Will this trigger the end of the commodity bubble?

May 23, 2011

In this issue:
» Brand value in India Inc.
» Will land reforms help government change its 'lame duck' image?
» Why banks are seeing red in retail loan books?
» Yet another subsidy plan to weigh on govt's books
» ...and more!
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One look at the March quarter numbers of India Inc and you know to what extent commodity prices can erode margins. Especially if they are accompanied with higher cost of borrowing. Commodity prices - be it food or non food - have assumed a disproportionate weightage in government and central bank policy making. Especially so in the past 18 months. During this time they have also emerged as a very lucrative investment. The meteoric rise in prices of precious metals like gold and silver, resources like oil as also some food crops has confirmed this belief. Most analysts and investors recognize the fact that commodities by nature are cyclical. Hence the rise in their prices cannot last forever. However, there seems to be little to suggest that supply for the goods will outstrip demand anytime soon. Unless you dig a little deeper into what kind of demand is pushing up the prices.

Speculative demand has had some role to play even in the rise of prices of gold, silver and crude oil. Its impact was seen more closely in the recent crash of silver prices. In the case of food grains too, speculative interests have at times camouflaged adequate supplies. But this time the speculative minds seem to have turned to a commodity that lies at the core of nation building - iron ore. The management of China's biggest steelmaker Baosteel has been quoted in Bloomberg with the opinion that iron ore prices are near 'bubble level'. With multinationals like BHP Billiton hoping to get a pie of China's and India's infrastructure pie, the stakes have got higher. The cost of M&As in the iron ore space have been going through the roof. And it is only a matter of time before the speculative demand backs out from steep pricing.

Honestly, we do not know if this will really mean the end of the commodity bubble. Nor are we of the opinion that prices of necessary resources will hit their lows anytime soon. Hence pain on margins is certain for companies that do not have pricing power. However, investors would be better off not getting carried away with the greed of riding the commodity bubble.

Do you plan to invest more into commodities in the near term? Let us know your views or post them on our facebook page.

 Chart of the day
That the commissioning of power capacities in India is well short of the targets for the 11th 5 -year plan is not news to most readers. Power generation companies have complained of land acquisition issues for the lack of timeliness in setting up of new projects. But shortage of coal which remains a necessary fuel for 60% of the power generated in the country is also a major hurdle. In fact as seen in today's chart, shortage of coal was at its peak in the latest fiscal (FY11). Unless the power companies get their coal linkages in place for new projects, most of India's infrastructure plans could well remain on paper.

Data source: Tata Power March 2011 result presentation

Try and do this exercise if you can. Compile a list of companies with the highest average return on net worth (RONW) over the last 10 years. And now, try and identify one common characteristic that the top ranked companies possess. Our guess is that most of the top ranked companies would be the proud owners of one or more brands. Alternatively put, presence of brand seems to be one of the most important characteristic that separates a wealth creating company from the one that either destroys wealth or stagnates after a few years.

In view of this, it is hardly surprising that Warren Buffett, one of the biggest wealth creating machines the world has ever seen, puts so much emphasis on the presence of a brand. The good news is that this phenomenon may not be restricted to the West alone now. A lot of Indian companies are also warming up to the idea of brand creation and valuation. Already, nine Indian companies feature in the list of Global 500 ranking of brands by a leading brand consultancy. And the way things stand now, we will not be surprised to see a lot more companies making the cut. What more, for us investors, the list is likely to provide a readymade source for identifying potential investment opportunities.

Things are not hunky dory for the financial markets globally. The Euro zone especially has seen its problems escalate with Fitch Ratings cutting Greece's debt ratings. This has pushed the country deeper into the junk. In the meanwhile, Italy has also seen its ratings cut to 'negative' from 'stable' by Standard & Poor's. All this has naturally taken its toll on the Euro, which has lost its value against major currencies.

Interestingly, debt concerns in the Euro zone has sent investors scurrying for havens such as gold and US government debt. Now, investing in gold is a sensible stance given the questionable worthiness of paper currencies. But buying more of US debt raises one's eyebrows given that US is not out of the woods either. Debt in the US has soared to huge proportions and economic recovery has not really started there either. Asia is having its share of hiccups too in the form of higher inflation, rising input costs and crude prices and the impact all this is having on the profitability of companies in this region. As a result, problems in the developed world and concerns in the emerging markets have certainly played a role in dampening investor sentiments. Nevertheless, over a longer term perspective there can be no doubt that emerging nations will display a stronger growth trend as compared to the rich world.

Repeated interest rate hikes by the RBI over the past year are expected to soon take a toll on banks' loan growth prospects. They have started passing on the impact of the rate hikes to their retail customers. Interest rates on housing and auto loans have thus, been hiked by 1-2%. But, this increase is pinching customer's wallets, which are already burdened by rising fuel prices and food inflation.

