Brent spot price which showed signs of cooling off has gained USD 24 from its recent low of USD 88 in six weeks.The crude which scaled to its historical high of USD 144 per barrel closed at USD 113 on August 7th, 2012. Last Friday, oil slipped as data from China announced decline in oil import in the month of July, and International Energy Agency lowered forecasts for 2013 by 400, 000 bpd due to weak global economy. On the other hand between June 24th, 2012 and July 20th, 2012 Brent gained 16% while wheat and corn gained 34% and 43%, respectively. The drought in US is the prime reason for out performance by Agro commodities clusters and monsoon failure in India too is a cause of concern, overall food inflation is expected to spike.
As per Food and Agriculture Organization (FAO) the situation is not so grim, in July report it says that stock ratios of cereal, coarse grain and especially, rice are better than previous year’s though wheat’s stock is low.We believe that despite FAO’s optimist note the commodities might still rally going forward. The following (Chart 1), looks at the re based prices of prominent commodities of energy, food grains, industrial metals and precious metals. We see that copper has been the top performer followed by gold, oil and wheat, and as highlighted all the commodities has converged thrice since 1982 and in all instances in was during some crises. Since last crisis,followed by momentary convergence, prices of all commodities diverged strongly but lately a whiff of convergence seems to be playing out with wheat outperforming others which might probably coincide with the next market correction.
The following chart (Chart 2) looks at the bushel to barrel ratio i.e. ratio of prices of wheat and crude oil since July 1982. The ratio is close to its historic low denoting that from price perspective wheat is trading at discount to crude oil. Moreover fundamentally, expected low wheat production combined with slowing of Chinese economy might push wheat further up.
Nifty boiling point
As chart (Chart 3) shows India’s trade numbers are in precarious state and will worsen as India is short of many resources that are needed for growth. Petroleum, Crude and Products account for 30% of import followed by Capital Goods and then by Gold and Precious Stones. The non-oil trade deficit too is growing strongly since 2005 which adds to woes so unless this component is tempered down the trade deficit will remain stretched.
Inflation can be due to domestic supply demand mismatch or it can be imported, though the current debacle of Indian Rupee can be attributed to rising fiscal deficit. While investors want RBI to ease, the persistent inflation has tied the hands of the central bank. With grim situation in agro commodities the only hope is weak crude price which needs slower growth of Chinese economy.
With this back ground we look how crude price affects Nifty and at what price band of crude does Indian market turns jittery. From the chart (Chart 4) we can see that crude didn’t have much say in Nifty’s performance prior to 2008 as indicated by correlation of less than 20%. But since the crisis the correlation has been on the higher side. As highlighted in the chart the correlation broke as crude breached USD 100 per barrel and even in 2008 as marked in the chart correlation again broke when crude surged past USD 100 per barrel. So it seems the market turns cautious whenever crude moves above USD 100. But as the economy recovers this threshold level will move up but as of now oil at USD 100 makes Nifty boil (sic).