'Inflationary spiral to return; commodities to revive'

February 18, 2009

The economic downturn has hit almost all major commodities except gold which is seen as a safe haven investment in times of crisis. Despite the stimulus packages announced by OECD and emerging economies, the prevailing mood is one of fear and anxiety as base metals and energy sector whose recovery depends to a greater extent on stimulus packages continues to be hit by subdued sentiments. However, in certain commodities like sugar which has performed well due to shortage in production, inventories are rising for several other commodities. Meanwhile some reports rindicating revival of commodities in 2009 has come as a solace.

In these uncertain times, Kuljeet Kataria, Vice President Commodities, Motilal Oswal Financial Services Ltd told Sreekumar Raghavan of Commodity Online that 2009 might see the return of inflationary spiral and revival of several commodities now hurt by crisis thanks to huge liquidity infusions. Excerpts

Economic downturn has affected virtually all sectors and certainly commodities market is no exception? Can you briefly give an overview of how far commodities have been hurt by the credit crisis?

Yes it is true that economic downturn has affected all the asset class including commodities. The crisis which started with the US housing market has now reached the developing economies. The most affected commodities are the base metals and energy. In 2008 we saw both highs and lows in some of the commodities. Best example is Crude Oil which hit a high of Rs.6333 on MCX in the 3rd quarter of 2008 but in the fourth quarter we witnessed a steep fall and it registered its life time low on MCX. The major reason for the downfall in commodities was the deflationary concerns due to slowing in the global economy. Slowing in the global economy has affected the demand which reached a high level in the industrial metals complex, and major world producers have announced aggressive capacity reductions. The only commodity which gave positive returns in 2008 was gold due to its safe heaven status. The reason behind gold's up move was premature inflationary worries due to huge liquidity infusions by major economies.

In many analytical reports base metals was the worst causality in the downturn? Most of them have been badly beaten in LME with inventories rising. How is your rating for base metals in 2009 considering that Chinese stimulus package has started working although demand from emerging countries is not picking up that fast?

Global slowing and deflationary spiral has brought about a imbalance in the demand supply scenario of all industrial metals. We know that China is the major consumer and producer of base metals, so any change in Chinese economy will have a major impact on the prices of industrial metal. China's stimulus package of $585 billion and Chinese State Reserve Bureau (SRB) plan of buying 1 million tons of industrial metals have supported the prices from going down further. But the rising LME stocks indicate that the prices can fall further. The production cuts by majority of the industrial metal miners indicate a tighter supply in the near future setting a stage for good recovery in base metal prices. We expect that with the economic recovery copper will be the first base metal which will lead the recovery in the industrial metals complex.

Sugar and Gold were rated as the top performing commodities in 2008? For 2009 how do you view these two commodities? For Sugar of course, India's production is estimated to be down from 26 mn tonnes to 18 mn tonnes which will have a bullish impact and gold is rallying because other sectors are down. Your comments.

We expect Gold to continue its upward trend in the first half of 2009 and in the second half it should give some corrections. The main reason behind bullishness in Sugar is estimated production which is expected to be down from last year. Indian Government is planning to import raw sugar from Brazil to meet the shortfall in production. In the medium term we are expecting prices to trade on the higher side.

Another major casuality as far as India is concerned is pepper whose export demand has fallen and market looks subdued as of now. Arrivals are also not picking up. How do you think Pepper would perform in near term and medium term?

Pepper exports in the Apr - Nov period fell 33.2% to 16850 tones as demand took a hit from the global financial crunch. The market is expected to be weak in the short term as international demand will revive from mid February. Estimated production in this season is around 42000-45000 tones. Unfavorable weather conditions in the initial days of the crop, coupled with aging creepers of pepper being more prone to diseases have led to lower pepper production. The domestic consumption is around 40000-45000 tones. Lack of sufficient carryover stocks is also encouraging local buying interest in the commodity despite low demand from overseas buyers. The current stocks are at historic lows, around 8,000 tonnes. During the previous season, the stocks stood around 15,000 tonnes during the same period. This has made fundamentals of the commodity strong. In medium term we are expecting prices to trade upside.

There was a Financial Times report based on Baltic Dry Index which indicated that spring time had arrived for commodities? Resource based ETF's of ETF Securities Ltd, London has also fared well providing 20% returns? What do you think are the prospects for commodities in first half and later half of this year?

Deflation was a major headline in the second half of 2008 as the global economy slowed at a very fast pace. 2009 will see an inflationary spiral due to huge liquidity infusions by major economies. Pre mature inflation has already been discounted in the market which can be seen from the ETF's holding in gold and silver reaching record highs. In the first half we expect that gold will cross its previous highs in US $ and in the second half base metals will start recovering. Crude will be in the range of 50-75$.

Do you think shortfall in production of pulses, spices and other agri-commodities will affect India's commodity markets?

As we all know that commodities market is driven by its demand & supply fundamentals. It has been witnessed that farmers shifting from one commodity to another because they are not getting the fair value of their crop which creates shortfall in production. Scarcity in the supply of the agricultural commodities will definitely result in higher prices.

India's commodity futures business continues to grow at a rapid pace. FMC figures show a growth of 34% helped by growth in 3 major bourses. How far has lifting of ban on four commodities helped? What more needs to be done by FMC and government to increase trading in commodity futures?

Lifting of ban has just improved the sentiments towards the commodities markets. For the growth of commodities market in India, FMC should introduce options and allow banks and FII's to participate.

How far will crude and rubber prices recover in 2009?
Crude prices should be in the range of 50-75$ in 2009.No view on Rubber.

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