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Commodities: Pros and Cons - Views on News from Equitymaster
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  • Jan 1, 2003

    Commodities: Pros and Cons

    The year 2002 has been a mixed bag for the capital markets around the world. On one side, the developed markets like the US and Europe are closing the year with economy that is still sluggish and prone to repeated profit warnings and accounting scandals, whereas, China has been able to manage growth of just under 8% in 2002 (one of the fastest-growing economies in Asia) and, it is likely to continue on a similar strong growth path. A similar trend has been shown by India, though not as strong as the Chinese economy. India has been able to maintain a growth of about 5-6% in the last few years and is likely to end the year at around similar GDP growth as per the Reserve Bank Of India (RBI). Though at the beginning of the fiscal, the Budget had envisaged a growth of 6.5%, it seems unlikely that the government will be able to achieve the targeted growth rate.

    Though the Indian bourses are ending the year on a positive note, it has been a mixed trend for the various domestic sectors. On the one hand, automobiles and software have outperformed the market due to factors supporting their strong growth whereas, the commodities and the fast moving consumer goods (FMCG) segments have been a dampener. The major cause for the setback in these core sectors has been the after-effects of the 9/11 attacks. The attacks aggravated the already slowing down global economies. However, since last September, the scenario has improved and respite seems in sight. According to leading organisations like OECD and IMF, world economies are set to improve in 2003 led by the US and Europe.

    On the domestic front, there are a few reasons to cheer for commodities (steel, cement and aluminium) sector. With optimistic growth rate targets set for the economy and an overall improvement in sentiment (facilitating the current growth rate), it seems that the year ahead is unlikely to worsen if not improve. With the government's initiative on the infrastructure front and the prevailing low interest rates facilitating a boom in the housing and the auto sectors, it seems that the steel, cement and aluminium sectors will continue their growth momentum which picked up in the second half of 2002. Since these sectors are part of the core sectors of an economy, any improvement on the economic front is ought to be reflected in them. This is evident from the fact that these sectors tend to move in line with the Index of Industrial Output (IIP), which is an indicator of the health of the Indian economy.

    There are various factors supporting the view that these commodity sectors are set to improve in the next year. As can be seen from the chart above, the IIP growth and the corresponding growth in the cement and steel consumption have been encouraging. And this growth is more likely than not to be maintained at healthy levels. With interest rates down and various tax incentives being offered on housing loans, the current demand in the housing sector is likely to be maintained. Also, the Golden Quadrilateral Project has maintained its pace and will continue to perk up the demand for commodities. With the government planning to increase the amount of projects to Rs 80 bn offered to the private sector under the annuity/build-operate-transfer (BOT) model in the second phase of this project, as compared to Rs 58 bn in the first, the private sector players are likely to benefit. Announcements like the launch of the Rs 150 bn Rashtriya Rail Vikas Yojna for accelerated development and expansion of rail network in the country, adds up to the commitment being shown by the government towards country's infrastructure development.

    The improvement in the US and European economies will lead to a flow of positive sentiments to other countries. China, which continues to show an 8% GDP growth, is likely to continue creating demand for various commodities, especially steel. The Russian economy is also on the recovery path. To top it all, the optimism being shown by the domestic industry for the coming year is something that cannot be overlooked. The business confidence index remains optimistic. Most surveys and studies indicate the possibility of the continuance of the current growth into the second half of the current fiscal.

    However, there are also a few factors that go against the popular belief that the second half will be a good one for the domestic industry. The biggest of all is the rising tension between US and Iraq, which is dampening global sentiment. The slightest indication of the beginning of a war between the two could send the world markets spiraling to newer lows. For India and other developing nations rising crude oil prices increase the risk higher inflation. Another factor that does not support the optimists on the domestic front is the lack of investments in the industry combined with the decreasing non-food credit. The proposal by the Kelkar Committee to reduce the tax sops being offered on housing loans has come as a setback for the housing industry. The impact of poor monsoons also remains to be seen.

    However to summarize it all, the negative factors may or may not take place whereas, much of the positive factors are those that are already in existence. So, having a medium-term view, there seems to be a bright future ahead for the domestic commodities sector.



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