Commodities - wings of time, a magical adventure!

 COMMODITIES – WINGS OF TIME, A MAGICAL ADVENTURE!

|AUTHOR GOPUL SHAH| |SPECIAL CONTRIBUTIONS N. S. RAMADOSS | |28 OCTOBER 2017|

The world of commodities has changed significantly over the past decade with the introduction of Financial regulations, Novel technologies and raw materials, Digitisation, Demographic changes, Eco-friendly innovations, Financial engineering, and Good governance. This change is offering significant growth and value creation opportunities for those with the confidence, courage and the ability to look forward to learn (and unlearn), change, evolve, lead, and experience this magical adventure of creating a thriving and sustainable value delivering business of social repute and integrity!

A SLOW PIVOT! After the Lehman collapse and backlash on Wall Street and banking industry, the financial and commodity markets have been buffeted by severe economic, financial, political and social crisis. Income and wealth inequalities have increased, stringent regulations on financial and tax compliance has been enacted, and demographic changes have shifted demand to emerging markets. There is active advocacy on environment and social impact concerns, right-wing politics have taken centre stage while digitization and technological (Di&Tech) changes have flourished.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, the European Market Infrastructure Regulation, Basel Accords, tax scrutiny on cross border transactions, compliance and controls over commodities and financial transactions has increased business costs and higher risk capital requirements thus reducing the overall returns for market makers.

Falling returns have withdrawn liquidity providers and market makers from commodity and financial industry; this has severely impacted commodity demand, prices and returns [see chart 1], subdued volatility, flattened carry, inverted prices –  impact of which is evident in falling productivity and investments in commodity industry, shorter uncertainty driven disruption cycles, accelerated redundancies, impairments, and debt restructuring.

Lower returns have also reduced risk appetite, curbed speculation, purged surplus capacity, and induced corporates to enhance productivity, competitiveness, scope, scale and improve sustainable shareholders value by using Di&Tech and best in class management practices. In the meanwhile, fear of protectionism and technological disruption has heightened uncertainty and risks, increased costs, slowed new investments, economic initiatives and employment generation.

In quest to sustain or ensure higher returns in the tough and changed market conditions, some corporates and executives have erred big – bets have failed, moral hazard, adverse selection, and reputational risk have been incurred - severely denting its credibility, financial credit and sustainability.

Until all changes and productivity gains are consummated and the best quality performers surface, whilst a painful yet magical process, we should expect the commodities, financial, and debt capital markets to remain uncertain, disrupted, volatile, stressed and consolidating.

PROTECTIONIST RHETORIC RIGHT-WING POLITICS - INDUCING STRUCTURAL REFORMS, FREER MARKETS AND REDUCTION OF INEQUALITY. Inequality of income and wealth, corporate redundancies, trade deficits, and loss of jobs in both developed markets and emerging markets has allegedly accused free trade, investment, immigration and clean environment policies which is partially true. The ‘win-win’ from globalisation has mostly favoured a few emerging markets and high net worth individuals due to selectivity and slowness in structural reforms, tardy and lopsided infrastructure development, imperfect access to education and digital services.

Right-wing politicians have also capitalised on the hollowing and redundancy impact to rhetorically promote protectionist, local-first, and reversal of environment friendly policies. It is highly likely that political rhetoric will be only used as a bargaining chip selectively with closed emerging markets for negotiating a fair and free access to its markets for trade, investment, services and Di&Tech, improving governance, spending and quality of life. 

The unheeded realism is that the impact of regulations and protectionism, Di&Tech, demographic disruptions are more profound on corporates and global markets. While Di&Tech has created new opportunities, it has also proven to be disruptive, risky and reducer of knowledge asymmetry, arbitrages and competitiveness. Di&Tech disruption has also created a ‘hollowing and redundancy impact’ that has adversely impacted employment of unskilled/ older workforce, income/wealth generation in all markets.

DEMOGRAPHIC CHANGES, DIVERSE POLITICAL PHILOSOPHIES, AND MILLENNIALS -  ALTERING PATTERN OF GROWTH, INVESTMENT AND ADOPTION OF DIGITIZATION AND TECHNOLOGY. Developed markets have a high proportion of ageing population and influx of immigrants which has altered societal mix, demand, and increased cost of business. Emerging markets have large proportion of young population where growth, investment and Di&Tech adoption is faster. However, Di&Tech access isn’t universal to benefit everyone, China’s intranet remains inaccessible to global Di&Tech companies unless IP is registered with regulators.

