Federation of Karnataka Chamber or Commerce and Industry

ARTICLE: COFFEE, COTTON AND THE CHANGING WORLD OF COMMODITIES

Adhvith Dhuddu, Regular Columnist, DECEMBER 2007 ISSUE

The commodity market boom coupled with inflation is taking more out of our pockets for everyday purchases of coffee, channa, chilli and crude oil (petrol, gas, and diesel) than ever before. These elevated prices are here to stay and it’s not too late to explore opportunities to put your money to work in the commodity arena. This extended Bull Run initiated at the turn of the millennium is expected to last at least another decade.

The explosion in commodity prices (i.e. raw materials, natural resources, precious metals, etc) closely resembles the buoyant stock markets the in the late nineties (in USA), the only difference being these lofty prices are sustainable over the long term. This is because of the tremendous imbalance in the supply demand relationship in the next few decades, attributable to the rise of South East Asian economies (more demand) and fast deteriorating supplies.

It's imperative to be well-informed about commodities as they — unlike stocks, bonds and real estate — are a part of our lives every day. Your breakfast includes corn and milk, your Coffee Day mocha contains sugar, cocoa, and coffee, your lunch and dinner include wheat, rice, beans and pulses; the car you drive is made up of steel, aluminum and rubber. Every day you touch and feel commodities that are traded on a 24 hour basis around the world, and every day the demand for these consumables is outpacing the supply.

Sugar for example has been experiencing a rise in prices for the last few years. An increasing number of sugar beet processing plants being shut down since the mid 90s in the US and higher demand for sugar from China (China has increased its sugar imports by 20 percent year-over-year for the past 6 years) are some reasons. Brazil’s (Brazil is one of the highest sugar producers) smarter use of its home grown sugar for local consumption and ethanol use have reduced its capacity to export also contributing to the price rise. Being one of the top producers, consumers and exporters of sugar, India has shown it is self sustaining but this resilience might soon fade away once Indian producers start to feel the pinch.

Lead is a metal with wide ranging applications in electric power systems, lead-acid batteries, ceramics, roofing, forklifts, television, computer monitors, etc, and its demand is expected to swell in the next two decades. With supply either constant or deteriorating, a price rise in lead is inevitable.

Global freight and shipping rates are at all time highs (check the Baltic Exchange Dry Index), and these outrageous prices affect commodity players. This automatically drives up the prices of steel, copper, aluminum etc, because either the producer or the supplier has the burden of paying shipping costs. This was an insignificant factor a few years ago, but increased sea traffic, insufficient ships and inadequate port capacities is driving freight rates to record levels and directly impacting commodity prices.

The Central Banks of any country have the power to warm up the printing presses and create more money out of thin air if there is a need. But it’s impossible to similarly create tangibles like foodstuffs, precious metals and raw materials. It will take time (10 to 15 years) to bring to market these highly demanded commodities to meet the supply.

It is cumbersome to invest directly in commodities like sugar, lead or coffee, but more direct methods like investing in a commodity index (tracks a bunch of commodities), or an ETF tracking a commodity index solves the problem. Some internationally acclaimed indices like the Rogers International Commodities Index and the Dow Jones AIG Commodity Index are up many-fold in the past few years.

Other alternatives include investing in companies that produce commodities. Behemoths like Arcelor-Mittal (produces steel), Alcoa (produces aluminum), Phelps Dodge (produces copper), Rio Tinto (mining giant), Vedanta Resources, etc, are sure to rope in record profits in the next decade and a half with rising commodity prices. In fact most of these stocks are up over 300 - 500 percent in the last few years and still appear undervalued. Locally, scrips like Amara Raja Batteries, Hindustal Zinc and Tata Steel have risen over the last few years. An economic slowdown in the US or the Asian subcontinent will drive commodity prices lower, but this only presents a buying opportunity for long term investors.

It is also very safe to invest in countries that produce commodities. Natural resource rich countries like Australia, New Zealand, Canada, Bolivia and Chile will experience good economic times in the next few years.

High net worth individuals (HNIs) can also invest directly in commodity exchanges. Multi Commodity Exchange of India (MCX India) and National Commodity and Derivatives Exchange (NCDEX) are two major commodity exchanges in India. As our economy expands, the volume of commodities traded locally will rise and the demand for membership to these exchanges will increase with it. This will translate into increased revenue and higher profits for commodity exchanges (the main source of revenue for commodity exchanges is trading fees and membership fees).Long term investors can thus obtain membership and watch its value rise, or simply purchase a stake in the exchange. Something very similar is unfolding in our stock exchanges, spurring a rat race for stakes in the National Stock Exchange of India (NSE) and Bombay Stock Exchange (BSE).

One spectacular book, “Hot Commodities,” written by legendary commodity investor Jim Rogers explains why the next decade and a half will see an unprecedented boom in prices of all types of commodities be it precious metals, energy, cereals or food. Being the first to foresee the commodity boom in 1998, he commands immense international respect.

Not surprisingly, the Canadian dollar was worth US $1.04 three decades ago during the late 1970s commodity bull market. It was exactly during this period that oil hit the record high of $101.30(inflation adjusted). The late 1970s was also when gold and silver hit record levels. This is exactly what has been happening in the recent past, and will continue to do so in the future. History might not repeat itself but it definitely rhymes with the past.

Online link to this article: FKCCI DECEMBER 2007 ISSUE