Growth engines: Commodities, Energy & Emerging markets

Commodities and energy have been hot since last couple of years. Most of the hedge funds, private equity funds and venture capital funds have been investing and trading the asset classes for better growth and return opportunities. The rational is simple about demand-supply mismatch that oil and precious commodities’ supply is limited or the future is unforeseeable while consumption is increasing resulting in higher commodity prices.

Some simple observations based on demand-supply scenarios are:

Commodities

1. Two of the largest populated countries in the world China and India have population of 1.3 billion and 1.1 billion respectively and it has been estimated that India will surpass the China population by 2030. Let’s take it for India where per capita income in India has increased from merely ~$2000.00 in 2000 to ~$4500.00 in 2007 as per World bank reports. Since per capita income is increasing and because of better market sentiments and more job opportunities in Software, Hardware, Auto, Pharma, Business, Exports and host of other sectors, food habits of people is changing and more options for food is available all across the towns. More and more number of mall and recreational centers opening leading to more consumption on transportation, gas and commodities leading higher commodity prices.

2. The biggest recession since world war 2 has made people think before they invest that the asset class is right one and would not create future bubble preserving the investment value. Fed has decreased interest rates to 0% for lending to banks and helping to continue the money and credit supply in the market by providing stimulus package to critical industries, so as the industries can start creating/maintaining new jobs and the nation can survive on consumers’ spending patterns. Because of 0% interest rates and stimulus package the economic recovery is faster and ‘V’ shaped. The faster recovery and longer sustained 0% interest rate will further create inflation, hence increasing/inflating the demand of commodities like Gold where people is thinking a safe investment option.

3. Since the interest rates in the lower range around 0%, there is no benefit to risk-savvy investors as they are not getting any good debt returns, leading them to invest in currently considered safe heaven investments as Gold which has very limited production. When lot of people chase very limited resource, the resource price going to inflate realistically.

4. Emerging markets have seen loss of agricultural land because more land is getting converted towards industrialization and housing, leaving less land for cultivation and this widens the demand-supply gap, leading to higher commodity prices.

5. Since many governments have legalized mixing ethanol with oil, demand for ethanol has been increasing constantly. While ethanol is produced mainly from corn, there is huge demand-supply gap in corn production leading to higher corn prices. This will continue till we have some other alternative fuel to replace oil.

Energy

1. Oil supplies are limited and oil companies are spending a lot on discovering more oil resources. Till the time there is no viable alternative found for Oil, oil is going to remain hot commodity. Although oil prices sky-rocketed in 2008, emerging market’s oil consumption is increasing everyday, because people have more money and their spending pattern is changing. Due to this demand-supply imbalance, again there will be rise in oil prices.

2. Solar-energy and wind-energy are alternative energy sources to oil and they have potential to generate electricity and act as viable energy source, but the energy produced using the sources neither have a consistent pattern of energy production nor it is cheaper than the existing sources like coal and oil. Solar and wind energy are very much dependent on the geographic conditions and cannot be implemented everywhere. Further they require substantial investment to produce the energy. In future when oil/coal prices sky-rocket, this sources might be beneficial in terms of cheaper energy needs.

3. Since the limited supply of oil, there is renewed interests in searching alternative energy fuels. Some venture capitalists and universities are investing heavily inventing alternative energy sources.

Emerging Markets:

1. Since Goldman Sachs coined the term BRIC in their 2000’s research report, Emerging markets such as China and India have remained focused for better growth engines for many funds. Due to surge in consumption demand, stable governments, and better economy prospects emerging markets give better returns than their developed world counterparts. As specified earlier, the per capita income in India has surged leading to better consumption growth story. As per sources, China and India continue to grow at 7.5% and 10.5% of their GDP respectively. Apart from that government’s spending on infrastructure & power, health/medicine sectors will provide necessary boost for the growth as well as good indications to foreign investors to invest in the developing countries, where hugh thrust on developing infrastructure and providing services at cheaper rates will boost the economy.

2. International Olympics Committee recently chose Brazil for hosting the 2016 Olympics and Brazil is also hosting 2014 FIFA World-cup. For this Brazilian government will spending hugh money on building roads, bridges, and stadiums, providing lots of jobs and business opportunities. As per consumer reports, Brazil will witness 11-12% of GDP growth and will fetch millions of foreign visitors. It will boost hotel, airlines, local restaurants and host of other local businesses including the currency.

Based on the points discussed above commodities like gold, silver, oil, gas will give better returns than index funds or any other asset class, but it give little comfort to consumers because they will see their daily budgets shooting the skies. Investing in emerging markets companies is associated with risk towards government stability, foreign policies and management, but however it will give better returns. Infrastructure companies in emerging nations that construct roads, build bridges and infrastructure, produce power will give very good returns.

The observations are solely based on demand-supply scenarios, and they do not represent any speculation on the commodities e.g. oil and gold, but rather a conservatively optimistic views of the author on the particular asset classes.