It’s been a bloodbath in stock exchanges round the world in the last few days. But wheat, corn, sugar and soya have little to do with US Fed, the yen or the Nikkei. So why have your commodity chips plummeted as well? ET helps you join the dots.

There are two important facts to remember. First, in 2006, commodity markets attracted ‘hot money’ from some very large non-traditional investors, such hedge funds, pension funds, and indices traders. These cash-rich punters have almost come to dominate the market because their deep pockets allow them to accumulate fairly large positions in any commodity they fancy.

Their favourite trading philosophy is “a little bit in everything and commitment to nothing”.

Hedge funds, which manage about $1.3 trillion worldwide, are loosely regulated private investment funds that seek to profit from new opportunities using alternative investment strategies.

About 8,000 hedge funds trade globally, based on estimates from Hedge Fund Research in Chicago. Commodity-trading hedge funds returned between 13% and 23% last year, according to a survey of 100 commodity funds by NewFinance Capital, an investment adviser based in London.

Global investment in commodity funds doubled to $24 billion in 2006 and may rise 25% in 2007, according to NewFinance. Investment banks, too, have a risk trading culture, deep pockets and both physical and financial traders.
In the US, these non-traditional players on Nymex, CBoT and NyBoT became so numerous that the local regulator, CFTC, decided their trading positions in each commodity should be listed separately in its weekly market round-up.
In India, we saw the same trend of non-traditional players moving in when stock market traders decided to invest in commodity futures as a way of expanding their risk portfolio.

The second fact to remember is that futures are a highly leveraged game. By putting upfront a small amount of cash, called initial margin, you can acquire positions in commodities worth several times over.

However, even this margin money is not without risk. If prices move against you, i.e. the value of the commodity you bought alters, you are expected to put in more cash as variable margin. If you don’t have deep pockets at that juncture, you may have no option but to exit the market with a loss.

When the markets are relatively placid and less volatile, punters face little risk. But a sudden upheaval can kill. That is what happened last week when the Shanghai stock exchange saw its biggest fall in a decade and Wall Street had its worst day since the aftermath of the 9/11 attacks.

Shares began to look risky. Hedge funds and other financial institutions had to suddenly find money to either meet the margin calls on their equity portfolio or sell out. A relatively painless way of doing it was to book profits by selling off their positions in the commodities market. With the big punters heading for the exit simultaneously, the meltdown in equity markets was replicated in the commodity exchanges as well.

When funds liquidated their positions on commodity exchanges, it drove prices of wheat, sugar, coffee and cotton into the ground. The worst hit were the punters’ favourites over the last one year, such as soya and corn. In metals and bullion, there was an additional factor. Traders were suddenly nervous about an impending Chinese economic slowdown. As Chinese demand has been the significant pull factor for global metal prices in 2006, a slowdown would immediately impact the demand-supply equilibrium and the fortunes of players in the entire metals value chain. Funds with long positions turned into sellers.

Gold is usually a natural hedge against inflation. But traders reasoned that if the Chinese economy slows down along with possibly the US economy, then there would be less demand for goods and services and therefore, a lower threat of inflation. Speculators, who were heavily long, headed for the doors.

Should you worry too? For genuine hedgers and traders, there is little reason. After all, there has been no change in the fundamentals in the last few days. Even in precious metals, investment interest remains keen and if global stock markets remain volatile, they may well become the last refuge for punters once again.

Source :ET

The savage correction razing stocks across the board this week has been triggered by many factors including an exit of funds triggered by a rise in Japan's yen, macroeconomic concerns at home and prospects of a slowdown in China and the US, but among the key figures that have caused the turmoil are regulation-wary hedge funds which have been quietly operating in Indian stock markets.

"The long term India growth story remains strong. However, in the short term of three to six months, the stock market will move either sideways or even witness some more corrections," said Bharat Banka, group head, finance, AV Birla Group.

Though shadowy in their operations because of participatory notes (PNs) that act as a cover for them, hedge funds are believed to be key players, but they face, as they do across the world, increasing regulatory scrutiny that makes their movement fragile and risky.

At least 40 per cent of foreign fund inflows are accounted for by hedge funds through PNs, said a leading finance expert, who did not want to be named.

A key factor this week is that many stocks have gone back to or below the levels they hit last May, when the market saw a plunge despite the "India story" based on high economic growth and solid corporate earnings.

"With the rising risk premium and amid regulation issues, hedge funds or PNs, which command more than 50 per cent of the inflows to the Indian market, are either reluctant to take fresh exposures or are withdrawing from the market," the US-based head of a leading hedge fund with active exposure in India told Hindustan Times on condition of anonymity.

There is fear that the world’s two largest economies, the US and China may witness a slowdown. Beijing is facing Washington's pressures to devalue its currency, which can hit China's export-centric growth, the fund manager told Hindustan Times. Emerging markets such as India are at the receiving end of the cascading effect triggered by such fears.

"The current trend is the culmination of many factors," said R Sreesankar chief investment officer of IL&FS Investmarts. "Because of rising risk, premium liquidity has dried out. Domestically 9 per cent growth is simply impossible with a 11—12 per cent lending rate.

"Meanwhile, many companies have embarked upon massive capital expenditure. These are some of the signs, which clearly indicates that there will more pain in the market,” he said.

Small and mid-cap stocks have been the most devastated in the current correction. The BSE Sensex has lost 2,308 points from its all-time peak of 14,723 on February 9 to 12,415 on March 5, a loss of 15.67 per cent. Some 135 stocks from BSE 500 has lost more than 20 per cent. In fact, 32 companies from this group have lost more than 30 per cent since then.

Compared with May 18, 2006, when the market was down after a big correction, many of the stocks are currently trading at substantially lower levels, particularly in the sugar and real estate industries, which have been the target of heavy speculative positions.

Sugar stocks, such as Shree Renuka Sugar, Sakthi Sugar have loss as much as 75 and 70 per cent respectively. The top five sugar companies have lost between 64 to 75 per cent since May last year.

Subir Gokarn, executive director and chief economist at credit rater and economy researcher CRISIL said that the interest rate is expected to remain high in the short term.

“Reserve Bank of India projected a GDP growth rate of 8.5 per cent with inflation of at sub five per cent. As long as any of these two – inflation and growth—is beyond the projected figure, the central bank will continue to intervene either through sucking liquidity or hike the interest rate.” he said.

Source : Hindustan Times