Emkay's Ashok Mittal on best ways to trade commodities

Commodity prices move according to global and domestic demand. Slowdown in construction, rising inflation, political unrest, and other such different economic scenarios have an impact on commodity derivatives portfolio, says Ashok Mittal, co-head retail business at Emkay Global Financial Services.

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What is happening in the US, Europe and such other big economies, in terms of their economic data, political events, geopolitical concerns, too have an impact. Also any impact on dollar as a currency, impacts commodities as well. Weak Indian rupee is also affecting commodity prices here.
He says when data comes out, it has to be interpreted in the context of developing a view on how the market would pan out and in relation to how it was earlier and also market expectations.
Mittal says, there is a lot of combination in terms of demand, supply, investment which have to be kept in mind while trying to understand how to invest in commodities.
In the last few months, gold prices have come down. Economic scenario is not so good, hence people are not investing. So there is no physical demand and also the investment demand has come down, he says.
If a retail investor has to invest in commodities, he has to do so via brokers, says Mittal. He says for retail investors, they need to depend on one particular agency whom they have to trust because if they keep running around to different people, they will not get the right advise. It will only end in confusion. So they have to depend on one and continue doing transactions based on the advise given by the financial service provider or advisor who advises them, Mittal says. Below is the verbatim transcript of Ashok Mittal’s interview on CNBC-TV18 Q: What are the different economic factors that you as an analyst keep in mind when you are looking at commodity derivatives?
A: In fact there are many because when you trade on the commodities, you are not trading any domestic market but you are into the global market, international markets. So you need to know what is happening across the world, majorly, the major economies. So you should know what has happened in Europe, what is happening in the US and these economies Europe and US release a lot of data, almost everyday we will find some economic data being released by them.
Other than the economic data, there are political events, there are geopolitical issues. So when you trade on commodities, which are global in nature, you need to know everything that is happening. For example, US will release unemployment data, they will release gross domestic product (GDP) data, they will release trade balance. So is Europe, so is Japan so whatever data comes that definitely impacts certain parts of the economies or that will impact dollar as a currency.
The moment, there is an impact on dollar as a currency, that will have an impact on commodity as well. So any data, which says okay there is an expected increasing demand for energy, crude oil, you will see suddenly crude oil prices going up. This can be either by economic data where you see that the stock is lesser or the demand is more from economic perspective. Geopolitical perspective, any tension in the areas where production takes place, so anything happening anywhere in the world will suddenly impact the prices of commodities across the world so the impact will also come in India. The only additional factor, which is affecting commodity prices in India is Indian rupee which is forex.
So whatever happens in the international market, if the gold price in international market comes down by USD 10 per ounce, let us say that USD 10 per ounce will impact by another Rs 100. But at the same time, if you have dollar/rupee impact that will add. So commodity trading is little difficult or critical and from that perspective you need to know fundamentally, what is happening across the world. Q: Put it in perspective for us because over the last four years or so, we have gone from a global economic scenario, which was very plush especially in China etc where there was a lot of activity, there was a lot of consumption as a result of that to a situation where we have had a slump in the Chinese economy. We are beginning to see a whisper of recovery in the US economy, from the commodities, derivatives basket, how have we seen the shift in different assets as in from industrial metals to either bullion or to the energy so on and so forth?
A: There are two factors. Earlier maybe around 10 years back, people used to track how demand and supply scenario was. So if there is demand for base metals in China, prices will go up, if there is no demand or less demand, prices should be coming down but in the last around 8-10 years, other than changes in physical demand for consumption, the investment part has also got added to commodities where a lot of treasuries, banks, funds have included commodities in their portfolio.
So for example, earlier we used to say if there is a marriage season or festival in India, gold demand will go up but now it is not necessarily happening in that way because a lot of people are investing in commodities. So in the last 10-years a lot of demand for gold and silver was because people were investing in that despite consumption demand not being so high. So is in base metals, so is the case with energy, crude oil etc.
So now you have to look at two aspects, one is how is the demand scenario, how is the supply scenario and sometimes you will find that there is no physical demand but price is going up because people are investing in that. What change we have seen in the last few months, gold prices have come down and all. So economic scenario is not so good, so people are not investing. So there is no physical demand and also the investment demand has come down.
