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Journalism of Courage
Mukesh,29,is an electrical contractor. Over the last few years he has seen the price of electrical wire rise significantly. The suppliers told him that this was happening because the price of copper used in the wire has gone up. He wondered if there was an investment opportunity there,and if he could profit from this price rise. That is when Mukesh came to see us.
Undifferentiated products
I told Mukesh that copper is a commodity and commodities have been in a bull run since 2000.
Mukesh looked confused. 8220;What is a commodity?8221; he asked.
8220;A commodity is a product where the supplier has no scope for differentiating his goods from his competitors products. So buyers it does not matter who they buy their supplies from,8221; I replied. For example,copper is copper no matter who supplies it. Its price is universal and fluctuates daily based on global demand. On the other hand,an MP3 player is not a commodity since it can have many levels of quality and features depending on who makes it.
Commodities include metals like copper,iron ore,lead,zinc,etc. Apart from metals,resources such as crude oil,coal,and agricultural products such as tea,coffee,sugar and so on are also commodities. Commodities go through bull and bear cycles just as the stock market does. However,commodity cycles are long. A bull run in commodities can last as long as 15 years and can be followed by a bear cycle that is equally long.
8220;Fifteen years!8221; Mukesh exclaimed and asked,8221;What causes commodities to have such long cycles?8221;
8220;Good question,8221; I replied.
Demand up,and supply failing to catch up
The price of commodities is determined by demand and supply. Lately,countries like India and China have been growing rapidly. This has resulted in the need to build new infrastructure such as dams,bridges and roads. All these need steel and cement,hence there is great demand for these raw materials. Similarly,the electrification of these countries will require electrical wires. Wire is made from copper and aluminum,hence the demand for these metals has also increased. The increase in demand is not restricted to metals alone. As prosperity has increased in China,the Chinese have developed a sweet tooth. This has increased their consumption of sugar. Today China consumes about 60 per cent of the world8217;s nickel supplies,40 per cent copper,and 50 per cent steel. This demand is expected to increase further as India and other emerging markets also start consuming equally large quantities.
Supply,on the other hand,is limited. For years the existing supplies of oil,lead or uranium were adequate to meet world demand. There was therefore no incentive for suppliers to increase supplies. But now with growing demand the existing supplies are woefully short. With demand outstripping supplies,commodities have seen a bull run.
8220;But why don8217;t they just increase supplies now since demand has risen?8221; asked Mukesh.
8220;That is easier said than done,8221; I replied. Increasing the supply of raw materials takes a long time. Take the example of lead. To increase supplies,a mining company would first have to locate a lead deposit. Next it would have to obtain government and environmental clearances. Typically,the deposit is in a remote area that has little infrastructure. So the company would need to develop housing and schooling to get people to work there. It would also have to build roads to transport the lead to the nearest port. Only then can it begin mining operations. As can be seen,this is a time-consuming process. Moreover,by the time this mine comes online demand may have increased further. Consequently,it takes a number of years for supply to outstrip demand. During all these years the prices of commodities continue to rise.
Myriad investment vehicles
8220;Hmmm sounds interesting,8221; said Mukesh. 8220;But can I part take in this commodity bull run?8221;
8220;Sure,you can,8221; I replied. Several investment vehicles are available for this purpose. First,one could buy commodity futures and roll them over upon maturity. Second,one could invest in the stocks of companies involved in mining commodities. In India companies like Sesa Goa iron ore,Hindustan Zinc,and Gujarat NRE Coke are examples of pure commodity companies. Third,one could invest in mutual funds that are dedicated to investing in commodities. Mutual funds investing in global commodities such as the ING Optimix Global Commodities Fund or the newly launched DSP BlackRock Mining Fund may be considered.
The caveat
8220;However,I must caution you that commodity investment is not for the faint hearted,8221; I told Mukesh. Commodity prices witness severe volatility. One should be able to take a 50 per cent correction in price in one8217;s stride if one is investing in commodities. Further,the bull run in commodities had commenced over nine years ago. Investors entering into commodities now can not expect the same level of profits as those made by early investors. Another factor is the foreign-exchange risk. Commodity prices are denominated in the US dollar. Thus,profits can be affected by exchange-rate fluctuations between the dollar and the rupee. 8220;You should therefore have the ability to take on a high risk investment before you enter the commodities arena,8221; I said.
Mukesh smiled. He is a risk taker. The gleam in his eyes said he was intrigued by this new investment avenue. He bid goodbye and left our office.
The author,a certified financial planner,is the chief executive of Sardesai Finance. ceosardesai.com
