(Coma)dity funds: Would they Revive?   May 04, 2013

As many of you may be aware that India has been facing a problem of high Current Account Deficit (CAD) for quite some time now. In the last reported quarter i.e. October to December 2012, it ballooned to 6.7%, as per data released by Government, led by imports of crude oil and gold. As you know, India's insatiable appetite for gold and heavy dependence on imported crude oil (nearly 80% of domestic demand) is often blamed for the substantial rise in CAD. With exports almost stagnating due to relative softening in demand from crisis hit developed economies (especially the Euro zone) and intense competition, has brought in a worrisome picture to portray as well. However, the recent descending move (in the last few months) in gold and crude oil prices, at least for the time being, has turned the tide is favour of India which has thus far reeled with the pressure of ballooning CAD. So, given this present situation, pressure on CAD in the ensuing quarter of the fiscal year gone by is expected to ease. And even at the turn of the financial year, the prices are remaining soft which may be a positive sign for in coming quarters as well.

Who has not benefited...
However, what is positive for one country may be a cause of worry for another. This is a reason why many commodity exporting nations invest heavily in countries which import commodities for the purpose of hedging their risk. For example, oil and natural gas exporting nations invest in oil and gas sector of an importing country. On the same premise, even commodity importers may invest in countries that export commodities. Also, with some exceptions, demand for commodities is cyclical in nature. It is noteworthy that, when global economy was in an exuberant phase from 2003 to 2007, demand for dominant industrial metals such as copper, iron, zinc and nickel amongst others, went up several times. Business of miners blossomed and they started ramping up their capacities expecting boom to continue for several years to come. Not anticipating that there could be turbulence faced going forward, some fund houses in India also launched in pomp, commodity oriented funds investing largely in equities of producers of commodities in India and also mandated to tap opportunities existing in international markets as well. While some fund houses launched feeder's funds investing in offshore funds of the same fund houses, the others launched them mainly with a mandate to invest in companies in India which are mainly producers of commodities.

Turbulence in Commodities...
It's not only crude or gold that has fallen but some industrial metals too have been witnessing a selling pressure of late.. As mentioned earlier, fall in commodity prices point at weak demand and hence affect the businesses of miners negatively.

Let's review the performance of commodity focused funds amidst falling commodity prices, but before that first look at how deep is the fall has been in commodity prices.

A slump in Commodities
  Commodity Prices in USD
  2-Jan-13 22-Apr-13 Change
Copper (Tonne) 8084.8 6875.5 -15.0%
Zinc (Tonne) 2086.8 1836.5 -12.0%
Nickel (Tonne) 17422.5 15180 -12.9%
Lead (Tonne) 2384.5 1997.5 -16.2%
Primary Aluminium (Tonne) 2093.25 1841 -12.1%
Brent Crude Oil (Per Barrel) 112.98 99.4 -12.0%
Gold (Per Ounce) 1693.8 1412.7 -16.6%
Data as on April 22, 2013
(Source: LME, Nasdaq, PersonalFN Research)

The chart above reveals that all major industrial metals have registered double digit losses since the beginning of 2013. Slower than expected growth in China, persisting risk of Eurozone debt crisis and speculation about Federal Reserves (Fed) discontinuing the Quantitative Easing (QE) programme earlier than expected has been the primary reasons for falling commodity prices.

What is the story in mining?

Data as on April 19, 2013
(Source: HSBC, PersonalFN Research)

Well, the story of miners hasn't been any great either. The chart above, exhibiting how HSBC Global Mining Index has moved, narrates that since January 2013, mining stocks have been on descending move (lost reflecting about 27% till April 19, 2013)the fact that weal commodity prices have negative impacted the businesses of miners.

It is noteworthy that the HSBC Global Mining Index captures the stock market movement of companies engaged in mining and excavation businesses globally. As per the latest disclosers as on March 31, 2013, the index has 186 constituents spread across geographies. Moreover, the index is diversified across various categories of miners.

Commodity Funds - Under Pressure
Scheme Name YTD# 6 Months 1 Year 3 Years 5 Years
DSPBR World Energy Fund (G) 1.2 -2.4 -1.6 3.4 -
DSPBR World Agriculture Fund (G) -1.9 1.1 3.9 - -
Birla SL CEF-Global Agri G) -4.7 -0.5 2.8 5.0 -
Birla SL CEF-Global Multi Commo (G) -10.0 -9.4 -3.9 -0.4 -
SBI Magnum Comma Fund (G) -12.3 -11.9 -8.9 -8.0 -3.4
Mirae Asset Global Commodity Stock (G) -12.8 -8.5 -9.0 -2.6 -
DSPBR World Mining Fund (G) -24.7 -23.2 -27.8 -7.3 -
DSPBR World Gold Fund (G) -33.5 -38.6 -32.3 -6.4 -3.9
PineBridge World Gold Fund(G) -35.5 -41.8 -32.6 -8.2 -
Birla SL CEF-Global Prec Metal (G) -38.5 -43.7 -37.3 -14.1 -
NAV Data as on April 22, 2013
#YTD Year to Date: That is from Beginning of 2013 to April 22, 2013
Returns upto 1 year are absolute and above 1 year are compounded annualised
(Source: ACE MF, PersonalFN Research)

Taking cues, funds following commodity theme too have witnessed steep losses. Barring the exception of DSP BlackRock World Energy Fund and DSP World Agriculture Fund, all other funds following commodity theme have fared badly. The funds that have done well have managed to do so only because of some underlying fundamental strengths. The table above also suggests that the funds have faltered on performance across time periods. The picture could look uglier had Indian Rupee appreciated sharply.

The road Ahead...
Although factors driving hard and soft commodities are different and their demand-supply trends too vary to a great extent, most of the commodities are cyclical in nature. Demand for industrial metals would remain soft if China slows down further or restructures its economy making it more consumption oriented. Accommodative monetary policy stance adopted by the western economies have helped metal prices recover from the lows recorded in 2008-09; despite an edgy recovery witnessed thereafter - thanks to ample liquidity chasing limited physical assets. But going forward if Federal Reserve turns off the liquidity tap, metal prices may dwindle. Lower industrial metal prices for sustained time period would also mean there is a possibility of another recession in the global economy. On the other hand, demand for soft commodities such as Soybean, coffee or maze may remain relatively inelastic. However, supply shocks may put pressure on companies using them as a raw material.

It is vital to note that, thematic funds may generate envious returns when the theme or underlying sectors are witnessing or expected to witness rapid growth. But they hardly find proponents when the momentum fizzles and funds start performing miserably. PersonalFN has always believed that thematic and sectorial funds are extremely risky investment propositions for this very reason.

To conclude...
PersonalFN believes that cyclicality of commodities make commodity funds risky. Since many of these funds invest outside India through a Fund of Funds format, currency movement may also affect the return potential of such funds to a great extent. PersonalFN is of the view that investors would be better-off if they avoid such fads and stay with diversified equity mutual funds. They might not quench your excitement of trying out new investment alternatives, but they may do a lot better than sectorial and thematic funds over a longer duration. What matters is the right selection.

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