BackCan commodities decouple when equities do not?
Can commodities decouple when equities do not?
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After the sudden sharp fall last week, commodity prices have been inching up again. The most common view is that commodity prices are tied to the dollar and the relapse in the dollar after last week’s rebound has led to commodity prices going up again. But The Economist’s commodity index measured in euros went up from 144.1 on 15 January to 152.5 on 17 March, a rise of 5.8% in two months, implying that while the crashing dollar may be a big reason for the rise, there are other factors pushing up commodities.
With China becoming the world’s workshop, Chinese demand is also seen as a factor in boosting commodity prices. The key question is: Is Chinese commodity demand a derived demand, linked to exports to the US? Last September, a much-discussed report by UBS economist Jonathan Anderson said that China is not an export-driven economy at all. He argues that while the headline exports to GDP ratio is high, that metric is misleading because “it compares two incompatible concepts: exports are defined as total turnover while GDP is measured in value-added terms." Anderson takes the value-added proportion of Chinese exports and concludes that it’s just under 10% of Chinese GDP, slightly higher than India.
At first sight, Anderson’s theory about Chinese decoupling also seems to be borne out by recent data, with the Chinese economy growing by 11.2% in the fourth quarter of 2007, when US GDP growth was flat. The Chinese government has proudly announced that domestic consumption accounted for a bigger slice of GDP growth than investment and export in 2007, for the first time in seven years.
Nevertheless, everybody agrees that even Chinese growth will slow this year. Citigroup economist Yiping Huang gives two reasons why growth hasn’t been affected so far: “One, until December 2007, the slowdown of the US economy concentrated mainly in the housing sector. Non-housing activities maintained 2.5% growth and, therefore, steady demand for Asian products continued. But this picture changed at the end of last year. Two, there is a time lag between weakening in US consumer spending and Asian exports. Statistical analyses suggest that Chinese exports normally lag US consumption by five-six months." Food and energy prices may behave differently, but if they remain high, that could hit consumption demand.
And finally, the other big reason for rising commodity prices is buying by funds that have started adding commodities to their portfolio. The trouble with that is, if you believe that the balance sheets of the global banks are going to continue to contract and de-leveraging will continue, then the attraction of commodities as an investment class will be hit.
Much of the commodity story depends on the fate of economic “decoupling". Right now, we have a situation where Chinese and Indian equities are being sold on the assumption that decoupling doesn’t hold, while commodities (non-food) are being bought on the theory that it does. That contradiction cannot last.
Jaiprakash Associates gets a boost from ICICI Bank deal
Shares of Jaiprakash Associates Ltd jumped 16.5% on Tuesday after its subsidiary unit constructing the Taj Expressway project secured $287 million (around Rs1,154 crore) in funding from ICICI Bank Ltd through a 1% stake sale and a long-term loan. The company’s shares were among the worst hit in the January-March correction, falling by as much as 61% from its all-time high of Rs510 per share before Tuesday’s rise.
Having won two large expressway projects with related rights for real estate development, the company had, to a large extent, become a real estate play. It’s hardly a surprise, then, that its shares fell like other real estate stocks. But the company has also had to contend with some other negative developments.
Last month, its talks with private equity player ICICI Venture for a large stake (about 10%) in the company were called off, reportedly because of differences on valuation after the crash in the stock market. At one point, there was also confusion about the company’s stake in the Taj Expressway project, with the company reportedly claiming at an investors’ conference that its stake was much lower than 100%. This led to concerns that the group’s promoters had gained at the expense of minority shareholders. But the company has clarified that it holds the entire stake, except for the 1% stake sold to ICICI Bank and another 1% stake held by an employees’ trust.
While the deal with ICICI Bank will ease things, the funding cost will surely have risen. The earlier plan with ICICI Venture would have involved equity and equity-linked instruments, but the bulk of the funding from ICICI Bank is through the long-term loan. Moreover, according to an analyst tracking the company, a 1% stake dilution hardly acts as a benchmark for valuation. The ICICI Bank deal values the Taj Expressway project at Rs25,000 crore, in which Jaiprakash Associates holds 98%. Still, the company’s market capitalization is just Rs26,000 crore, which either means that the market ascribes little value to other businesses such as cement and power or that the deal with ICICI Bank is not seen as a benchmark.
If the company is able to place equity with other investors at the same valuation, it would perhaps lead to some upgrade in analysts’ estimates of the underlying value of the Taj Expressway subsidiary unit.
Write to us at marktomarket@livemint.com
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