/ 27 March 2008

Commodities: boom or bust?

Gold, oil, diamonds, metals: commodities have been booming. But as prices hit record highs, is the bubble about to burst? Turmoil in financial markets has, some analysts say, pushed prices well above fair market value across energy, metals and agricultural goods as investors take flight to supposed ''safe plays''.

Gold, oil, diamonds, metals: commodities have been booming. But as prices hit record highs, is the bubble about to burst?

Turmoil in financial markets has, some analysts say, pushed prices well above fair market value across energy, metals and agricultural goods as investors take flight to supposed ”safe plays”.

Heavy profit-taking last week saw commodities — from gold and oil to grains — tumble as investors cashed out, taking profits at near-record prices and reducing risk from positions built on borrowed money.

”Gold is priced in US dollars and, therefore, usually suffers when the US dollar prospers, and it’s also bought as a hedge against inflation so, consequently, the Federal Reserve’s concerns about inflation and its decision not to cut interest rates by a full point are seen as bearish omens for gold,” says Andy Gadd, head of research at independent financial adviser Lighthouse Group.

”Investors need to understand that investment into gold and other commodities is not necessarily a one way ride.”

The Reuters/Jefferies CRB commodities index — which includes crude oil, gold, wheat, cattle and maize — has dropped 8,4% — the largest fall since its inception 50 years ago.

Against that backdrop, some analysts are turning bearish.

”We’re bearish on commodities in the short term, primarily due to over-speculation in the markets,” says John Davey, a research analyst at broker Bestinvest, ”although long term agricultural fundamentals look attractive due to low inventories and positive demand from the food, fuel and feed sectors along with increased westernisation of Chinese eating habits”.

Others say the commodities boom is far from over.

”I don’t think anything much has changed,” says Mark Dampier, head of research at investment broker Hargreaves Lansdown.

”There’s been heavy profit-taking in an area that has gone up like a rocket, and a bit of a correction is healthy.

”I’m not convinced this is the end of the commodities story: it’s a long-term bull story.”

Demand from emerging markets — China and India particularly — should continue to stoke commodities markets.

”While fund flows have certainly contributed to the market’s rise, perhaps to unsustainable highs, fundamentals on the supply side have tightened faster than demand has deteriorated,” Lehman Brothers said in a recent research note.

”And there are no visible signs yet that demand growth has deteriorated significantly outside of the United States.”

Commodities were the best performing asset class last year, according to Clerical Medical’s biannual ”asset watch” survey, posting a 20,6% rise.

That compares to a 10,7% rise in residential property, 6% in cash, 5,3% in United Kingdom shares and 3,3% in UK bonds.

Some commodities funds have fared better than the overall market over the past 12 months: Merrill Lynch Gold & General, First State Global Resources and JPMorgan Natural Resources give retail investors access to a diversified portfolio of commodities, and are up 46,6%, 37,6% and 23,3% respectively, according to Trustnet data.

Dampier also tipped CF Junior Oils, a specialist fund that invests in smaller oil-producing companies, and is managed by Angelos Damaskos, the son-in-law of City veteran Jim Slater.

”These companies, Dana Petroleum and the like, are very profitable and tend to get taken over by the major players,” he adds.

However, such funds remain high risk, and investors must be wary of over-exposure: other holdings are likely to give exposure to commodities, particularly natural resources.

Ian Shipway, investment director at independent financial planning group Thinc, warns against piling into an asset class on a bull run to the detriment of maintaining portfolio balance.

”Private investors should continue to do what they should always do: ensure that they have sufficient liquidity to meet short-term expenditure requirements and hold a diversified portfolio of other asset classes — equities, bonds, property, alternatives — to provide growth and protect their purchasing power over the longer-term.

”What they should not do is take decisions on their long-term strategy based on short-term market movements.” – Reuters