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Commodities: Inflationary Spiral Ahead?

The view on Buying Gold and major commodities from Mumbai, India...

THE GLOBAL ECONOMIC DEPRESSION has hit almost all major commodities except Gold Bullion, notes Commodity Online in Mumbai, which is clearly seen as a safe haven investment in times of crisis.

Despite the stimulus packages announced by major OECD and emerging economies worldwide, the prevailing mood remains one of fear and anxiety as base metals and the energy sector – whose recovery might seem to depend on stimulus packages – continues to be hit by weak investor sentiment.

However, certain commodities such as sugar have performed well due to a shortage in production. And in these uncertain times, Kuljeet Kataria – vice president of commodities at Motilal Oswal Financial Services Ltd – believes that 2009 might see the return of inflationary spiral, led by the rapid revival of several commodities now hurt by the banking liquidity crisis.

Commodity Online: The economic downturn has affected virtually all sectors and certainly the commodities market is no exception. How far have commodities been hurt by the credit crisis?

Kuljeet Kataria: Yes, it is true that the economic downturn has affected all the asset classes, including commodities. The crisis which started with the US housing market has now reached the developing economies, too.

The most affected commodities are the base metals and energy. In 2008, the best example was crude oil which hit a record high vs. the Indian Rupee in the 3rd quarter of 2008 but in the fourth quarter suffered a steep fall and registered a life-time low on Mumbai's MCX exchange. The major reason for the downfall in commodities was deflationary concerns due to slowing in the global economy. Slowing of the global economy has affected demand, which had previously reached a high level in the industrial metals complex.

Now major world producers have announced aggressive capacity reductions. The only commodity which gave positive returns in 2008 was Gold Bullion, due to its safe haven status. The reason behind the Gold Price moving up was premature inflationary worries, I believe, due to the huge liquidity infusions by major economies.

Commodity Online: In many analytical reports, base metals were seen as the worst causality of the downturn. Most of them have been badly beaten at the London Metal Exchange (LME) with inventories rising. What is your rating for base metals in 2009, given that the Chinese stimulus package has started working – even though demand from emerging countries is not picking up that fast?

Kuljeet Kataria: The global slowdown and deflationary spiral has brought about an imbalance in the demand-supply scenario of all industrial metals. We know that China is the major consumer and producer of base metals today, so any change in the Chinese economy will have a major impact on the prices of industrial metals. China's stimulus package of $585 billion – plus the Chinese State Reserve Bureau (SRB) planning to buy 1 million tons of industrial metals – has supported metal prices from going down further.

But the rising LME stocks indicate that prices could fall further. The production cuts by a majority of the industrial metal miners then indicates a tighter supply in the near future, setting the stage for good recovery in base metal prices. We expect that, with the economic recovery, copper will be the first base metal to lead the rally in the industrial metals complex.

Commodity Online: Sugar and Gold Investment were rated as the top performing commodities in 2008. So for 2009, how do you view these two commodities? For Sugar of course, India's sugar production, for example, is estimated to be down from 26 million tonnes to 18m tonnes – which might have a bullish impact. And gold is rallying because other sectors are down. Is that right in your view?

Kuljeet Kataria: We expect Gold Prices to continue their upward trend in the first half of 2009 and in the second half they should see some corrections. The main reason behind bullishness in sugar is estimated production. It's expected to be down from last year.

The Indian government is now 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.

Commodity Online: Another major casualty as far as Indian farmers are concerned is pepper, whose export demand has fallen and the market looks subdued right now. How do you think Pepper may perform in the near- and medium term?

Kuljeet Kataria: Pepper exports in the April to November period fell 33% to 16,850 tonnes, while demand took a hit from the global financial crunch. The market is expected to be weak in the short term, but international demand will revive from mid-February we expect.

Estimated production this season is set to be around 42,000 to 45,000 tonnes. Unfavorable weather conditions in the initial days of the crop, coupled with aging creepers – which are more prone to diseases – have led to lower pepper production. Domestic Indian consumption is seen around 40,000 to 45,000 tonnes, and a lack of sufficient carryover stocks is also encouraging local buying interest in the commodity, despite low demand from overseas buyers.

The current stockpiles are at historic lows, around 8,000 tonnes. During the previous season, pepper stocks stood around 15,000 tonnes during the same period. This has made the fundamentals underpinning the commodity strong. In the medium term, we are expecting prices to trade to the upside.

Commodity Online: There was recently a Financial Times report, based on the Baltic Dry Index [of shipping costs], which indicated that spring time had arrived for commodities? Resource-based ETFs have also fared well, providing 20% returns in short order. What do you think are the prospects for commodities in the first half and latter half of this year?

Kuljeet Kataria: Deflation was the 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 the major economies.

Premature inflation has already been discounted in the market, which can be seen from the ETFs holding gold and silver reaching record high stockpiles. In the first half we expect that the Gold Price will cross its previous highs in the US Dollar and in the second half base metals will start recovering. Crude oil, we believe, will be in the range of $50 to $75 per barrel.

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

Kuljeet Kataria: As we all know, the commodities market is driven by its demand and supply fundamentals. It has been noted that farmers in Indian are now shifting from one commodity to another, because they are not getting the fair value of their crop – and that creates a shortfall in production. Scarcity in the supply of the agricultural commodities will definitely result in higher prices.

Commodity Online: India's commodity futures exchanges continue to grow at a rapid pace. Figures from the Forward Markets Commission (FMC) show growth of 34%, helped by growth in the 3 major bourses. How far has lifting the ban on four commodities helped? What more needs to be done by the FMC and government to increase trading in commodity futures?

Kuljeet Kataria: Lifting the ban has just improved sentiment towards the commodities markets. For genuine growth of the commodities market in India, FMC should introduce options and allow banks and other large institutions to participate.

Commodity Online is a leading online, print and content provider of news, information and research reports on the commodities sector. With offices in Mumbai, New Delhi, Ahmedabad, Cochin, Bangalore and Dubai, it also powers content in the SME sector, as well as the insurance and banking industries.

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