Those who track gold would have seen that there is something called SPDR holdings, the holdings in gold ETFs, so those holdings in ETFs have come down drastically below 1,000. That means whoever is investing in gold is withdrawing their money. So not only industrial activities, consumption activities, which will impact the prices but also the investment activities will impact.
Another thing, which I said, any economic data or anything that will impact the price of dollar because dollar is not only a currency but also directly linked with the commodities so the moment you say anything which is good for US economy, which will strengthen the dollar as in currency, that effectively means anything which is denominated in terms of dollar will come down. So if dollar strengthens you will see price of gold, silver, crude, copper everything coming down. So there is a lot of combination in terms of demand, supply, investment when you try to understand how to invest in commodities. Q: Exactly that point, taking it ahead because that means that any retail investor who is watching this show is looking at a huge basket of information which he has to cull through. So now how can a retail investor participate in investing in commodity derivatives, does he necessarily have to do it through a brokerage where there is already analysis, research or can he do it on his own as well?
A: Any retail investor if he has to invest in commodities, he has to go through a broker member only.
How he takes the decision? I think a lot of information is available on the media, on the internet and also his broker provides him with information. The only point is for retail investors, they need to depend on one particular agency whom they have to trust because if they keep running around to different people, they will not get right advise because somebody is bullish or bearish. So they will get confused. So they have to depend on one and continue doing transactions based on the advise given by the financial service provider or advisor who advises them.
I want to specifically mention this, a lot of time when the data comes and we read the data and we say okay, this data is good or bad, that data should not be seen in absolute terms good or bad, it should be seen in terms of what was the expectation of the market and whether this data is as per the market expectation or better or worse than that because market moves as per the expectation and also because of this data what is the future expectation of the similar data.
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So if you see GDP of US is not good this time, which means not good for US economy so people will interpret how it was last time, how it was expected to be this time and based on that what will be next course of action in future by the government, which will impact dollar as a currency or commodity hence the impact will on various commodities. Q: So the data has to be basically interpreted in the context of developing a view on how the market would pan out and in relation to how it was earlier?
A: Yes and how the market expectations were for this time also. Q: We are almost in the second half of this calendar year. Now, we are seeing domestically a considerable slowing down of gross domestic product (GDP) and growth. We are seeing a weakening domestic currency, we are seeing inflationary environment which the central bank is trying to accommodate. How do you make a strategy for this kind of an environment if you are trading the commodities derivatives basket?
A: When one looks at commodity and currencies, they are two different segments. When one trades them in India one has to take an outlook on both of them and one has to decide on what kind of duration or time horizon one is looking to invest. There are two things. One, is time horizon, one is the kind of risk to reward one is looking at.
The contracts in the commodities are two months or one month. Also when one takes a decision, one is taking a decision based on certain data or information which one gets. For example, crude oil, one gets the inventory data that comes on a regular basis, weekly basis. When one looks at some data, they are either on a monthly or a quarterly basis so this fundamentals when one looks at is longer duration in terms of deciding the direction of the market. How Q3 will happen? How bond buying will happen in the United States etc. Along with that one also needs to look how the Indian economy will perform because the rupee movement will happen based on that.
In this current scenario when one sees, when we see that the Indian economy is not growing well, so one knows that rupee is going to weaken, the price of commodity should be going up. But at the same time, overall global scenario is the price of commodities are not going up because of demand not being there, consumption not being there, growth of economies not being so good. We have to make strategy based on individual data.
The moment one sees okay there is an improvement in the Chinese economy or the demand for base metal has gone up suddenly one can decide, okay I want to be long on the base metal side. This will help one because your base metal demand for copper and lead, nickel etc will go up from China. At the same time one will know that rupee is going to weaken. This will help in terms of deciding the long side. But at the same time if you have a decision, okay gold price in the international markets are falling so one is seeing that from USD 1800 odd one is close to USD 1300 so ideally gold should have come down drastically but the weakening rupee is pushing prices up. One has to mix it up.
