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Commodity exposure

Apr 6, 2004

The most talked about phenomenon, till some time back, was the scorching growth of the Chinese economy and its effect on pushing up the global commodity prices. Further, in recent times too, the talk about China has continued, but this time, in a different context. The world now seems to be focusing on the probability of the sustenance of the 8%-9% growth of the Chinese economy and in absence of the same, its effect on global commodity prices, which have single-handedly been driven by the huge Chinese consumption. While the world (read experts ad analysts) continues to have a mixed opinion about the Chinese growth and the fate of global commodity prices, we conducted a poll on our website trying to gauge what our readers think about the same in terms of their investment call towards commodity stocks.

Above is the chart indicating the poll result wherein a majority (43%) of those who voted believed that the prospects for commodity stocks continue to remain promising and they would consider investing into the same at the current juncture. This view was closely followed (39%) by those who would continue to hold onto their investment in commodity stocks, of course on the assumption that the story in commodity stocks is not over yet. A mere 18% were of the opinion that it is time to book profits.

Commodities stocks in sectors like aluminium, steel, nickel, zinc and copper (among others) are all trading near their multi-year highs, thanks to the insatiable Chinese appetite for these commodities. China has emerged amongst the lead consumers of these commodities, which has increased the exposure of many countries (including India) to China in the form of exports. Further, companies across the globe and across sectors have initiated huge capacity expansion plans citing the continuation of the demand from China. However, this 'over-dependence' on the Chinese economy could spell disaster for the global commodity markets if Chinese consumption fails to live up to expectations.

It must be noted that there are already increasing noises that the Chinese economy is over-heated and the government will need to slam the brakes sooner than later. Further, the meteoric rise in commodity prices has started pinching the user-industries of these commodities, as they are unable to pass on the increased costs to consumers owing to high competition. Increased opposition by the user industries against further hike in prices seems more a matter of time than anything else. Thus, we feel that whether the Chinese economy slows down or not, the pressure of increased supply of commodities in the near future is bound to be reflected soon (especially steel).

While it must be noted that predicting commodity cycles is a very difficult task, investors (especially retail) should take utmost caution while investing in these stocks at higher levels. This is because during times of cyclical downturns, stocks of commodity companies, tend to get severely affected owing to fixed costs and their capital intensive nature, which brings along with it huge debt and consequently interest component. Thus, before investing in commodity stocks, investors need to consider certain factors like integration levels of the company, cost efficiency, diversification (across markets and product categories) and the most important of all - valuations.

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