For centuries, mankind has been familiar with commodities as a consumption asset. Commodities are goods with economic value, produced and traded in bulk, and are raw material for further processing. All commodities are in some way products of Mother Earth — energy products like crude oil, natural gas and coal; various metals including industrial, precious and base metals; and all agriculture commodities including grains, fibres, spices and many more.
Equities are generally known as an ‘investment asset class’. Bonds and foreign exchange have also over years gained in importance for investment purpose. However, in the last 20 years or so — since the turn of the century — commodities have started to attract financial investment and are currently seen as investors’ delight.
SEBI has announced that a World Investor Week will be celebrated every year; this year, from November 23-29 with the theme: ‘Investor Awareness — Key to Financial Well-being’.
Today, as an asset class, commodities are placed in the same league as equities and bonds, as commodities have brought attractive returns to investors. History of the last two decades tells us that commodities have often outperformed other asset classes which should explain the rising investor interest. Media has played a role in popularising commodity markets.
No wonder, financial investors are rather active in the commodity market. Gold and crude oil are two prime examples of commodities as an investment option given their stellar price performance of recent years. Gold prices increased double-digit year-on-year from 2001 till 2012. More recently, we also know the rally in the yellow metal between April and September this year.
So, gold is not only a consumption asset but also an investment asset; it is a safe haven asset and a hedge against inflation.
Big in US and China
In the US, commodity markets are bigger than the equities market. There is tremendous institutional investment interest in a range of commodities. Commodities have played a big role in China’s dazzling growth story of the last 25 years.
Massive production, consumption and foreign trade in a range of commodities have propelled the Chinese economy so high that today China is seen as the ‘mover and shaker’ of the world commodity market.
Our economic growth over the next 25-30 years will be significantly commodity-intensive and commodity driven. Commodity production, processing, consumption and trade will contribute significantly to our economic activity and, thereby, to GDP. We already are and will continue to be major producers, consumers, exporters and importers of a range of commodities covering energy, metals and agriculture.
By their very nature, commodity markets are volatile. They are impacted by a host of drivers covering economic growth, geopolitics, monetary policy, currency, weather and fund flow. Regional and seasonal factors come into play, especially in the case of farm goods.
Because of this, investment in commodities would demand that the investor stays glued to the dynamics of market drivers. A through product knowledge and market knowledge is essential for investors to succeed.
Given the volatile price movements, an ‘exit’ strategy is more important than even ‘entry’ strategy. Investors should know when to exit the market and adopt strategies such as ‘profit booking’ and ‘cutting losses’.
The US has two separate regulators — the SEC for equities market and the CFTC for commodities. In our country, some time in 2016, SEBI became the single regulator for equities and commodity derivatives.
To deepen and widen the commodity derivatives market, SEBI recently took a slew of initiatives which include allowing more participants and more products. Mutual funds and AIF-III are now allowed to trade commodity derivatives. Options trading (including options in goods for select commodities) and index trading have been introduced. The next logical step may be to allow banks to trade commodity derivatives as part of hedging or risk management plan.
Several investment avenues are now open. One can invest in physical goods for cash and carry arbitrage, and in futures as well as options contracts. Investment in indices is also a good option. Commodity ETFs too are gaining popularity.
The writer, a commodity market specialist, is an Independent Member of SEBI Commodity Derivatives Advisory Committee . Views are personal