Our research shows that we are at the middle of a cycle which will probably have a life of another seven-eight years. - MR ARINDHAM GHOSH, CEO, MIRAE ASSET MANAGEMENT.
Mirae Asset Management has launched a Global Commodity Fund at a time when commodity is perceived to be the next big bubble. Mr Arindham Ghosh, CEO, Mirae Asset Management, suggests that we may be only mid way in the current commodity rally that is likely to last another eight years. He feels the current rally has been fuelled by inequilibrium in the demand-supply of commodities, especially in the emerging market countries.
Excerpts from the interview:
The launch of your fund comes at a time when there are concerns of a commodity bubble. Is the upside at this point not limited?
The new fund launch is on the basis of an extensive back testing . We decided to sequence this product at this time because we are of the belief that commodities normally follow a long cycle. And if you go back into the last 130 years, you would find that there have been three long commodity cycles and they all had a life of over 17-18 years. The first cycle started from 1907 and lasted till 1923 . Then in the 1930s you had the Great Depression coming and therefore from 1933 to 1953 we had the longest 20-year commodity cycle. And thereafter you got into the recession of the 1970s.
From 1968-82, therefore, you had another long commodity cycle. If you again look at the commodity markets from 1999 it has again been on the move up. So if you typically look at it from a cycle and its life, we are probably at the middle of a cycle and our research shows that this cycle will also probably have a life of another seven-eight years left. But really what happens is that within the commodity space there are different sub-cycles. So you will have some commodities that will probably follow a shorter cycle of this boom and bust. But overall, from an asset class point of view, this is one asset class that is going to remain buoyant for the next seven-eight years.
Are the current prices especially in crude driven by mere demand or by an increased investment interest?
If you have look at crude, our view is that the upcycle will last anywhere between the next six months and two years. That’s the kind of life we particularly see for prices to remain at reasonably high elevated levels.
Having said that, our belief is that it will not substantially come down to the $60 or $80 levels. We may have to face the reality of living with a $100 a barrel situation in the future. The reason is that if you move away from the demand and look at supply you will find that there have been no major oil discoveries in the last 50-60 years. The number of active oil rigs world over has been coming down. Many of the multi billion barrel reserves have actually peaked out. So clearly there are supply pressures.
If you look at the OPEC countries, they follow the quota system. Typically what happens in a quota system is that without any kind of independent audit, nobody really knows the extent of reserves that these OPEC countries have. They have this system for a very strong reason and probably there is a temptation to inflate figures. Now if you look at Russia, it is the number two oil producing country in the world. They run on technologies that are pretty much archaic . While they have been pumping oil they do not have the pipeline capacity to get it to the market.
So there are supply issues and I am not even talking of a geo political escalation of tension. If you look at gas, it is almost the same except that excavating gas is much more expensive because you have to go deeper to extract gas.
Have you seen different sub-cycles in the case of metals?
In base metals, copper, aluminium and tin will continue to have buoyant demand emanating from China and India and some of the other markets. Take a commodity such as bauxite — China imports in bulk thus keeping the demand strong.
Coking coal is a really scarce resource concentrated in Australia and China. These two countries alone hold 85 per cent of the world supplies. In case of nickel and zinc we are not at this point in time very positive about the prices as we believe that the upside is quite limited.
So you have, even within the base metals, some commodities that are at a certain stage of the cycle and few others probably at the end of the cycle. So the point that I am trying to make is that the demand-supply inequilibrium, whether it is crude or food grains or base metals, is going to persist for many more years. . You will probably hit a point where demand starts to come off or there is a behavioural change in people — say people cycle to office instead of driving their cars. But that is going to take a while.
What has changed now to cause the sudden spike in commodity prices?
Our belief is that this sharp escalation in commodity demand is not something that is very recent. It has been happening. But because the equity markets are now going through a downturn and people are sitting up and taking notice that commodity prices are high. Because inflation has moved up, people probably look at inflation and interest rate as the killers for the stock markets and therefore commodity comes into action.
People start looking at commodity prices and wonder whether commodity is behind all this. We don’t think so. We have to understand a simple theory that (and this is on the basis of evidence) India and China today have been increasing their contribution to world GDP.
The emerging market countries are going to drive growth. If you go back in history, Japan and the US, at some stage, were also developing economies. When Europe was a developed world, the US used to be a developing economy. Japan was a developing economy five-six decades ago. So when you have such giant developing economies with large population , you will have an increasing section of population who will start to consume more as per capita income goes up .
So when some of the world leaders are voicing their opinion that India and China are behind this, they are not altogether incorrect. But when they were developing countries they were also consuming as much.
Do the current inflation across the globe and signs of moderation in growth, especially in India, worry you?
We have to confess that we have probably seen a fairy tale run over the last four-five years before the downturn that we have now. Today we are actually besieged with many issues that have got magnified beyond proportions. Like inflation with where it is, our belief is that if we see one more round of pass-through happening, it may push it further up. If you look at the current under-recoveries, particularly in the downstream companies (of course a certain portion gets passed on to the upstream companies as well), it would probably be in the region of $55-60 billion.
It would depend on how much of these can get bailed out through oil bonds. But the concern is that whether it is oil or fertilisers, the off balance sheet items have today been left to a situation where your deficits have really been ballooning up. Now with current account deficits of 3 per cent expected to go to 5 per cent and fiscal deficit of around 6 per cent expected to get pushed to 9 per cent we have a lot of problems on hand.
If you go back two months ago, nobody was talking about the domestic problem. We were all talking of the US and were trying to figure out when they were going to start investing back in India. Today, nobody talks of the US. Suddenly the domestic issues scream for attention.
Today we have a situation where we have to first start to address the local issues and challenges on hand — which is typically the interest rate, inflation, deficit, subsidies.
We do expect inflation to remain at certain elevated levels until the end of this year or early next year when the base effect starts coming in. And therefore we do expect further monetary tightening measures to come in.
On valuation our belief is that there would be some compression happening in valuation as well.
