The recent but consistent growth in world GDP has seen higher consumption of ferrous and non-ferrous base metals, leading to an increase in investment focus in these commodities. Between the two, base metals have been investment favourites with commodity-specific as well as diversified funds due to consumption patterns, worldwide listing and high liquidity. The leading exchange in the world for non-ferrous base metals is the London Metal Exchange (LME).

In India, on the NCDEX, the only ferrous commodities listed are mild steel ingots and sponge iron, both of which do not have sufficient volumes. Similarly, though MCX has iron long, steel flat and sponge iron, there is lack of volume which deters serious players.

But in non-ferrous base metals, MCX has aluminum, copper, zinc, nickel, tin and lead, of which copper has very good depth and liquidity and the volumes are better than even gold on most days. The others don?t fare too badly either. NCDEX has followed up in base metals with copper, aluminum, nickel and zinc and is trying to reposition itself as a non-agri exchange to make up for falling volumes.

In general, it can be said that base metals are bullish largely due to growing industrialisation worldwide, led by Asia (mainly China and India), Russia and Brazil.

Growing economies have an insatiable appetite for metals as they have diverse uses. Developing countries too are moving towards being developed economies and per capita consumption is expected to increase accordingly. We must keep in mind that the world GDP growth has also doubled to about 4.5% in the last few years, and the BRIC countries, though among the fastest growing, are not the only game in town. Construction and power industries lead the demand for aluminum and copper. At such times of high demand, even minor supply constraints get exaggerated. In any case, there are limited resources and it also takes time to bring new production to market. The rise in prices will fund technological breakthroughs required as more money will go into funding new technology to fulfill growing needs. One significant change in the last few years has been that commodities have become an accepted asset class. This has led to higher investment demand as more and more funds are parking money in commodities in a bid to get higher returns as well as diversify their portfolio.

On the industrial front, production growth has been maintained. The companies involved in the production and marketing of ferrous and non-ferrous metals in India are doing reasonably well except for some fluctuations in all metals and with specific emphasis on aluminum and alumina producers. Balance sheets are healthy and expansion and M&A is the name of the game with worldwide companies as targets. One clear offshoot of high prices has been the development of science and technology on non-ferrous metal industry for better, faster and more efficient extraction processes. Due to good profits, there has also been increased investment in non-ferrous metal mines. However, there has been some decline in investment in non-ferrous metal smelters which is expected to correct this year. In addition, there has also been a renewed focus on energy saving due to its increasing cost. Indian industry is now consolidating and looking to absorb foreign capital and bring in international management expertise for increased efficiency and larger scale of operations. Base metal prices have seen a marked comeback after the precipitous fall in the summer of 2006. Copper has been the star performer though, of late, it has seen a fall in prices along with other base metals. Lead and aluminum prices too scaled new highs this year.

After centuries of large-scale exploitation, the global non-ferrous metal resources are becoming increasingly valuable, so the prices have kept a long-term rising momentum. Though the speed of growth supply/demand and price of non-ferrous metal industry may decline from its peak, it is unlikely to be large. More than likely, the forthcoming five years will remain as the boom period of non-ferrous metals industry, which will lead to continuous increase in production capacity, and the next couple of years are likely to see a new peak period in the expansion of smelting industry which were neglected with capital flowing towards mines. All this makes for an excellent investment opportunity which international funds have been quick to latch on to.

Exchange volumes in India have largely done well in base metals and there is considerable trading volumes and hedging interest with prices having clear international correlation.

Trading and investment

Base metals have been trading favourites for several years and today, when commodities are widely accepted as a separate asset class, metals are the flavour of the season – be it investing or trading. As with any investment decision and irrespective of whether you are a corporate or an individual, it is necessary to know the purpose of the investment outlay. Usually the purpose is either investment or trading but in the case of corporates an additional reason could be risk mitigation. In any case, the aim is either profit or protection of profit where the latter is done by hedging with commodity futures in exchanges like MCX and NCDEX.

When the purpose is investments, there are several ways of entering the markets for corporates and individuals. The first is to take futures positions in those base metals where you are taking a directional call-now this is an open position and will be open to the vagaries of market movements and is in fact speculation. In such trading calls, keeping a tight eye on international markets and technicals is a must as also following trends and understanding seasonality-for example, crude prices typically rise before winter in anticipation of rising requirements. Besides, regular trading discipline has to be maintained-strict stop losses trailing profits and avoiding averaging in view of potential cash flow crisis which is a characteristic of leveraged markets. Since closing prices are marked to market, the difference has to be paid/received everyday and in such a situation, even if you are eventually right, the cash flow could be stifling and may lead you to cut your position at the most inopportune moment. Therefore this strategy has to be undertaken keeping this risk in mind-much like the famous statement that the markets can remain irrational for far longer than you can remain solvent! So never underestimate the value of a disciplined and strategic approach to commodity investing.

There are certainly relatively safer investment avenues available as well. One of the favourites is arbitrage opportunity between markets and these could be spot-futures or calendar spreads (profiting from ?abnormal? differences in near month and far month contracts). In that case, you can play on increasing and decreasing difference in the price of metals between the current and far month contracts or even delivery spreads where delivery does happen – currently only bullion.

Unfortunately, unlike developed countries, mutual funds are not yet allowed to invest in commodities and this robs many investors of the opportunity to diversify their portfolio in line with international trends and expand their asset allocation to de-risk their investments. I believe that permission is inevitable and will happen sooner than later which will allow the lay investor to enter commodity markets through MFs. It may be pertinent to note here that investing directly in commodities is different from investing in commodity stocks (say, like Hindalco or Sterlite) because commodities work on a pure demand-supply situation and are not affected by other subjective issues like management quality, cash flows and such like. Barring man-made taxes and given the international nature of base metals, all investment automatically have a global tinge and represent the free markets in the truest sense of the word. All investments, of course, follow the risk-return paradigm and just like equity markets, returns in commodities too cannot be guaranteed. Having said that, your broker does have certain products available which are suitable for your risk appetite and funds situation. Therefore, a full-service broking house with a comprehensive and responsive research desk remains the best way to start investing in ferrous and non-ferrous metals.

The author is head – commodities, Religare