Multi-culture and diverse-political philosophies, economic structure and formidable emerging market competitors co-exist in the business world - trusting China; believing in Indian, Brazilian, and Indonesian growth; recognising Russian strength and a safari ride into Africa and Central Asia - have become essential to expand into new markets. 

Millennial customers and talent are now in the workforce – they are highly educated, tech-savvy, socially mobile, self-aware, diverse, positive and achievement driven, open to entrepreneurship and training. They aspire for an engaging and fulfilling career and they demand sustainable and ethical business practices.

SUSTAINABILITY, ENVIRONMENT, COMPLIANCE, AND SOCIAL IMPACT STRATEGY – NON-NEGOTIABLE INTENT. There is a growing advocacy to ensure equitable and eco-friendly growth, promote regulations and corporate conduct that ensures ethical and sustainable practices while protecting environment, health, and society.

Millennia’s love sustainability as they seek a meaningful work-life and are   conscious of environment, social, health, ethical behaviours and business actions.

Corporates are fine tuning corporate governance to strategically focus on social contributions, diversity, mutual respect, reducing income and wealth disparities, encouraging positive behaviour and conduct that promotes ethics, environment, health, safety, and sustainability.

DIGITIZATION, TECHNOLOGY AND MOORE’S LAW - RAISING THE BAR ACROSS ALL INDUSTRIES. Corporates are aggressively investing and adopting Di&Tech to improve scope, productivity and agility; promote efficient use of resources; integrate global supply chain, deliver value to customers, talent, and stakeholders; ensure sustainability ad regulatory compliance; create customer experiences; improve shareholders return; manage disruption, disrupt competition and stay relevant.

The application and impact of science, Di&Tech, engineering, medicine, new materials, renewable energy and the shared economy is impacting work, daily lives, supply chains, values, governance, ethics, and regulations.

Di&Tech is promoting use of mobile and cloud computing, e-commerce, data mining, sharing of resource, robots, drones, and artificial intelligence. Space, internet of things, renewables, robots, bio-technology, molecular DNA science, and genome technology is replacing traditional technology.

Artificial intelligence models are disrupting (and selectively replacing) physical supply chains, performing high speed trading, reviewing legal documents, performing compliance, due diligence and credit analytics.

Governments are investing in Di&Tech to deliver services and subsidies to its citizens – India has taken a lead in creating unique identification for its citizens to be used for delivering subsidies, tax and regulatory compliance, and cash payments. China aspires to be a global leader in artificial intelligence and robotics.

Demand for Di&Tech has made technology, e-commerce, and defence companies the most valued companies, surpassing finance, energy, industrials, commodity, real estate and retail titans [see Chart 2].

Di&Tech has helped create retail giants like Amazon, Alibaba, Flipkart, Uber, Airbnb, Flipkart, and similar players that are scaling up with go to (disintermediated) direct market model with financing products -  redefining technological applications, international trade practices, enhancing transparency, and reducing cash cycles in spite of limited investment in brick and mortar assets. On the other hand, industrial companies and banks are catching up to emulate similar structures as Di&Tech companies occupy their domain.

Di&Tech risks isn’t a deterrent – corporates and banks are actively investing and internalising or acquiring Di&Tech companies. Corporates are also actively managing - execution and integration risks; loss of asymmetry of information and intellectual property; cyberattack and algorithmic errors; ensuring safety, health, and environment; and promoting positive social community and behavioural impact. 

Meanwhile  Moore's law is aggressively playing out - exponentially increasing the power of Di&Tech and reduced costs - making it challenging for corporates to catch up with newer Di&Tech applications, agile competitors and rising customer expectations.

Aggressive investment in Di&Tech and emerging markets is yet to pay-off, risking a Di&Tech bubble, consolidation and restructuring.

FINANCIAL ENGINEERING SOLUTIONS AND FINTECH – A CATALYST FOR CHANGE. Non-banking and fin-tech companies are competing with banks and offering financial engineering solutions to help commercialise bite sized technology investments in solar, wind, grain harvesters, so forth.  The typical debt light easy to repay innovative financing structures are like deferred leasing, hire purchases, licencing fees, or repayments that are innovatively linked to use of asset, productivity gains, earnings and cash flows causing least stress on business.

Financial engineering, data-mining, distributed ledger (an uberized block chain concept), exchange listed crypto-currencies applications are also playing a big role in commercialising and monitoring use, financing, and sharing of economic resources.

Distributed ledger behaviour data that captures performance, credit and payment behaviours on counterparties is also helping to create a reliable ‘network effect’ within the industry and individual performance. The creation and use of exchange traded crypto-currencies for cross border payments is also helping commodity industry reduce use of foreign exchange and mitigate associated risks.

