commodity as an asset class
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DESCRIPTIONCommodity as An Asset Class. FINANCIAL MARKETS. CAPITAL MARKET. DEBT MARKET. FOREX MARKET. COMMODITY MARKET. MONEY MARKET. MUTUAL FUNDS. Overview of Presentation. Supply/Demand and the New consumers Other Factors too: - The US Dollar outlook - PowerPoint PPT Presentation
Commodity as An Asset Class
FINANCIAL MARKETSCAPITAL MARKETMUTUAL FUNDS FOREX MARKETCOMMODITY MARKETDEBT MARKETMONEY MARKET
Overview of Presentation Supply/Demand and the New consumers
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- Better Returns- Diversification benefits- Hedge Against Inflation- Scenario Analysis
Supply & Demand /New Customers
World Demand New ConsumersAluminum: pounds per capita consumptionSource World Meta Bureau
World Demand New ConsumersSteels: pounds per capita consumptionSource World Meta Bureau
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 markets 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
Other Factors: the US DollarThe Dollar broke down in 2002 Created Using Metastock
Other Factors: the US DollarIn fact, the gold price often turns with US$ Created Using Metastock
Commodity Prices and US$So does S&P commodity price index USD IndexS&P Commodity IndexCreated Using Metastock
The Outlook for the US DollarThe RMB and Asian currencies must rise!Source - IMF
When the dollar declines against the Asian currencies:Local demand picks upLocal prices eventually start rising
But since Asian consumers are driving commodity prices, the dollars decline against Asian currencies is far more important for commodities than other factors such as the dollars 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 EuroWe could say
Commodity Prices and Interest Rates with the S&P Commodity Index
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.
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 pricesWe could say
The Commodity CycleThe shortest copper cycle lasted 16 years50 day Moving AverageCOMEX Copper Prices from Jan 1988- Oct 2010TubeSheetsWires
The Gold CycleThe shortest gold cycle lasted for 10 years
The Commodity CycleThe shortest gold cycle lasted for 10 years
The Wheat CycleThe shortest wheat cycle lasted 16 years
The Commodity Cycle
Gulf warNYMEX Crude Oil Prices from Jan 1980- July201050 day Moving Average
Reserves Source - IMF
Foreign Exchange Reserve (Sept 2010)CountryMn $ CountryMn $China 2648300 Singapore214,662Japan1050235 Switzerland255,522Euro system 726850 Germany197107Russia 501100 Algeria150000Saudi Arabia 410300 Thailand182691Republic of China380505 France142834India 295792 Italy144287South Korea 289780 United States128,601Hong Kong 266100Brazil282921Total Sum of all Countries10008392
Investment Demand in CommoditiesCommodity asset class room to grow!
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 CommoditiesCommodity asset class room to grow!
The Economic Cycle and generally decline during/after recessions
The Economic Cycle
Goldman Sachs IndexRecessionary phase
Agri commodity prices
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 pricesConclusion
Commodity Delivers Better Returnsabsolute and risk adjusted returnsThe average historical risk premium of Commodity Futures has been about 5% per annum during the period from 1959 to 2010.
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
Diversification Benefits the importance of negative correlationPortfolio 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
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
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 portfolios, Right??? Therefore VaR for this portfolio is USD 31921 + USD 33552 = USD 65473No !! 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
VaR for the portfolioThe standard deviation of the change in the value of the portfolio consisting of both stocks over a one-day period is thereforeSQRT (13700^2 + 14400^2 + (2*-0.71*13700*14400)) = USD 10719The 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
In Summary, Commodities Offer:Positive Expected Risk PremiumStrong Diversification EffectsUnique Risk HedgingBenchmark ChoicesVariety of Investment Vehicles
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