Retail loans were a huge growth driver for banks over the past year, since there was a lot of pent up demand, post the recession. Housing loans also saw a fillip on account of aggressive marketing, and teaser loan schemes. In the financial year 2010-11, retail credit grew by 17% YoY (year on year). And within this segment, housing loans and auto loans saw fantastic growth of 15% and 24% respectively. But with customers now balking at higher interest rates, banks are expected to see a major slowdown in retail loan book. And, with no cut-back expected in RBI's monetary policy stance, and increased provisioning on bad loans, most banks are in rough waters currently.

It's been 7 years since Prime Minister Manmohan Singh's government came to power. While the government may skip no chance to pat itself for the high rate of economic growth and the various social welfare schemes, it is desperately struggling to change its "lame duck" image. The recent scams and scandals in India have laid bare the poor governance of the government.

Now, the government has promised to push a key land reform bill in the July parliament session. What will the bill do? It will make land acquisition easier. In other words, setting up factories, mines, roads and power plants will be easier and smoother with this bill. On the other hand, rural land owners will get a better deal. No wonder that the Congress government has made this announcement at this juncture. Though the passing of the bill may be a desirable move, it is sad that reforms are initiated either to improve public image or gain political mileage.

Power distribution has remained a critical issue for the economy's GDP growth prospects. Many distribution companies are running huge losses. As a result, they have found it difficult to raise funds to expand operations or even to fund existing operations. The government now plans to help out these companies through a subsidy. The subsidy would be in the form of lower interest rates. So the distribution companies would be able to raise funds at preferential and lower interest rates than those prevailing in the markets. For this, the government proposes to set up a national electricity fund (NEF) which would take care of the interest rate differential. The main idea is to limit the power transmission and distribution losses to a maximum of 15%.

Although the fund was proposed in 2008-2009, it is yet to take shape. Meanwhile, the power distribution companies have continued to bleed. We do applaud the idea of taking care of the future of not just power generation but also distribution. But we wonder if creating another subsidy is the right way of going about it. The havoc created by oil subsidies is not exactly a secret. Despite the huge subsidies, the oil marketing companies still continue to bleed. Maybe just privatizing power distribution and thus making it more competitive maybe a better alternative.

Led by weak global cues and profit booking in banking, auto and capital goods stocks, the benchmark indices in the Indian stock market nosedived into the negative territory as the session progressed. At the time of writing, the BSE Sensex was trading lower by 328 points (1.8%). Asian indices across the board closed lower, with China, India and Indonesia leading the pack of losers. Europe has also opened on a negative note.

 Today's investing mantra
"When stocks are attractive, you buy them. Sure, they can go lower. I've bought stocks at $12 that went to $2, but then they later went to $30. You just don't know when you can find the bottom." - Peter Lynch

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5 Responses to "Will this trigger the end of the commodity bubble?"


May 24, 2011

Commodity by itself has a future value inbuilt + ve or - ve. So, valued by the eye of its beholder. Often he gets bored watching it every now and then. I mentioned it often so its roller coaster, and after sometime he totally gets bored, its natural so not to blame the beholder. Yes, its subjective.
The question is how long he is going to stare at it and how often he would stare at it? In todays world beholder has a lot of choices, mind you its his belief, he gets attracted to many a things and yesterday and today it was this commodity which he believed he would marry to.. :)

PS: You know how marraiges are



May 24, 2011

Not comodities, not Real Estate, not shares, not mutual funds, then where? Today most of the asset classes where traditionally one used to invest are fraught with uncertanity and controvercy. Investment for some was an exercise to attain a certain peace of mind, hoping to save for the rainy day. The rainy day will and does come for every one sometime.
Some of us can accept making less profit on our investment but can not accept erosion of the capital. My reading of the current investment enviornment is to WAIT & WATCH PARK THE MONEY IN THE BANKS AND WAIT FOR THE STABILITY IN THE MARKET. The world currencies are shakey, the numbers coming out from China are suspect, USA has not got a grip on its financial problems, Europe is shaking as if afflicted by Malaria, the experiment that is India is still an 'experiment'. We are in a dark tunnel the light at the end has not been seen. So hang on for your life and to your money is my advice.



May 24, 2011

If derivative trading on essential commodities can be banned, world wide price level will come down
Anybody dare enough to try?


Muralidhar BN

May 23, 2011

There will be a bubble in currency & not in commodity. Theres is nothing on earth that cost X INR is costing INR X-100 or X-1000. But Money is loosing value Y INR for a Commodity G is costing Y+100 or Y+1000. so your analysis is incorrect Mr. Equity Master.


nikunj shah

May 23, 2011

according to my opinion ,we do not see any end in commodity bubble i am not sure of metal but agri commodities has a long way to go,since emeging countries marging towards urbanization,so there will be shortage of agri products in the coming year.thanks

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