Track commodities for making gains in equities

The commodity markets are a rather new beast in India, signifying fear of the
unknown, trepidation and even neglect as far as the rank and file trader/ investor is concerned.

But the overseas markets, especially the US and Europe, are much more efficient in prioritising asset classes. Traders in these markets are equally savvy in understanding that commodity prices actually lead equity trends and not vice versa. Thinking equity prices can lead commodity prices is akin to putting the cart ahead of the horse!

Take the following cases in point:
1) Take the example of Arvind Mills (a leading denim manufacturers in the world), which uses cotton as a primary raw material. Should cotton prices spike higher for some reason, the stock price of Arvind Mills is slated to decline, albeit with a small time lag. 

The time lag is the killer factor here. A vanilla equity trader will know of the decline in share price when it occurs, but a commodity trader will immediately gauge the impeding trouble for Arvind Mills as soon as he witnesses a rally in cotton prices. That advance knowledge can sometimes be the only dividing line between a profit and a loss.

2) The direction of the share prices of oil marketing companies like BPCL, HPCL and IOC are largely dependent on the prices of crude oil on the commodity exchanges. Higher crude oil prices hurt the bottom line (and stock prices) of these companies. If you were to ignore the crude price trends on the commexes, you would be at a clear disadvantage in being able to accurately forecast stock prices of these oil marketing companies.

3) But the most pronounced example is this. Whenever a worldwide recession ends and a period of economic prosperity sets in, the smart money gauges the demand/ supply equation of various commodities. Once the prioritising is done, the commodity with the highest demand-supply mismatch is identified and the stocks of companies which deal in these commodities are targeted for investment. This is typically seen in cyclicals like
base metals, cement, energy, E&P and utilities.

In the present Indian context, I expect the prices of the following commodities to rule firm. In the metals space, steel, copper, nickel, zinc, lead and aluminium; in energy, natural gas, crude oil and furnace oil; and in agri commodities, sugar, refined soya oil, crude palm oil, wheat and pulses.

As a result, the coming quarters will witness a bullish trend on Tata Steel, Hindalco, Nalco, Ruchi Soya, Cairn India, Petronet LNG, GAIL, Hind Zinc, Shree Renuka Sugars, Balrampur Chini, Tata Power and NTPC, to name a few.
Smart investors/ traders know that they can ignore commodity trends at their own peril.

Even if you are a dedicated equity investor, it pays to have a knowledge of commodity markets.

Fair disclosure: Of the stocks recommended above, the writer has investments in Cairn India and Petronet LNG.
 
The writer is the author of A Traders Guide to Indian Commodity Markets and invites feedback at vijay@BSPLindia.com.