Rising crude prices call for diversifying commodities portfolio

Written by Kunal Shah | Updated: Mar 22 2011, 05:33am hrs
Tension in West Asia has led to a sharp rise in bullion and crude oil prices. In fact, the WTI (West Texas Intermediate) crude oil hit over $100 a barrel for the first time this year due to the unrest in Libya, thus compelling those associated with the financial markets to deliberate on crude oil prices. Most of them are curious to know where crude oil is heading.

When crude oil hit a record high in the last fortnight, Indian equity markets corrected sharply. This mandates traders and investors to have an exposure in commodities, which have provided a refuge to market participants during turbulent times in the domestic markets. So, it makes sense to diversify your portfolio by taking commodities into account. Earlier, traders and investors put their money in commodity stocks only to benefit from the bull run in commodities. Now, even volumes matter as participation in bullion, base metals and crude oil has seen a several-fold jump in the last few years. Silver prices rose by 80% in 2010 and are still showing no signs of cooling off. With so much liquidity and robust growth in the emerging markets, commodity prices are very likely to move up.

Even agricultural commodities have risen a great deal. We can say that the year gone by will be remembered as one of the worst years of the La Nina phenomenon, which caused severe droughts in south America, Russia, Ukraine and China, and heavy rains in Australia, thus making agricultural commodities the best performing asset class in the year.

Besides, with the launch of new exchanges in India, introduction of commodity exchange traded funds, several related products in the pipeline, rising volumes, massive inflows of capital into commodity index funds in the international markets, traders and investors cannot ignore commodities anymore, clearly indicating that the commodity market has grown by leaps and bounds.

In India, we do not have ETFs of various commodities except for gold. However, investors can avail of the options in commodities on the National Spot Exchange (NSEL). Spot exchanges in India have a very big role to play as they bring farmers, retail investors and other trading communities together on an electronic platform.

In the Indian context, agricultural commodities present excellent opportunities due to high domestic demand, drop in carry forward stocks and robust exports. Also, the agricultural futures market in India is showing signs of maturity with a good delivery-based mechanism in place and the discounting of weather uncertainties on the futures platform.

Buying agricultural commodities in the spot market or taking delivery from exchanges and selling the futures has been giving handsome returns, which vary between 15-18% per annum in commodities like jeera, pepper, chana, sugar, among others. Additional reforms will help the commodities market grow exponentially. Recently, the Ficci and Assocham exuded support for the pending bill to empower the Forward Markets Commission (FMC). The bill aims to make FMC an independent regulator for the commodities derivatives market, similar to Sebis role for the capital markets.

The amendment of FCRA will smoothen the process of options trading, index trading, trading by domestic and foreign institutions on the Indian bourses, portfolio management services, etc. The Indian commodities market needs such a reform to attain the next level of growth. Volumes in commodities may grow 2-3 times in the next five years. Hence, diversifying by investing 10-15% of ones portfolio in commodities is recommended.

* The writer is head of commodities research at Nirmal Bang Securities