1. Commodity as An Asset Class

2. FINANCIAL MARKETS CAPITAL MARKET MUTUAL FUNDS FOREX MARKET COMMODITY MARKET DEBT MARKET MONEY MARKET

3. Overview of Presentation Supply/Demand and the ‘New consumers’ Supply/Demand and the ‘New consumers’ Other Factors too: Other Factors too: - The US Dollar – outlook - Real Interest Rates – not rising … - The Commodity Cycle - lasts years … - Massive Reserves - Developmental demand - The Economic Cycle Portfolio Diversification With Commodities Portfolio Diversification With Commodities - Better Returns - Diversification benefits - Hedge Against Inflation - Scenario Analysis India Story India Story

4. Supply & Demand /New Customers

5. World Demand – New Consumers Aluminum: pounds per capita consumption Source – World Meta Bureau

6. World Demand – New Consumers Steels: pounds per capita consumption Source – World Meta Bureau

7. If supply cannot expand at the rate of intended demand, the price of commodities MUST rise in order to squeeze demand back to the available supply. In the true sense; a rising price is the market’s way of rationing demand. Accordingly, central banks run serious risks by tightening monetary policy in hopes of suppressing the rise in commodity prices. We could say…

8. Other Factors

9. Other Factors: the US Dollar The Dollar broke down in 2002 … Created Using Metastock

10. Other Factors: the US Dollar In fact, the gold price often turns with US$ … Created Using Metastock

11. Commodity Prices and US$ So does S&P commodity price index … USD Index S&P Commodity Index Created Using Metastock

12. The Outlook for the US Dollar The RMB and Asian currencies must rise! Source - IMF

14. When the dollar declines against the Asian currencies: Local demand picks up Local prices eventually start rising … But since Asian consumers are driving commodity prices, the dollar’s decline against Asian currencies is far more important for commodities than other factors such as the dollar’s relationship with say the Euro! 2010 Phenomenon: Gold & Euro: Sudden payment crisis in some EC countries (Greece/Portugal/Spain/Ireland) caused a loss of confidence in the Euro We could say…

15. Commodity Prices and Interest Rates … with the S&P Commodity Index …

16. News: 15th November 2010 Gold gained half a % on Monday, after falling three % in the previous session on talk of an imminent interest rate hike by China that triggered a broad commodities decline. Copper fell on Friday, receding from the previous session's record high to hit a one-week low on talk of an interest rate hike in top consumer China, but analysts said good fundamentals supported the metal longer-term. Oil prices slumped more than 3 % on Friday, retreating from a 25-month high, amid a broad commodities rout on fears that China may raise interest rates to brake its economy and concerns about euro zone debt.

17. When real interest rates (inflation-adjusted) decline, demand for goods and services generally responds positively This demand is reflected in the demand for raw material in general and key commodity prices specifically In fact, the data shows that both the Dollar and real interest rates are negatively correlated with commodity prices We could say …

18. The Commodity Cycle The shortest copper cycle lasted 16 years 50 day Moving Average COMEX Copper Prices from Jan 1988- Oct 2010 Tube Sheets Wires

19. The Gold Cycle The shortest gold cycle lasted for 10 years…

20. The Commodity Cycle The shortest gold cycle lasted for 10 years… 50 day Moving Average COMEX Gold Prices from Jan 1979 - July2010

21. The Wheat Cycle The shortest wheat cycle lasted 16 years

22. The Commodity Cycle Subprime crisis Iraq War Gulf war NYMEX Crude Oil Prices from Jan 1980- July2010 50 day Moving Average

23. Reserves Foreign Exchange Reserve (Sept 2010) CountryMn $ CountryMn $ China2648300 Singapore214,662 Japan1050235 Switzerland255,522 Euro system726850 Germany197107 Russia501100 Algeria150000 Saudi Arabia410300 Thailand182691 Republic of China380505 France142834 India295792 Italy144287 South Korea289780 United States128,601 Hong Kong266100 Brazil282921 Total Sum of all Countries10008392 Source - IMF

24. Investment Demand in Commodities Commodity “asset class” room to grow!

25. The value of managed assets in the world is about $55 trillion … Estimates suggest that only $175-200 billion of this is invested in commodities Assuming that the “commodity asset class” will grow to about 3% of all assets … There could be an 8-fold increase in commodity investments! Opportunities in Commodities Commodity “asset class” room to grow!

26. The Economic Cycle … and generally decline during/after recessions

27. The Economic Cycle

28. Goldman Sachs Index Recessionary phase

29. Agri commodity prices

30. Commodity Prices Source: IMF

31. The dollar has a major impact on commodity prices … So do real interest rates … The commodity cycle generally lasts for years The Commodity complex has become an “investment class” Recessions damage commodity prices Recovery pushes up prices Conclusion…

32. Portfolio Diversification

33. Commodity Delivers Better Returns … absolute and risk adjusted returns… The average historical risk premium of Commodity Futures has been about 5% per annum during the period from 1959 to 2010.

34. Commodity prices and prices for stock and bonds respond differently to changes in market and economic conditions. The difference in how they respond to global events and the timing to these responses can provides commodities with valuable benefits when combined with other financial assets. Diversification Benefits …when other disappoint, commodities stands!!! Source – DataStream

35. Diversification Benefits …the importance of negative correlation… Portfolio I Consider a position consisting of a USD 1,000,000 investment in S&P 500. The daily volatility for S&P 500 is 1.37% (2nd Jan, 2009 to 30th May, 2009). VaR for S&P 500 Since size of the position is USD 1 million, the standard deviation of daily changes in the value of the position is 1.37% of USD 1 million or USD 13700. The 1-day 99% VaR of a USD 1 million position in S&P is 2.33*13700 = USD 31921

36. Portfolio II Position consisting of a USD 1,000,000 investment in Gold. The daily volatility for Gold is 1.44% (2nd Jan, 2009 to 30th May, 2009) VaR for Gold Since size of the position is USD 1 million, the standard deviation of daily changes in the value of the position is 1.44% of USD 1 million or USD 14400. The 1-day 99% VaR of a USD 1 million position in S&P is 2.33*14400 = USD 33552 Diversification Benefits …the importance of negative correlation…

37. So if we combine these two Single-Asset Case portfolio and form a new Two-Asset Case portfolio the VaR for the portfolio should be??? Simple – Sum of the VaR for the two portfolio’s, Right??? Therefore VaR for this portfolio is USD 31921 + USD 33552 = USD 65473 No !! Correlation gets involved here. If S&P 500 and gold were perfectly correlated (+1), the VaR for the portfolio would equal the VaR for the S&P 500 plus the VaR for the gold (31921+33552 = 65473). Less than perfect correlation leads to some of the risk being “diversified”. IF Correlation between both the asset classes during the given time period is -0.71 Diversification Benefits …the importance of negative correlation…

38. VaR for the portfolio The standard deviation of the change in the value of the portfolio consisting of both stocks over a one-day period is therefore SQRT (13700^2 + 14400^2 + (2*-0.71*13700*14400)) = USD 10719 The 1-day 99% VaR for the portfolio is therefore 2.33*10719 = USD 24977 The amount (31921 + 33552) – 24977 = USD 40496 represents the benefits of diversification. IMPORTANTLY COMMODITY HAS HISTORICALLY PROVIDED DIVERSIFICATION DUE TO LOW OR NEGATIVE CORRELATION WITH OTHER ASSET CLASSES!!! Diversification Benefits …the importance of negative correlation…

39. In Summary, Commodities Offer: Positive Expected Risk Premium Strong Diversification Effects Unique Risk Hedging Benchmark Choices Variety of Investment Vehicles

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