It will depend on each commodity and each time whether one wants to be long or short. In derivatives market not necessary one only goes by duration of the contract but also how that economic scenario will play for longer period, now we know that overall economic scenario is not good and our outlook and mostly outlook is that it will remain the same for the next one two years. One has to be on that side where one knows commodity prices will not rise too much. The kind of returns one is seeing in the last 6-7-8 years those kinds of returns will not happen. Q: In fact, that is what I wanted to understand from you – in a good economic scenario and in a weak economic scenario what is a realistic return that you have got from bullion, crude, agri commodities, so historically what are the kind of returns seen in which case one can align their expectations and understand risk to reward probability?
A: Right. We have seen gold giving around 25-30 percent return in the last 10 years, every year. Base metal in the last 1-2 years has not really given good returns so, gold and silver have given better returns. Crude is now minus after it has been going up. In this year, the return which one has got is largely driven by the depreciation of rupee.
The returns are more or less equal to what extent rupee has depreciated not really great. For the next 1-2 years, one can’t expect those kind of returns which one made 25-30 percent being on the long side. I think the range will be narrow. Markets always remain volatile but then it compensates with each others movement and in that case my idea will be that one should take a conservative view if one gets around 18-20 percent return in a year.
More importantly for retail customers, as per our experience, most of them are always comfortable being long. So, whenever into derivative one should be fully comfortable going short because this is the opportunity of selling something because one is investing money - Rs 2 lakh, Rs 2.5 lakh whatever - which is being used as margin so if one finds that okay this direction is quite clear and the price is not going to rise one can even sell that commodity because he or she does not need to give delivery on the derivative exchanges so one can keep selling and rolling it over that will also give returns.
One should be clear that if one gets around 4-5 percent absolute movement in that commodity so that 4-5 percent is almost 40-50 percent in terms of money which one invests so, getting 4-5 percent return in absolute terms on any commodity is fairly good and nowadays 4-5 percent movement in around one month time. That can be a time horizon in terms of looking to invest in the derivative products. Q: Economic moves, if there is an impact on crude very often with the hurricanes in US – if there is any kind of political unrest like you were saying – geopolitical that is stretched over a longer period of time, if we had debt crisis or shortage of food grain etc that is also a long-term view. How does a retail investor decide when to go in and put his money for a duration in a contract given the fact that if one takes a two month contract and his view is that for the next six months commodities is going to either be sideways or is going to rise, he might have to rollover or take fresh contracts which will increase his outgo?
A: Let us assume one is doing a monthly contract and now one is investing in that. One has to see how much upside one is looking at. For example, if one looks at the absolute price of the commodity will increase in 6 percent. If one is to do a monthly contract and monthly rollover one should look at what is the cost of rollover because there is always a cost of rollover which is typically in some commodity around 0.5 percent, gold will be around 0.5 percent per month which means, one is going to pay 6 percent per annum.
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If one holds gold for one year 6 percent goes into rollover. In agri-commodity, it is higher also. Look at the cost of carry which will be incurred versus the expectation which one has got. The cost of doing transaction is negligible so one has to look at cost of carry when one looks at these and 10-12 percent kind of return one should get in six months time, which is fairly good. Q: We would like to understand that in this current economic scenario if you put a global and domestic perspective together what commodities would you be bullish on? What commodities you think show bearishness when you are looking at the entire basket, agri, metals, bullion, energy?
A: Now in this environment wherever we have seen that there was a lot of investment demand for the commodity, which has come down, where that is the area where we will not be able to invest, we have to go for the commodity where consumption demand is quite high. Now what has happened over a period of time and also considering the cost of production, gold has say fallen a lot, also we need to consider the price at which we should enter.
So around USD 1170-1200 per ounce is a good price for gold to invest because that is very close to the cost of production, technically that is a good support level and we also expect that at those levels you will start seeing demand coming from consumers as well as investors.
Similarly, silver also at lower levels when you see around say USD 16.50-17 is a good level where you can invest, base metal is something where there is a combination of what happens in China as well as what happens in the US. So unless both the economies start growing well Chinese demand in terms of base metals and housing sector demand in the US who use a lot of copper till that time you will not see that amount of consumption happening right. So that price will remain maybe range-bound in the next say 6-8 months or 12 months.
