COMMODITIES AS AN

EMERGING INVESTMENT CLASS

Team CVS
Chethan Swaroop (08311)
Sushant M Mallya (08338)
Vijeth P.R. (08345)

1
 Introduction to Commodity
Markets
 A commodity futures market is a public market
where commodities are contracted for
purchase or sale at an agreed price for
delivery on a specified date.1

 This purchase / sale is made through a broker
who is a member of the commodity exchange
and such transactions are always in the form
of standardized contracts

 Commodities include agricultural products,
energy products, base metals, precious
metals, industrial metals, bullion and biofuels.

2 1: "Commodity Futures Markets in India: Riding the Growth Phase" by Dr. Alok Kumar Mishra
 Commodity Markets in India
 Organized market for commodity futures began
in 1875 with the setting up of the Bombay
Cotton Trade Association Ltd.

 Market exists in two forms
Over – The – Counter (OTC) Market
Exchange Based Market
 Three major exchanges – MCX, NCME and NCDEX

 Turnover of the exchanges has increased from
Rs. 5.72 lakh crores in 2004-05 to Rs. 33.75
lakh crores in 2007-08.

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
 Asset as a Class of
Investment
While arriving at whether an asset is a good


class of investment, the following needs to

be considered
Risk of the asset
Returns on the asset
Liquidity

4
 Commodity Demand cycle

5
6
7
 Commodity in a portfolio
 Difference between a portfolio with and without
commodities.
 Data considered are Nifty for Equity, CCIL T-Bill
index for bonds and MCX COMDEX for
commodities.
 Time Period: 5th Oct 2005 to 5th Oct 2009
Asset Class Expected Standard Correlations
 Return Deviation
Equity Bonds Commoditie
 s
Equity(Nifty-50) 16.220% 23.10% 1 0.278 0.1855

Bonds(T-Bill Index) 4.4% 5.47% 0.278 1 0.3

Commodities(MCX-COMDEX) 11.9% 15.00% 0.1855 0.3 1

Portfolio with Equity-Bonds
Allocations % %  
Equity Bonds Commodities Exp . Ret St . Dev Sharpe
Ratio
0 1 0 4.400 5.470 0.796
0.1 0.9 0 5.582 5.991 0.924
0.2 0.8 0 6.764 7.193 0.934
0.25 0.75 0 7.355 7.960 0.919
0.275 0.725 0 7.651 8.372 0.909
0.3 0.7 0 7.946 8.800 0.898
0.4 0.6 0 9.128 10.631 0.855
0.5 0.5 0 10.310 12.588 0.816
0.6 0.4 0 11.492 14.620 0.783
0.7 0.3 0 12.674 16.701 0.756
0.8 0.2 0 13.856 18.814 0.734
0.9 0.1 0 15.038 20.949 0.716
1 0 0 16.220 23.100 0.700

The highlighted row represents the combination with the best

Sharpe ratio
Efficient Frontier with Equity and
Bonds






Portfolio with Equity-Commodities
Allocations % %  
Equity Bonds Exp . Re St . Dev Sharpe
0 0 Commodities
1 t11.930 15.000 Ratio
0.792
0.1 0 0.9 12.359 14.112 0.873
0.2 0 0.8 12.788 13.635 0.935
0.3 0 0.7 13.217 13.611 0.968
0.4 0 0.6 13.646 14.044 0.969
0.5 0 0.5 14.075 14.893 0.942
0.6 0 0.4 14.504 16.092 0.899
0.7 0 0.3 14.933 17.570 0.847
0.8 0 0.2 15.362 19.263 0.795
0.9 0 0.1 15.791 21.120 0.746
1 0 0 16.220 23.100 0.700

The highlighted row represents the combination with the best

Sharpe ratio
Efficient Frontier with Equity and
commodities

 The data point in black represents the best Sharpe

Ratio.

Portfolio with Bonds-
Commodities
Allocations % %  
Equity Bonds Commodities Exp . Ret Std . Sharpe
Dev Ratio
0 1 0 4.400 5.470 0.796
0 0.9 0.1 5.153 5.560 0.919
0 0.8 0.2 5.906 6.002 0.977
0 0.7 0.3 6.659 6.727 0.983
0 0.6 0.4 7.412 7.654 0.963
0 0.5 0.5 8.165 8.720 0.931
0 0.4 0.6 8.918 9.879 0.898
0 0.3 0.7 9.671 11.103 0.867
0 0.2 0.8 10.424 12.372 0.839
0 0.1 0.9 11.177 13.674 0.814
0 0 1 11.930 15.000 0.792
 Efficient Frontier with Bonds and
commodities

The data point in black represents the best Sharpe

Ratio.

 Efficient Frontier with Equity,
Bonds and commodities

Table for the above graph would be provided with the report
because of many combinations of allocations

The data point in black represents the best Sharpe

Ratio.

Commodities: Advantage

  Return S.D

E_C_B 7.08% 6.59%

E_B 7.08% 7.60%

B_C 7.08% 7.23%

 Diversification- Not as per
Developed commodities market
Our analysis for 4 years shows that correlation
of Commodities with Equity is 0.61
Very High Correlation
Contradicts developed markets where
correlation is negative or nearer to 0.
As commodity futures prices move with stock
exchange, commodities do not provide
necessary diversification as it has in US and
other developed market.
 Inflation Indexed
Correlation between Inflation and Commodity
Futures Prices: 0.128
This again is contradicting developed markets
where commodities are Inflation indexed in
which inflation is factored in the commodity
prices.
Inflation indexing is currently not happening in
India

Factors driving commodities
Population of India
Future deficit for commodities like Energy,
Metals and Agriculture is imminent.
This would drive commodity markets as
people would try to hedge more.

 Conclusion
Commodities in portfolio would definitely
provide better Risk-Return combinations.
Commodities have high correlation with Equity
in India contradicting diversification
advantage in developed markets
Commodity prices in India are not Inflation
Indexed.
The reasons might be that the commodity
market, in terms of Volume is not developed
in India and hence investors relate it to stock
market which accounts for the high
correlation between them.
Conclusion
 Advantages Commodities

 Diversification Yes

Efficient Portfolio No

Inflation Indexation No


Commodities have not yet started offering
goods that they have been offering in
developed markets and hence would take
time to emerge as an investment class in
India.
 References
 Books / Papers / Journals
Commodity Futures Market in India: Riding
the Growth Phase
 - A whitepaper by Dr. Alok Kumar Mishra


Websites


www.nseindia.com
www.mcxindia.com
www.rbi.org.in
www.finmin.nic.in


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