A global economic slowdown appears imminent. The subprime crisis has taken a toll on financial heavyweights. The US is in turmoil; Europe and Asia are fast catching up.
Sectors like oil, metals and agriculture make for gainful play
A global economic slowdown appears imminent. The subprime crisis has taken a toll on financial heavyweights. The US is in turmoil; Europe and Asia are fast catching up. The world is anticipating its worst economic nightmare — that of high inflation with low growth.
One would expect commodity prices to soften about now, but the exact opposite seems to be happening. Commodity prices have been shooting up, showing no signs of a respite.
This is giving rise to fears of stagflation — a combination of high inflation and slow economic growth, both occurring at the same time.
Typically, stagnation can be cured by expansionary monetary or fiscal policy; in simple words, cutting of interest rates. On the other hand, inflation can be cured by contraction of monetary and fiscal policy or tightening of liquidity in the system by hiking interest rates. However, when both occur at the same time; it poses a big dilemma — the central bank risks slowing the economy if it hikes the already high interest rates and stoking inflation if it lowers interest rates to propel growth. At this stage, India does not seem headed for stagflation, though the US and Europe do.
Should those fears come true, manufacturing and infrastructure might be the worst hit, given high interest rates, tightening credit, lower consumption and rising commodity prices, which greatly increase their input costs.
However, the situation is advantageous for firms that process raw materials, as they will be inclined to cut down supply, creating supply shocks (artificial scarcity) leading to higher prices. Thus, commodity related sectors like oil, metals and agriculture will immensely benefit despite manufacturing slowdown and diminishing demand.
The performance of most mutual funds, which have invested heavily in manufacturing and infrastructure sectors, could take a beating.
The dominance of infrastructure funds seems to be fading already, and it would be a wise idea for investors to switch to commodity-focused funds.
Commodity-focused funds invest in companies related to the commodity business in sectors such as oil, gas, metals and agriculture, etc.
Fund houses like SBI and Reliance have introduced commodity-focused funds. While the SBI COMMA Fund is a complete commodity play, the recently launched Reliance Natural Resources Fund will scout for opportunities in the alternate energy sector, besides investing in companies in commodity related businesses. While the former has a proven track record, the latter has a great investment team, adept at selecting good stocks. Either way, investors stand to benefit from investing in any fund.
Another commodity asset class that is interesting at this stage is gold. This can be either in the physical form or in the form of exchange traded funds or gold mutual funds. Gold acts as an excellent hedge against inflation and the prices of gold are highly correlated to that of crude oil. Gold price is also globally driven and in the days of low risk appetite amongst global investors, gold will be a preferred parking space for a lot of funds.
Looking at the current scenario, the commodity play seems to be far from over and one can only see it gain momentum in the near term.
Commodity funds are recommended for a short-to-medium-term timeframe as part of an investor’s satellite portfolio, instead of infrastructure funds.
PARK Financial Advisors
(www.parkfa.com, info@parkfa.com)
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