Don’t worry, the party in commodities isn’t over yet

Philip Salter
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COMMODITIES took a big knock in the recent correction, but the fundamentals still point towards continued rises over the medium term. Assuming you aren’t planning to fill your home with sheep, soybeans and platinum, with certain provisos, commodity funds can offer you a route in.

Investors who joined the commodity party just prior to the correction might feel as though they pitched up too late – some will have cut their losses and gone straight back home to perceived safer assets. For those that didn’t attend, reports of its slump could have confirmed their suspicions that the asset class is in a bubble. But the party isn’t over: commodities will bounce back.

Because food and energy represents about a quarter of CPI inflation and over three quarters of its volatility, exposure to commodities is a way of hedging against inflation, something investors can’t get from most other assets. Inflation is continuing to bite, so investors are continuing to like them.

Added to this, the central banks of the US and Japan are still priming the pump, which is getting soaked up in oil and other commodities. Also, demand from emerging markets will continue to put upward pressure on commodity prices. Peter Toogood, Director of Investment Services at OBSR, says that in relation to oil, China is expected to be turning out 25m cars by 2015, double that of the US. Combined with supply problems from lack of investment and with access to oil getting increasingly difficult, oil looks to be on the up. However, getting access to oil through a fund is difficult. Toogood says that as it is a futures game the rollover of contracts kills you. As such, the trade “doesn’t work.”

Investment cycles in the capacity building of businesses working across most commodities means that the bull and bear takes a long time to turn. The current bull market has been going for only nine years, while the previous bear market ran for around twenty-one years. In spite of the risks of popping bubbles down the line, Brazilian, Indian, Chinese and Russian growth is a trend that still has some way to go.

As the table shows, not all broad basket commodity funds turned a profit in the last three years. A better, if potentially riskier tactic, would have been to choose a specific sector. In precious metals over the last three years, investors have seen 162.7 per cent growth from the ETFS Physical Silver exchange-traded commodity (ETC), while in soft commodities they could have profited by 89.99 per cent from the ETFS Cotton ETC. Picking winners is a risky strategy though. Investors would have lost around 80 per cent on natural gas energy ETCs. But as Stephen Barber, who advises Selftrade on markets and economics says: “A diversified fund could mean diluting exposure to the best performing assets.”

Research from Deutsche Bank from 4 May shows that despite the dip, commodities are still the top-performing asset class so far this year. Commodities total returns are 7.1 per cent, followed by equity at 6.2 per cent, then emerging markets at 3.8 per cent, with bonds at 0.3 per cent and forex losing 1.1 per cent. Investing in commodities is not for the fainthearted. Commodities and the funds that track them suffer hugely from volatility and in the long run it is a bet against technological innovation. It is also vital to avoid commodities funds like oil that cannot profit from the trend. In these cases equities are a much better bet.

Nevertheless, investment cycles suggest that we are still in a bull market and as inflation persists and the world’s have-nots chase the lifestyle of the world’s haves, for the foreseeable future demand for commodities will increase.