How will the next quarter be for Indian commodities? In one word: bearish. The hot money has vanished. Shortages have given way to plenty. Between July and September, Indian farmers, commodity producers and traders would find it hard to make ends meet as returns fall below cost of production.
But companies buying raw material, metals, energy, food and fibre, can expect to breathe easier. ET helps you join the dots. Food and fibre will lead the fall. Already, Indian wheat, cooking oil, sugar, cotton, pulses, potato and onion prices are sliding because godowns are full and supply, stimulated by high prices, has overtaken demand.
If the monsoon is good and large harvests arrive in October, the fall will accelerate. Sugar is a classic case of corporates and farmers suffering when a commodity that is expensive to produce overshoots demand. Purchases by food, confectionery and beverage companies don't increase immediately due to low prices.
But sugar mills are legally obliged to sell a certain quantity each month and the export window is shut. Extra availability has depressed wholesale prices to Rs 24 per kg, which means a Maharashtra mill loses three bucks on every kilo. The loss is greater on sugar meant for ration shops because state governments are tardy customers. Crucially, raw material is expensive due to high government-fixed cane prices.
The cost of carrying unsold sugar is higher as banks tighten interest rates. Before mills can recoup, a bigger harvest will be ready. Cash flows could become a trickle by October, just when irate farmers demand quick payment. India is bearish because a political decision to exit the $1.29-trillion global food trade has ring-fenced local output. Global food prices continue to climb because record harvests have not been able to restock godowns and weather plays truant with summer planting.
The FAO Food Price Index is still 37% above May 2010. Policy, not markets, have put India in bubble wrap. The downside of trade barriers is that buyers know crops have nowhere to go. Consumer gain will come at the cost of producer grief. But with 600 million Indians living off agriculture versus 1.2 billion consumers, UPA-II government is clear. Investment in farm this year is $5 billion.
The total food subsidy and MGNREGA bill is $23 billion. Indian metal prices will move in tandem with sluggish global prices. Global industrial production volume growth is down to almost half since December. In the developed world, factories have slowed down because expensive raw material, the Japanese quake crisis, EU fiscal consolidation and low disposable incomes have reduced consumer demand. Policy tightening in China and India to fight inflation has decelerated growth. Bellwether copper is a good indicator.
China, the world's top copper consumer, imported 40% less in 2010-11. With inflation at a 34- month high in May, recovery will be slow. Nickel, the main input for steel, and aluminium face a glut. Crude oil is gyrating on either side of $100 a barrel. Prices will remain capped by the world's limited ability to pay and sluggish demand. More importantly, hot money is flowing out of commodities.
Traders interpret dull equity markets as portend of a global slowdown affecting overall commodity demand. Luckily for them, major Wall Street banks have been almost uniformly and strongly bullish - with warnings about the potential for a sharp market tightening in the second half of the year and explosive price increases.
So, when prices rose in May due to this prodding, smart hedge funds used the rally to scale back their exposure. Net long position in crude oil is down 30% since peaking on April 26. So what does this add up to? Market disruption and greater risk. Farmers will be hard-pressed to recover investment, depressing rural incomes and demand.
With inadequate storage capacity, flat demand and trade barriers, there is no mechanism available to manage excess farm production stimulated by high prices and better yields. Consumers won't gain either because companies will use this opportunity to bolster margins. Neither will inflation drop.
Only manufacturers hammered by rising input costs would breathe easier. Especially those who haven't contracted entire raw material supply in advance. The rest will postpone purchases, slowing down trade. A global commodity shortage is undoubtedly still the big story. But these temporary jolts keep up the suspense.
