"Nowadays clients are constantly asking me how they can best gain exposure to the commodities cycle - or, as some commentators would have it, the commodities 'supercycle'. However, there are two things that make me nervous whenever I hear this question. First, everybody always seems so upbeat on the subject, whether it be with regard to oil or materials, and this is rarely a positive sign. Second, in my experience, nothing in investment lasts for ever. What do the panel think?"
John Husselbee,north investment partners
The recent commodity supercycle has been driven, primarily, by a surge in demand from the rapidly growing economies of China and India. The Chinese Dragon, in particular, has had an almost insatiable appetite for energy - specifically oil and gas - and industrial metals. This dramatic increase in demand has outstripped the existing supply and consequently driven prices up.
This supercycle has applied mainly to the commodity categories of energy, industrials and precious metals. The 'softer' commodities such as coffee and cocoa, livestock and grains have not seen the levels of price gains enjoyed by their harder counterparts. These softer commodities are more exposed to the vagaries of global weather patterns and, therefore, the supply and demand dynamic is driven less by economic growth and more by the hand of God.
Commodities tend to perform in environments of strong economic growth and rising inflation. There is no reason to think the rapid economic growth and demand for natural resources seen in China and India is likely to end anytime soon. This, combined with a general upward trend of rising inflation across the globe, should lead to a benevolent environment for these types of commodities for some time to come.
I'd agree that sometimes it is wise to take a contrarian stance but I don't believe everybody has embraced this commodity supercycle just yet. In fact, we have witnessed sell-offs in the market during the past few months and there is still room for the cycle to continue. Of course, it won't last for ever. The favoured environment of economic growth and rising inflation does not occur often. But a portfolio should be constantly reviewed at all stages of the economic cycle and adjusted accordingly.
At present, a retail investor has only limited access to the commodities sector. There are a few mutual funds that can offer specific exposure - Investec Global Energy, Merrill Lynch Gold & General and more general resource exposure through JPM Natural Resources and First State Natural Resources.
We await the arrival of exchange-traded funds focusing solely on commodity indices - expected to be given the acronym 'ETCs' - which will open up the asset class more directly to the UK investor. Retail investors might also consider investing in regions that have natural resources, such as Canada and Australia in the developed world and Russia and Latin America in the emerging markets, although there are political risks involved in the latter pair. The derivatives market, the usual home for commodity trading, should be left well alone.
The prices of most commodities have rocketed in recent years, thanks largely to China's seemingly insatiable demand for base metals. Demand for gold and precious metals has also been strong globally. The million dollar question, therefore, is whether the commodities market is a bubble waiting to burst or in the grip of a supercycle with plenty of upside left to come.
Despite the recent price rises, commodity prices in real terms are still close to their lowest levels in 200 years. Real commodity prices have fallen by a third over the last 20 years and have almost halved since the First World War. This lends some weight to the argument that we are experiencing the early phase of a supercycle and commodities prices will continue to rise for some years yet.
The general view is that demand from China will continue to mop up spare capacity in the commodities market, preventing a fall in prices. Dr Graham Birch, manager of Merrill Lynch Gold & General, believes demand will remain strong over the longer term and that even a fall in China's growth in the shorter term is unlikely to rock the commodities market.
The prospects of a crash are also softened by the long lead time - typically five to 10 years - for bringing extra capacity of most commodities online. This means that, provided demand does not slump significantly, supply shortages are likely to remain for a few more years yet.
However, it is important to be selective because supply is expected to catch up with demand for some commodities, especially basic metals such as copper and nickel. Conversely, high-quality iron ore and steel are forecast to remain scarce. There is also a danger rising commodities prices could fuel inflation, as has already happened to an extent, triggering a rise in interest rates and a subsequent slowdown in world growth, reducing demand for commodities.
Gold is quite unique because, unlike most other commodities, there is negligible consumption so new supply adds to the global stockpile. The gold price has more than doubled over the last five years, largely fuelled by demand from India and investors flocking to gold during turbulent stockmarkets. India typically accounts for about a quarter of global demand for gold. It is mostly used for jewellery and increasing prosperity in the country, as well as other emerging markets, may lead to increased demand.
Higher gold prices have prompted gold explorers and producers to increase budgets for exploration and development. This could risk oversupply in years to come if demand does not increase to soak up the extra capacity.
With the exception of gold, the consensus seems to be that there will be sufficient excess demand in the short and medium term to avert significant falls in commodities prices. Gold is more difficult to call, but reasons to be positive probably just outweigh the negatives.
Commodities continue to play an important role in portfolio planning. While their volatile nature makes them unsuitable for core holdings, they can be an excellent diversifier because their prices usually have little correlation with stockmarkets. As a rule of thumb, growth investors prepared to take a moderate degree of risk should usually aim to hold about 5% to 10% of their portfolio in this area.
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