to instill market discipline and protect prices.

The trend is fuelled also by the rise of new competitors form previously unknown geographies. Their ambition, cash flow and concentrated ownership means consolidation is unlikely to happen cheaply. There is a saying “Bulls will make money, Bears will make money but Pigs will get killed”. Entities with short term perspective and without backward and forward integration will get wiped out from this market.

International commodity exchanges during the last two years had witnessed a large number of mergers. While domestically we can not rule out similar mergers in years to come, it is important that the focus shifts form hype to the issues of exchange governance. It is also hoped that exchanges will come out with the clearing houses which is so prominently missing in the operating structure.

STT will continue to hang like sword of Damocles on Commodity Futures business. Abhijit Sen Committee report may perhaps see the light of the day unlike FCRA Amendments which may not get tabled in 2008 in Parliament.

At the national level the lack of institutional capacity to think coherently about food and energy security will lead to high cost import dependence. The inability to monitor, manage and report the demand effect of the growing economy will keep the economy highly vulnerable to price shocks.

Commodities have historically displayed a low correlation with other types of assets. While sectoral diversification is a plus, commodities remain...

Published in The Financial Express on 30 Dec, 2007

Beat the burnout blues

Amit Mukherjee (C) Business Today


December 12, 2007

Raghav Jutshi, 31, a collection and recovery executive in a leading mobile service provider, was catching up on the day’s events with his wife around midnight. He had had a long day at work that ended around 10 in the evening.

Just then, the mobile on the side table beeped. “So what’s your target for tomorrow?”—read the message from his boss. A sense of unrest immediately set on him.

He forgot what he was discussing with his wife.

Wide awake, all that he could think of was the number of collections he would execute the next morning and how much he would amass for his firm’s kitty.

Jutshi’s is not an isolated case. Corporate stress in the form of tough deadlines and impossible targets is taking a widespread toll on executives across the industries, especially in the high-growth sectors. 

Psychologists define it as burnout— a chronic condition that happens when the body or the mind can no longer cope with overwhelmingly high demands.

“This growth has resulted in riches; but has brought about psychosomatic disorders and early mental and physiological burnout of individuals, sometimes even before they have touched 40,” says Dr Aruna Broota, well-known clinical psychologist at the Dept. of Psychology, Delhi University.

Most companies, especially those in the fast growing sectors, acknowledge that employees are, indeed, stretched. “Considering that the need to grow to a global scale has struck us late; many of us are working overtime to make up for the lost years,” reasons Manoj Kohli, President & CEO, Bharti Airtel, India’s largest and fastest growing telecom giant.

Many of the present generation of executives who want to see India shine are working really hard despite burnout threats, Kohli adds.

So, how big is the burnout risk for India Inc’s young, restless and stressed workforce? Enormous, if corporate psychologists are to be believed. It’s a vicious circle that the employees are stuck in. “The jobs are paying well but, drain individuals physically or emotionally,” says Dr Broota.

If this situation continues for years, months, or in some cases for weeks, a person may finally reach the breaking point and fall victim to the burnout syndrome. 

To make matters worse, there seems no way of avoiding this stress. “India is in a time zone where we cater to markets both in the East (Singapore and Hong Kong) and in the West (Europe and the US).

That’s why the pressure is high and more work hours are required,” says Shyamal Gupta, Head (Institutional Business), Kotak Commodities.

It’s Catching’em Young

Workplace burnout is increasingly affecting the young workforce. Dr Suman Bhandari, Senior Cardiologist at the Escorts Heart Institute in Delhi, says about 25 to 30 per cent of heart ailments are among executives younger than 40.

“This has clearly to do with excessive stress and inability to cope with the present work culture,” he asserts.

Diseases like spondylosis, abdominal disorders, pain in heels (these are the symptoms of burnout as well. See Burnout alarms on top) are common disorders in the 25-40 age group.

Some companies have already woken up to the enormity of the crisis.

Software major Infosys Technologies has a 24-hour hotline connecting its employees to psychiatrists. But, stress and burnout are not limited to just the IT sector.

Long hours of work and immense pressure to produce results are ubiquitous across industries. Add erratic lifestyles and irregular eating habits; and there is a generation of physiological burnouts facing India Inc.

Work-life ImbalanceThe phenomenon is primarily due to the lack of work-life balance, say psychologists. “Unlike westerners, who work five days a week and relax and enjoy life in various ways on weekends, most of us do not have hobbies such as trekking, hiking or even music,” explains Dr Bhandari. Such activities are great stress-busters.

The problem has acquired a serious dimension as it is not being dealt with appropriately at the HR level, says Dr Broota. “Given the current scenario, interventions to ensure congenial working conditions should actually come from the HR departments of companies,” she says, recalling an instance where an executive of a mobile services company sought her counselling as office stress literally pushed him to his limits. Lifestyle intervention and stress management should be made mandatory for companies in India, says Dr Broota who conducts “three workshops every two days” on burnout-related issues for these companies.

The culprit sectors, according to her, are: IT, telecom, retail, and asset management.

Is There a Choice?

That’s a tough question to answer for both the companies and their executives. For executives, there is personal ambition as well as professional compulsions to meet targets. “If you don’t perform, there are plenty of others wanting to replace you,” says Gupta of Kotak Commodities.

