Commodities are hot again and it stands to reason. The rally in some of the metal stocks in the last fortnight has been spectacular. The same potion that spurs emerging market stocks on, fuels the commodity fire. Strong asset-reflation cycles triggered by easy liquidity generally tends to drive commodity prices higher, history is proof of that. This may eventually lead to strong inflationary pressures again, leading to central banks raising interest rates and that's when this cycle ends. We may be early in the cycle, so it's premature to worry about the endgame yet. For now, the easy money party is on.
The rising tide typically lifts all boats, so most global commodities will probably do well. Steel has generally been firm and the way Tisco and SAIL have moved of late tells you what the market is pricing in. Copper and aluminium should do well too and Sterlite is perhaps the cleanest way to play this move as it's unencumbered, unlike Hindalco. Resource companies should do very well too. So keep an eye on Sesa Goa and even Gujarat NRE Coke. Sadly there aren’t many gold mining companies in India, else they would have been good bets. There's a gold mining fund though, which has been a tearaway performer. Sure, some of these commodity stocks have run a lot recently so a brief correction should not be ruled out.
The thing about commodity stocks is fairly simple though, when the underlying commodity runs, the stock runs with it. The correlation is almost perfect. The other good thing is that commodity stocks, because of their cyclicality, trade at low valuation multiples. If the market were to run into frothy zone in the medium term, investors could easily justify far higher prices citing a long overdue rerating. These things have been known to happen.
This doesn’t bode well for the commodity consumers. Their margins will continue to drag. Auto ancillaries perhaps have a double whammy here. Squeezed by the rupee on one side and hurt by rising input prices on the other. Doesn’t look like a great place to be. Autos too should not expect much by way of margin relief, yet. This could be a time when the market pays a premium for the owners of natural resources, and it may be wise to focus on how to play it through stocks instead of shunning them as “commodities”.