Most of us limit our investments to equities, real estate and fixed income instruments. The equity market is a broad indicator of the health of an economy. And it is always noticed that when the economy is doing well, people tend to consume more which leads to rise in product sales and ultimately, the stock markets get buoyed further because of good results by companies.

However, from an investment perspective, if most of the investments are tied up in equity and real estate only, then there is a strong chance of your investment value to dip when the equity market catches a cold. This is because historically it has been noticed that when the stock markets do well so does the real estate market. But even the contrary is true. So what should one do?

Various studies and samples have supported the view that commodities and equity markets have low correlation. Research by Nik Bienkowski, head of research at ETF Securities supports this view. In the short term, the correlation between the two is higher. This is due to demand for the commodity increasing beyond immediate supply and inventory levels.

All finished products that we buy like cars, electrical appliances, water bottles and soaps are made of commodities like copper, zinc, aluminium, coal, oil, among others. As companies sell more of these finished products during good times, demand of commodities also go up. If availability of the commodity is limited, its price will rise immediately. Therefore, in the short term we may see high correlation between equity and commodity markets.

But over the long term, prices of commodities are not dependent only on demand, therefore its price may no longer be in sync with the consumer industry (or large part of the equity market). Factors like technological advances, time lag to respond to supply-demand changes, competition from substitutes, depletion of natural resources and changing weather patterns play a larger role.

For instance, if due to any technological breakthrough, exploration companies are able to pump out oil from currently inaccessible areas (like Alaska in the US), even with increasing demand, prices of oil will fall due to new unexpected supply. People will be able to buy cars without worrying too much about the mileage, benefiting the car manufactures.

Therefore, with falling oil prices, the stock price of car manufacturers and auto ancillary companies will rise. In other words, in spite of the fall in the commodity's price, a large section of companies benefited. That would automatically lead to the better health of the related companies and reflect in their performance in the equity market.

Likewise, if oil prices rise too high, the auto industry and ancillaries would find the going tough. Also, other related industries like financial services lending to these sectors get badly hit. So the investors who have these companies in their portfolio would find that their value has eroded.

On the other hand, if an investor buys crude oil as well as stocks in the equity market, the fall in the market will be partly offset in the rise in his commodity basket. A parallel can be drawn between other products and commodities as well.

To go about investing in commodities one can look at the commodity exchanges. Till recently, gold and silver were the only ones traded actively and that too, for mainly ornamental and religious reasons. However, in the last few years, with the launch of Multi Commodity Exchange (MCX) and National Commodities and Derivatives Exchange (NCDEX), many equity brokers have started offering commodities trading to the investor.

An investor can today buy energy commodities like crude oil and natural gas or agriculture commodities like jeera and turmeric or metals like copper, zinc, gold and others.

However, the exchanges are still in their nascent stages. Recently, the government temporarily stopped trading in certain commodities due to heightened speculation. The other option could be to use equity markets to invest in the commodity companies.

For instance, look for listed companies that benefit from rising commodity prices. Hindustan Copper benefits from rising copper prices; Raipur Alloys, an integrated steel producer with interest in iron ore mining benefits from an increase in steel prices; Hindustan Oil Exploration sees better margins due to successful oil fields at the time of high oil prices. This way you can have exposure in both equities and commodities and reduce the overall risk of your portfolio.

BS