The commodity bull market has just started!

Dec 9, 2010

In this issue:
» US prospects even worse than Europe, says China official
» RBI still uncomfortable with inflation
» Indian IT can only become stronger from here
» This could well be the farm game changer in India
» ...and more!!

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It is not just gold and silver which are making new all time highs on a regular basis. The bug seems to have bitten industrial metals as well. Take copper for instance. Just a few days back, copper surged to an all time high of above US$ 9,000 per tonne. Of course, the surge has been supported by fundamentals. Ever growing demand by emerging nations such as China and India gave strong boost to copper prices.

But there is one more important factor behind the stellar run of copper. The one we believe that has gone largely unnoticed. And it answers to the name of ETF (Exchange Traded Fund). Yes, that's correct. Now, it will be not just precious metals that will have their own physically backed ETFs.

Very soon, a new wave of ETFs that will be physically backed by industrial metals such as copper is about to get launched. A good part of the reason that copper has gone up in recent times is also because of this new demand driver that will come up in the market. And copper may just be the beginning. ETFs that would physically hold other industrial metals such as aluminium, zinc, nickel, lead and tin are also just around the corner.

This development could well mark an important turning point in the price dynamics of industrial commodities. For quite some time now, the fundamentals of commodities have remained strong. Things like fast depreciating dollar, demand from resource hungry emerging markets and strong chances of accelerating inflation had all combined together to make commodities an attractive long term bet. And now, we have this huge marketing machine whereby some of the biggest financial institutions in the world wanting to dabble in commodity related investment products.

It should be noted that physically backed Gold ETF was first launched in the early part of this decade. And if its returns so far are anything to go by, people who missed the gold rally perhaps have a chance to make up for that mistake. We could well be staring at a huge commodity bull market.

 Chart of the day
It is not a good time to be a small cap company in India. On the back of SEBI clampdown on a handful of companies, investors have taken most smallcap index stocks to the cleaners. Today's chart of the day shows the ones in the small cap index that have been hit the most over the last one month. As indicated, decline in the region of as much as 60% has happened in a span of just few trading sessions. It amply highlights the fact that while small caps can go up in a jiffy, their decline can also be equally dramatic.

Source: CMIE Prowess

A lot is being talked about the food crisis. Our President recently said we need a second green revolution. Increasing productivity is vital. But it is also important that the produce be well preserved. We're already facing a storage capacity shortage. The Warehouse Development & Regulation Act (WDRA) 2007 perfectly fits the context. Though the Act was passed three years ago, it was notified just recently. That too after the Supreme Court had made public its ire over the issue of rotting grains. A leading daily notes that the WDRA is perhaps one of the most important pieces of legislation in recent times. It could potentially change the way agriculture and the trade surrounding it happens.

Let's look into some of its implications. The primary cause of rotting remains poor storage conditions. The current storage facilities in the country are far less than what they ought to be. The WDRA could remedy that because it would allow viable private investments in good storage facilities. A big incentive, with the WDRA, is that warehouses will not have to be 'cleared' by multiple authorities. Now, all agricultural warehouses will have to meet the standards and procedure norms laid down by the WDRA. There are several other clauses to assure fairness and transparency. Though impressive, a lot will depend on the way WDRA gets implemented.

The Europe debt crisis and its repercussions are being given paramount importance by governments and investors alike around the world. So much so that the Euro has fallen against the dollar even though the situation in the US has not improved much either. Infact, in this regard, a Chinese official believes that US' fiscal health is much worse than Europe. He opines that at present US can take solace from the fact that much of the world focus is on what's happening in Europe.

But once the situation in Europe stabilizes, the spotlight will once again be on the US. And then the result will not be too great for the US as the US Treasury bonds and the US dollar will witness considerable declines. The US is in a bad shape. The economy is barely recovering, unemployment is pretty high and the deficit is huge. What is more, the recent tax cuts announced by the Obama government are expected to make an already deteriorating fiscal situation worse. Indeed, the government in the US seems to be at its wits end. It is anybody's guess as to when things are likely to improve there.

Last year marked a trough for the Indian IT industry. There were headwinds that the slowdown in US and Europe means bad days for IT were here to stay. However, the industry has seen a major revival in fortunes this year. Order pipelines are bloated. Margins are expanding. Things seem to be going good.

The main reason for this is that the Indian IT industry as a whole has moved up the value chain. Gone are the days when Indian IT only meant being a low cost outsourcing centre. While outsourcing continues to be a part of the industry, high value tasks like transformation services and research & development, form a larger part of the industry revenues. In fact there is a string of IT start ups that is developing high value products that are based on intellectual property. This move will lead to a new wave in the Indian IT industry. And this one will be based on the development of new technologies and not just on outsourcing.

Indians are known to be very tolerant. At least religiously and culturally. But thankfully such tolerance is not seeping into the behaviour of the country's central bank. The RBI's peers in developed markets seem to have developed excessive tolerance to threat of inflation and asset bubbles. But RBI Governor Dr Subbarao is not mincing words when it comes to the RBI's stand. Time and again he has expressed concern over the inability to curb price rises. Especially at the consumers' end (CPI and food prices). Despite being most proactive in raising interest rates, the RBI's job is far from done. To meet its inflation target of 4.5%, the rate of price rise needs to be halved from the current levels. Inflation numbers have cooled off from the double digit levels seen earlier this year. But going forward, it may need moves beyond higher interest rates to subside to the RBI's 'tolerable levels'.

We believe that the government needs to look into areas beyond food if the price rise is to be brought under control. Asset bubbles and excessive subsidies have both played havoc with fiscal planning. It is time that the RBI is not left to be the lone soldier tackling such issues.

Meanwhile, profit booking continued unabated in the Indian markets today with the BSE-Sensex trading around 150 points lower at the time of writing. BSE Small cap index was faring even worse, down more than 4% at the time of writing. This decline comes on the back of near 16% decline that the index has witnessed in the past one month. Most Asian indices closed strong today with Europe also opening in the green.

 Today's investing mantra
"Traditional value investing strategies have worked for years and everyone's known about them. They continue to work because it's hard for people to do, for two main reasons. First, the companies that show up on the screens can be scary and not doing so well, so people find them difficult to buy. Second, there can be one-, two- or three-year periods when a strategy like this doesn't work. Most people aren't capable of sticking it out through that." - Joel Greenblatt

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