The unregulated growth of non-banking financial and fin-tech companies, payment portals, bitcoins, Di&Tech and e-commerce companies that control and administer billions of dollar of cash is bubbling financial risk that could potentially spark uncontainable financial crisis.

FOOD AND AGRICULTURE - UNQUIET FIELDS - FARMS TO CUSTOMER, SUPPLY CHAIN, HEALTH AND NUTRITION. We witness generally stable weather conditions, directed crop irrigation and fertilisation, industrial multi-level farms, lower price of oil, fertilizers and transport cost, intensive use of Di&Tech, innovative waste reduction and environmental friendly agricultural practices. These have improved productivity, scale and scope of agriculture production that too with limited or no investments weighing down on agricultural commodity prices that helps lower food inflation globally.

Farmers are using satellite, GPS, and drones to map weather, monitor plant photo-synthesis, plant growth and productivity to target delivery of efforts, irrigation, fertilizers and farm inputs. They have invested in waste and carbon footprint recycling and reduction; improving product shelf life; reducing or reusing resources; producing renewable, solar and wind energy and organic fertilizers at farm gate; using tissue and bio-technology for promoting high yielding plants. 

Forward integration strategies are also helping industry to improvise and add value by focusing on customer needs, customer solutions, making consumer preferred products and brands. This strategy also helps them negotiate price, discover and share value by mutual negotiation that is market price agnostic.

Typical value addition opportunities and investments include processing grains into animal nutrition for producing meats, fishery, chicken, and insect protein; infant milk substitute formulations; low calorie sugar substitutes and diabetic foods; protein derivatives solutions; and pharma products. There are specialized initiatives that also satisfy demand of organic materials, bio-diesel, medicinal plants, non-animal meats, vertical and hydroponics.

INDUSTRIALS – LEVERAGING TECHNOLOGY, UNFINISHED CONSOLIDATION. Metals, mining, and ancillary industries are haunted by flattening global demand, surplus capacity, technological shift to environmentally sustainable production, shift to new commodities and product substitution, and unreliable government spending on infrastructure driven growth.

Industrials are boosting productivity by investing in robots, process controls, heat capture and recycling, renewable energy, and value-added processes. They are also using shared economy technology like Uber, google mapping, GPS, distributed ledger, mobile apps to share and monitor resources, capacity utilisation, transportation and title over goods, and payments.

Meanwhile, price pressure continues on commodities with commercialization of wind and solar, electric cars, cheaper battery storage, light weight material and new technology that fuels demand for competing substitutes like carbon fibre, light weight alloys and composites, cobalt, manganese, lithium, graphene.

These profound changes have accelerated the use of Di&Tech; corporate redundancy and restructuring; debt defaults; mergers and consolidation of industry; and dependence on government subsidy and spending.

ENERGY, OIL AND GAS – A CLEANER OUTCOME. A splintered OPEC, environment protection regulations and government support for clean and efficient energy and increase in shale and natural gas, and clean energy are heavily weighing down on the price of conventional energy and have accelerated redundancy in the energy sector.

Mega investments in coal, gas and oil are out of favour as investors prefer smaller investments in renewables and clean energy at locations where it’s demanded.

Renewable and clean energy demand is increasing as it is cheaper and can be produced at point of demand. Clean energy investments and production have also increased due to lower capex and operational costs, environment friendly laws, government support and innovative financial engineering solutions. Energy efficient technology like LED, light-weight composite materials, etc. is curtailing use for energy. 

Lower energy cost is weighing down on all commodities, industries and inflation which has helped many countries reduce its inflation and foreign exchange outflows though corporate redundancy and debt defaults in conventional energy sector have accelerated.

FINANCIAL MARKETS – ERRING ON SIDE OF CAUTION AND LENDING THE BEST. Economic and political uncertainty, financial market and tax regulations, Basel capital allocation rules, mega fines and investigations, heightened compliance, redundancies and credit losses have dented lending activities and profitability of many institutions.

Lower volatility, risk averseness, disappearance of arbitrages and information asymmetry have also lowered financial and commodity industry income from risk management services.

Banks are facing competition from emerging market banks, multilateral agencies (like AIIB/NDB-BRIIC Bank), sovereign wealth funds, non-bank companies, fin-tech and e-commerce companies, and payment banks that are lending or providing covenant light-credit insured or unsecured loan structures. Financial and commodity industry talent is being aggressively lured to Di&Tech and entrepreneurship that provide Fintech solutions that compete with banks and corporates.

