Seeking out the resources to keep up with global demand

GOLDMAN Sachs may have slowed the charge of the commodity bulls last week by suggesting that investors take profits on a basket trade of crude oil, cotton, copper, soybeans and platinum that it recommended in late 2010, but this week the markets have carried on regardless. But with political turmoil affecting the established commodity rich countries, there is a worry about the future of this rally as well as a push for new mining opportunities.

Evy Hambro, manager of BlackRock World Mining Trust, says “in terms of recent geopolitical factors and natural disasters, it’s important to maintain a broad macro view when looking at the markets. However, these recent events are likely to have a positive effect across the commodities spectrum, as nuclear power plants need to be rebuilt and investors traditionally turn to gold in periods of uncertainty and instability as a way of preserving wealth.”

Political instability, by its very nature, is not something that an investor should be pegging his hopes for steady returns on. Commodity investors, particularly in gold and silver, will rightly be questioning whether this is a bubble we are seeing or whether there is potential for future growth once the furore in the Middle East dies down. Will Smith, manager of City Natural Resources and portfolio manager of Geiger Counter takes the view that there will be continued demand from emerging markets, however identifying any potential bubbles can be a difficult task: “We believe the sectoral bull market in most commodities is intact. This does not mean prices go up in a straight line, and there are going to be periods of underperformance. Frankly, bubbles can only be clearly identified when they have burst.”

Rather than a short term effect created by government input, such as QE2 in the US or its potential sequels, Will Smith sees the commodities rally as having firm footing in reality: “QE has clearly been supportive of economies and the things we are monitoring are the potential for QE3 which might generate too much exuberance or conversely government policies that seek to restrain economic activity. Our underlying optimism is based on the infrastructure needs of both developing and developed economies and the inability of the supply side to match growing demand.”

But with this constant difficulty in keeping up with demand, eyes are on where the next big opportunities will arise.

Cameroon is typical of the frontier countries targeted by mining companies. Its economy has in recent years been dominated by the oil and agriculture industries but there are hopes that significant mineral mining opportunities exist. Underexplored for mineral resources, Cameroon is considered to be more stable than some of its neighbours and due to its oil resources has one of the better economies in sub-Saharan Africa. Through its agricultural and exporting history, it has a number of ports that could be expanded to accommodate the exports from a mining industry.

There are few mining companies active in Cameroon to date. Some, however, are currently dipping their toes in the water. AIM and TSK-quoted Afferro Mining has iron ore interests in Cameroon and Aureus Mining is involved in gold exploration. Sundance Resources, quoted on the ASX, holds the Mbalam iron ore project. Mega Uranium is currently exploring for the nuclear fuel and Geovic is involved in exploration for cobalt.

And herein lies the problem for retail investors. Picking winners in an environment of high speculation is a risky approach for the average investor. While there may be a high upside potential for mining equities that strike gold – be that literally or metaphorically – there is also a large potential for downside. Political turmoil, lower than projected grades of ore or Rumsfeldian “unknown unknowns” could all cause an upset. According to David Morrison, CFD market strategist for GFT, “individual mining stocks may be suitable, but only if you’ve really done your homework. If you’ve got a handle and think that you know what you’re doing you may take a risk, but you should be prepared for them to fail. Sectoral CFDs may be better for those wishing to take a position on the commodities sector as a whole. Similarly, if you look at the large mining conglomerates, these tend to be driven more by demand for industrial metals over gold and silver.”

In short, if you have a CFD quoted stock that you like the look of and are prepared to take the risk, then there is a potential for a big return. However, with demand likely to outstrip supply for the foreseeable future, a CFD on the long term performance of the sector as a whole could be a good choice for those who wish to tread more cautiously.