We Expect Commodities to Generally Trend Down In the Medium Term<
16-Dec-11   17:24 Hrs IST

Mr. Dhawal Dalal

Dhawal Dalal, expects commodities to generally trend down in the medium term. To be more specific, he expect's steel prices to gradually slide through FY13. Currently, there is excess supply in Europe which could worsen if demand deteriorates. In addition, given the slight slowdown in China, this could lead to an increase in exports, which could add increasing pressure on global prices.

We at Capital Market interacted with Dhawal Dalal, Senior Vice President & Head - Fixed Income of DSP BlackRock Mutual Fund, to know the outlook on Rupee, Commodities, Gold and Debt Funds in Calendar Year (CY) 2011.

Here are the excerpts: 

What's your call on Indian rupee? Don't you think if rupee continues to depreciate or even remain at current depreciated levels for long, India's growth story is as good as suspended? 

Although the rupee has depreciated 22% YTD and continues to remain under pressure, we believe that it will trade range-bound over the next three months and thereafter stabilize. At the rupee's current level, the exchange rate has priced in the increase in the current account deficit as well as the present weak trend of currencies in the emerging markets.

While the currency remains weak, we do not envisage any major slowdown in India's long-term growth story. Growth will continue to be driven by strong domestic consumption, which is mostly a result of a rising middle class, young working population besides strong rural demand. Furthermore, India's low dependence on exports as a percentage of GDP has somewhat insulated the economy from global macro shocks.

Overall how will the commodities perform in CY 2012 vis-à-vis CY 2011? Which commodities you are bullish and bearish on for CY 2012 and why?

Overall we expect commodities to generally trend down in the medium term. To be more specific, we expect steel prices to gradually slide through FY13. Currently, there is excess supply in Europe which could worsen if demand deteriorates. In addition, given the slight slowdown in China, this could lead to an increase in exports, which could add increasing pressure on global prices.

Aluminum prices may not be sustainable much below this level given the current global cost curve and given that there is some pressure on production/supplies in China due to the clampdown on power intensive industries there. Overall, there could be short term volatility, but prices should not settle at much lower than current levels in the medium term.

Zinc demand should come down as steel (including galvanized steel) production is cut in order to keep pace with demand shrinkage. Prices could thus be under some pressure. Also, historically the volatility in zinc prices has been quite high and therefore there could be quite a bit of fluctuation in the near to medium term.

There could be quite a bit of fluctuation in copper prices too, and given that no major supply cuts are taking place, the direction of demand would determine short to medium term prices. With some softening expected both in China and Europe, we expect a downward bias.  

Gold in India has been a great outperformer in CY 2011? What's your view on gold for CY 2012? How much percentage one should allocate into it?

We expect gold to remain steady but accompanied by significantly higher price volatility. In addition, if there is another round of quantitative easing by the central banks then expectations of future inflation will trend high. If there is higher inflation or potentially even fears of an increase in inflation, we could see an increase in the price of gold. Since market participants are uncertain of future market trends, we will continue to see volatility in the price of gold.

An investor should allocate a part of his/her portfolio into gold based on his/her risk appetite and consider the likely volatility in the price of gold over the near/medium term.

After remaining at high levels for past couple of years, can inflation come down in CY 2012? Will RBI be able to cut interest rate in CY 2012 or the rate will remain stable? What's your view on investment in debt in CY 2012?

Food inflation is likely to come down to 2%-3% range owing to strong base effect. This will subsequently help primary articles. However, non-food manufacturing inflation (proxy for core inflation) continues to remain stubborn. Commodity prices as at present and sharp depreciation of INR will put further pressure on manufacturing inflation and likely outweigh the positive effect from moderating food inflation. We expect the headline inflation to moderate to around 7.5%-8% range by January 2012 and remain range bound from thereon until the base effect diminishes.

We do not expect any reduction in interest rates by the RBI over the next 2 months. We do believe that the RBI will change its tone from neutral to dovish by then. Finally, by the end of FY 2011-12 we expect the RBI to take stock of the situation based on the inflation trajectory, growth expectations and external factors before commencing monetary easing. Overall, we are bullish on the fixed income asset class over CY 2012. 

Gilt Funds category has been facing net outflows since December 2010, what has been the reason behind it. Do you see any reversal in the trend in CY 2012? 

We have been in a rising interest rate environment since March 2010. Policy rates have hardened by 2.25% since December 2010. The benchmark 10Y bond yield has demonstrated a clear upward trending bias as the benchmark yield increased by about 150 bps from bottom to peak over the 2010-2011 timeframe. It is a tall ask for any long duration asset class to outshine in a difficult environment as such. However, this is likely to change.

We think that the interest rates are closer to their peak as inflation starts trending down gradually barring any further supply shocks. Investors are advised to consider investing gradually in the long duration fixed income funds with an investment horizon of at least six months. There is a case for accrual as well as likely price appreciation in government bonds over the next 12 months. It must be noted that G-sec will continue to remain volatile as fiscal slippage could result into additional government bond supply. 

What kind of debt funds would you be recommending to your investors right now and what are the expected returns from them? Given your expectations of where interest rates are headed next year, would you be advocating short term plans or longer term plans which can take advantage of the double indexation facility?

Investors with a reasonable risk appetite and understanding of volatility should invest in a long-duration fund such as a Government Securities Fund. Investors with a horizon of 12 months could consider investing in funds that focus on dynamic asset allocation. Investors with a limited risk appetite should invest in schemes such as Short Term Funds with a minimum holding period of six months.

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