Redundancy, liquidity, credit defaults, shrinking valuation, stringent due diligence, moral hazard and reputation risk, stringent credit and risk capital allocation, and shrinking shareholders value have restricted bank lending to the best fewer bankable corporates, sectors and regions.

THE BEST IS YET TO BE, ONLY THE BEST THRIVE! The core of every business is a satisfied customer, engaged talent, agile and aligned organisation structure, sustainability practices, robust corporate culture and a functional leadership that ensures a high class sustainable organisation and a good quality of return to all stakeholders.

Lasting corporate sustainability, high performance and quality of earnings is no longer about cost reduction or commodity carry or an individual contributor - it is about the team, the organisation’s collective values, and wisdom, the capability to leverage resources, knowledge and talent, and an institutional approach to execution.

Corporate leadership is about redefining and institutionalising narratives on collaboration, system and organisational learning mechanism, high performance, innovation, customer focus, talent engagement, incentive plans linked to performance and behaviours, corporate governance, communication and leadership orientation. They are also strategically focused on managing business portfolio, investing for value, redundancies, restructuring and pursuing inorganic growth through M&A; integrating supply chain; risk management, enhancing shareholders value, brand and reputation. 

Leadership is also constantly navigating change and staying relevant; managing risks and disruptions; investing in and executing Di&Tech, customer and market solutions; innovations; and investing in sound organisation governance and structures that ensures agility, alignment, and focus to widen scale and scope of business raise productivity, extract optimal value creation and ensure long term distinct competitive advantage.

OPPORTUNITIES GALORE – LEVERAGING HUMAN CAPITAL AND ORGANISATIONAL LEARNING SYSTEMS! The commodities space is poised for a new dawn of opportunities but at the same time (manmade) change seems to be the only constant! These manmade changes for a better future are profound and complex but not unsurmountable. We are also challenged with tackling competing or contradicting priorities. Thus, the future is for those who believe in human capital and can embrace change through dynamic adaptation and who can convert contradictions to complimentary opportunities.

The ideal approach is to take a whole systems view considering each contributor - whether human or organization - as ‘a dynamically interacting personality’. 

Each contributor has a core content along with somewhat rigid form of structural character and also with somewhat flexible functional character. However, human is special and unique -  with the ability to creatively manage change and unite the core contents through his spiritual, physical, emotional and mental interactions.   Only humans can embark on the magical adventure with the wings of change we dream about.

Organisational aspirations can be delivered through building shared visions while leveraging individual creative freedom and self-discipline. Team and individual learning promoting synergy can turn this magic adventure a reality.

NAVIGATING THE SWELL – CAPITALISE, SUSTAIN, AND THRIVE? WTO forecasts that the world merchandise trade volume will grow at 3.6% in 2017 and pick up slightly to between 3.0%-4.0% in 2018, while global GDP growth is expected to rise 2.8% in 2017 and 3.2% percent in 2018.

The demand and price of commodities are likely to improve with improved sentiments and economic activity in G3 and BRIIC countries, US infrastructure spending and tax cuts, China’s ‘one belt, one road’ policy and Indian structural reforms. With growth and confidence, economies will be emboldened to make additional structural reforms accelerating the growth momentum. There may also be short lived rebound in commodity prices from supply side disruption from weather shocks, reversal of regulations and government spending.

This overall recovery in trade and economic activity could also be undermined by downside risks, including trade policy measures, protectionism, monetary tightening, geopolitical tensions and costly natural disasters.

The expectation of a carry in commodity prices that swells earning and liquidity is likely to throw a life line for corporates to invest in long term sustainable future. The corporates that have remained invested in the structural changes are likely to extract material long term benefits, quality earnings and thrive.   

“The convergence of the systems thinking, achieving personal mastery, shifting mental models, building shared vision and team learning create new waves of experimentation, advancement and “Learning Organizations” in which people continuously expand their capacity to create the results they truly desire” - Peter Senge on “The Fifth Discipline’

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The authors can be reached at gopul@hotmail.com and ramadossns@gmail.com

Chart 1: “RISK OFF” on investing in COMMODITIES - DEARTH OF LIQUIDITY, CARRY AND VOLATILITY! how long will it continue?

Chart 2: “RISK ON” investing in TECHNOLOGY, CLEAN ENERGY, FINANCIALS, DEFENSE AND AEROSPACE! TETONIC SHIFT IN LIQUIDTY and will earnings sustain high growth in investments?