Agri space wherever there is consumption asset should be good, so you see oil and oilseed sector should be reasonably good in terms of investment globally, I think so. We also have a lot of disturbance in terms of supply side because yield and production of agri commodities is not really increasing too much specially in India, although they are seasonal, but you can still find out which agri commodity in which season I should invest. But there is an inherent demand from the consumer side for those commodities.
So, you have to be very selective based on the season in agri commodities, but overall what we have suggested especially for gold, you become a systematic investment plan (SIP) investor, systematic investment, which can be done in gold. So, let us say if you are going to invest, you spread it out for over a period of time and every month you keep investing so that your investment remains there in the gold. Q: So you take the e-gold route, which means you invest in it through your demat account?
A: You can do e-gold, you can do gold petals, there are contracts available on these exchanges which you can actually use, if people want they can buy it physically. Ultimately, it is a question of investment. So, they can do SIP, which will work well for say 3-4 years time horizon as well. But otherwise when you are an investor and your horizon is not too long in terms of investing and you are looking at returns so you should not really look at time only, you should also look at price. So, you say six months or one year, but you should also know I am expecting 10 percent, 12 percent or I am expecting more than that.
So in this overall scenario, I think if you get around 18-20 percent return a year that is fairly large, good investment in this scenario. Q: Let us look at a scenario when the economy was sort of moderating say about a year or 18 months prior to this when there was still some amount of optimism on Indian gross domestic product (GDP). The rupee hadn’t lost as much ground as it has, if you are faced with that kind of an economic environment then what basket of commodities can help you better your profits?
A: What happens, it is not only about the Indian scenario because earlier what was happening, gold was going up in the international market and rupee was more or less stable. Now gold has fallen a lot infact, but rupee has depreciated. So rupee price of gold has not really fallen that much. So you have to combine these together looking at how the economic scenario is global as well as in India and then only arrive at a price in Indian rupee terms of those commodities.
But still I think there can be various strategies, which can be worked out. So retail investor when he looks at say investment ideas or strategies it is not necessarily that you are only buying or selling, so one is that you take a view okay price will go up, I buy, stay invested and wait for sometime. Being derivatives you can go short, hold it for a longer period of time and remain short for some time and try to make some money, but when you are not really certain and the price movement is in a range bound there is something we call calendar spread or ratios.
They are also very good ideas or strategies to invest in these commodities. From retail investment perspective, number one, the amount of investment required is lesser when you do a spread ratio. I will give you an example, let us say you see gold price of this month and the next contract is at a level which is not really good and you feel okay this spread will increase. So what you do is you sell this current month and buy next month, expecting that spread will increase. 
Second, idea which actually is going to work and which we have come up with the report as well is let us say Nymex crude oil versus Brent crude oil. Now Nymex and Brent crude oil are - normally a Brent crude oil is a gap of around USD 10-12, now they are more or less at par. Infact they had more or less the same price a few days back. So, our idea is Brent crude oil should be at a premium to Nymex crude oil, around USD 8-10, so if you sell Nymex crude oil or buy Brent crude oil in expectation that this gap will increase this will give you returns with a much lesser risk. So you can work out on various strategy in terms of creating calendar spreads or ratios which are comparatively less-risky, conservative and give you decent returns. Q: Okay that brings me to the next question. We have spoken about how you diversify your portfolio, 30 percent goes into agri commodities and 60-70 percent goes into a breakup of bullion, base metals and energy. Where would you take a spread? Where would you take a pure view?
A: I think in a current scenario in the next few months what I will do is in agri commodities I will take views on selective commodity, spread it and invest it based on the view. In crude oil, which I said just now I will try to play on the spread for a longer period till the time I get my price and it may take around say a couple of months to reach at those levels, between gold and silver whatever money I am going to invest, I will go for the SIP route, so that I keep investing them over a period of time and that will be pure investment perspective where I am not really taking a directional view from speculation or trading perspective.
If you do this combination of three things, you are comparatively hedged because somewhere you are long, somewhere you are short, somewhere you have got a spread only. So what happens is even if your view goes wrong in one strategy where you have taken a call in terms of this price will go up or this price will go down, so it is comparatively hedged and I think if I do this combination I will be able to make decent returns over a period of time, let us say in one year period if I keep playing on these different strategies in different commodities, in different segments and if end of the year if I am getting around say 20 percent return, I am happy with that.