However, Raghu Pillai, President and Chief Executive, Reliance Retail, adds a new dimension to the excessive workload scenario. “Everyone in India really needs to work hard so that the next generations can enjoy the country’s success some years down the line.”

He agrees that some balance between work and relaxation is required but says, India cannot afford to have an easy work culture yet. “The developed nations are way ahead of us. Maybe the next generations can emulate them when things here are better,” he says.

Some, however, insist that burnout can hurt the high growth ambitions that are the very cause of this phenomenon. “Whether it’s the pressure of dealing with tight budgets or preparing for the next board meeting, executive stress does have a negative impact on your performance, decisions and even the company’s finance,” asserts Koustav Dhar, President, MDLR Airlines.

Dr Broota’s remedy: A change in the corporate mindset and work culture. Till that happens, India Inc’s tryst with burnout will continue.

Wanted: Energy managers

India Inc is realising that energy availability and its cost play a significant role in profitability. Hence, the urgent need to manage energy effectively. That’s the reason companies across industries are in hiring mode for energy managers. Explains Malavika Desai, CEO, RCG, a leading recruitment firm: “Take, for instance, the textile industry.

The share of energy cost in the total manufacturing cost in spinning mills works out to around 14 per cent per unit of production. It’s even higher in some other industries and every rupee saved in energy costs will go straight to the bottom line. Therefore, there is a great demand for trained energy managers.” The job of an energy manager involves planning, developing, and managing energy utilitisation programme. This includes assessing the energy use and devising the energy-saving methods.

All that glitters is not gold

Aman Dhall & Dheeraj Tiwari  (c)The Economic Times

4 Nov, 2007

The glitter of gold may not be the same this festive season with prices of the precious metal reaching an all  time high. But amidst this volatility in the international markets, the latest option of investment in gold through futures and exchange traded funds (ETFs) is wooing a new set of investors. Here’s an insight into why you should prefer investment in futures and ETFs over gold. 

Shining Instruments

So how does the mechanism of ETFs works? For starters, these funds are traded on stock exhange much the same as a regular stock does. “ETFs are essentially passively managed funds. If you buy a Gold ETF there is no real fund management involved and your invested money is simply used to buy the underlying commodity,” explains Jayant Manglik, head, commodity business, Religare Commodities, a Ranbaxy promoter group company.

Compared to buying the physical commodity, ETFs allow you to buy ‘units’. So you can invest in small amounts. There is also no entry load (except the brokerage) and zero or minimal fund management charges because it’s a passively managed fund. “Expense ratios are typically lesser. Eventually, investors in India too will benefit once the liquidity improves and more people take to ETFs. Besides, no one is ‘pushing’ the price,” says Manglik.

Precious Metal

Demat delivery (just like in equity) does away with the requirement of keeping the commodity in physical form, thereby making security a non-issue. Compared to the sharp increases in the prices of precious metals in previous years, the cost of demat is minimal.

Experts believe that futures have several advantages over ETFs in terms of leveraged positions and small margins, which effectively allows the investor to ‘buy’ the same amount of gold at a lesser ‘price’. “Rather than being a passive investor, it is better to buy through futures that allow you to take benefits of a fall in market prices as against ETFs, which are ‘long-only’ funds,” feels Shyamal Gupta, head, institutional Business at Kotak Commodity.

Delivery Route

Industry players believe taking delivery through futures is beneficial for people who want to buy to meet social compulsions. “One big advantage is that only the best hallmarked gold bars in the country are given as delivery by the exchanges like MCX and NCDEX and so purity is guaranteed,” says Manglik. But taking demat delivery has its own disadvantages. When the price goes against your position (price falls after you have bought) then you have to give the difference (known as MTM or marked to market) immediately to the broker. So, it’s advisable for those who don’t understand the dynamics of how the commodity market works to avoid buying through futures. There have been many cases in the past where individuals lost huge amount of money because of indulging in sheer speculation.

Diversify to balance

Experts recommend that you should hedge your risk by diversifying the portfolio. “It’s always a good ploy to invest in different financial instruments. So even if you are investing in gold futures or ETFs, it is always recommended to invest some part of your portfolio in other options to mitigate the risk,” says Vikas Vasal, partner, KPMG India, a renowned global consulting firm. Experts feel that gold, as a portfolio and risk diversifier, cannot be replaced. That’s primarily one of the reasons that today also all the major investors worldwide have 3 – 15% of their portfolio in gold.

Gold Talk

An ounce of gold has reached $800 for the first time since 1980. There is a perception among the people that the prices are running up due to festive season, but that’s not true. International factors like a weak US dollar and high crude prices have been the dominant reasons for price increases in recent months. Though experts widely accept that there’s no right time for investing in gold, some feel that as long as US economy is perceived weak and therefore the US$ is weak against other currencies and crude prices are high, gold will be seen as a hedge against crude-led inflation.

“The international geo-political situation remains tense. Asian countries such as India and China have fast increasing demand, and it’s unlikely that the prices will come down in the near term. Apart from demand being more than supply, a combination of above factors will ensure firm prices in the foreseeable future,” believes Manglik.

But Gupta has other thoughts. “Based on the fundamental and technical analysis, in the long run, say over a period of two years, gold prices are likely to come down,” he says.