Mumbai: Prices of many commodities—food, precious metals, industrial raw materials such as steel, crude oil—are ruling at a year’s high as the global economy shows signs of recovery and liquidity sloshes around in the economic system. Mint spoke with Pankaj Gupta, who manages a commodity fund at SBI Asset Management Ltd, to discuss whether this rise is sustainable and the sectors that would deliver the best returns. Edited excerpts:

What’s driving up the prices of commodities? Is this sustainable?

Investment ideas: Commodities have become an important asset class. Roland Magunia / Bloomberg

Secondly, there has been a lot of fiscal and monetary stimulus that has been announced by all major countries. That led to an improvement in sentiments.

Also, with the financial crisis people started having concerns on the dollar as a base currency. So, some sort of loss in confidence in the dollar has led to (people chasing) physical assets and hence the rise (in prices).

But above all, we have seen in the last five years that commodities have become an important asset class. This has made them more volatile. Earlier, prices were a function of fundamentals, of demand and supply, but over the last five years it has also become a function of fund movement and liquidity.

Now that China has tightened a key interest rate, how do you think commodity markets will react?

First of all, China is a very difficult market to comprehend. But having said that, an increase in interest rates may affect the prices of commodities in the short term.

But prices won’t go down by much since they are also a function of global fund movements. (Still), they (China) can’t afford to backtrack on their growth. So there would be a lot of deliberations that would happen before any drastic step is taken to reverse the monetary or fiscal stimulus in China.

Do you expect local prices to rise significantly once excise sops that were part of the fiscal stimulus package are withdrawn?

India may not be a very large market which can affect commodity prices. In metals, most of the Indian companies price their products based on import-parity prices. So it is more of a function of global prices and global demand and supply rather than local fiscal policy.

Among commodity-based companies, which sector is poised to deliver the best returns? Which are the ones you are buying now?

In the case of metals, stock prices invariably tend to move ahead of the rise in commodity prices. We have seen that metal stocks have given the best return of 230% in 2009. Given that, we would tend to balance our exposure between various sub-sectors. We need to have a balance between risk and reward.

Among metals, we are most positive on non-ferrous (such as zinc and copper) companies since Indian companies are the most cost-competitive. On others, we are positive on the agri-related space. Given the limitations of (stock-picking) ideas in India in this space, we favour fertilizer companies.