Imagine you are finalizing an earnings model for a major Indian cable manufacturer. You notice that while the global price of copper on the London Metal Exchange has corrected by 10% over the quarter, the company’s reported gross margins have unexpectedly compressed. To diagnose this, you must look past the spot price and into the company’s inventory accounting policy—specifically whether they use Weighted Average Cost (WAC) or First-In-First-Out (FIFO).
In a declining price environment, a FIFO-heavy firm will liquidate its high-cost inventory first, leading to a temporary margin squeeze that does not necessarily reflect structural operational inefficiency.
Fundamental analysis of commodity-linked sectors requires an intimate understanding of the ‘inventory lag.’ Companies rarely purchase raw materials at the exact spot price observed on the date of a balance sheet entry. Instead, they operate with a procurement cycle that can span several months, creating a divergence between current global benchmarks and the actual cost of goods sold (COGS). An analyst must adjust their valuation models to account for these ‘price lags,’ otherwise, the forecast will incorrectly project margin expansion when input costs are falling, or vice versa.
Furthermore, the valuation of commodity-linked stocks is hypersensitive to working capital requirements. When global metal prices surge, the capital locked up in raw material inventory rises significantly, putting pressure on free cash flow despite higher accounting profits. An analyst who ignores the impact of rising inventory valuations on the cash conversion cycle will fail to anticipate the debt-servicing risks that often accompany commodity booms.
To build a robust model, you must map the company’s procurement timeline against the price discovery cycle of the relevant international exchange to normalize these timing differences.
Consider the Indian FMCG sector’s reliance on palm oil or crude oil derivatives. During periods of high volatility, firms with strong balance sheets may choose to hoard inventory to protect against supply shocks, while others operate on a just-in-time basis to optimize cash flow. Your investment recommendation should be predicated not just on the price of the commodity, but on the management team’s tactical ability to hedge inventory costs versus the risk of inventory obsolescence or price correction.
Integrating these inventory dynamics ensures your valuation reflects the firm’s actual economic reality rather than a mere mechanical projection of spot price trends.1 2
Nuance
Check Your Understanding
An Indian manufacturing firm uses the FIFO inventory valuation method. If global copper prices experience a sharp, sustained decline during a fiscal quarter, how is this most likely to affect the firm’s immediate gross margins?
In the context of commodity-linked stocks, why does a significant increase in raw material prices often lead to a deterioration in free cash flow (FCF)?
This is a companion read for Section 11.4 — Correlation between international markets and domestic markets from PASS Research Analyst Certification Examination by Akhilesh Gururani, available on Amazon Kindle.
Copyright © 2026 Akhilesh Gururani. All rights reserved.
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FIFO (First-In-First-Out) assumes the oldest inventory items are sold first, which can significantly impact reported margins during periods of extreme commodity price volatility. ↩︎
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Working capital is defined as current assets minus current liabilities; in commodity-heavy firms, inventory often constitutes the largest component of this figure. ↩︎