Investing Ideas |
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Volatile natural resources By Faith Glasgow
It's not that long since commodities were considered the exclusive domain of professional investors. Not only was the sector volatile and peripheral, but private investors struggled to access it even if they wanted to. The But times have changed dramatically, and commodity prices have gone haywire in recent years. The price of oil increased sevenfold between 1999 and 2006, while prices for gold and base metals such as copper, nickel and zinc began to rise around 2001. Copper prices on the London Metal Exchange, for example, rose more than sevenfold over the five years to May 2006, and have rallied again since the widespread turbulence that hit commodities at that time. Zinc prices are up nearly as much over the same period. Gold, meanwhile, had risen from its low of around $250/oz in 1999 to more than $660/oz by the end of March - a gain of over 150%. Future super-cycle? A handful of specialist commodities funds have sprung up in the UK, and they have posted extraordinary returns on the back of these price hikes. This has prompted talk in investment circles of a commodities super-cycle that could stretch years into the future. This is being driven by a long-lasting upswing in economic growth - most crucially, the dramatic industrialisation and urbanisation of China, the fastest-growing economy in the world (and to a lesser extent that of India, the second fastest). So far, experts reckon, we're only in the early stages of this super-cycle, so prices are likely to continue upwards. It's important, however, to recognise that natural resources are inherently volatile and there are likely to be turbulent times along the way. China's massive economic growth is reflected in a huge expansion in the natural resources being used. According to the International Monetary Fund, between 2002 and 2005, China was responsible for around 30% of the global growth in consumption of crude oil, 50% of the growth in copper, aluminium and steel, and almost all of the growth in nickel and tin. But supply is still struggling to keep up with the increase in demand. Increasing production by setting up new mines takes years rather than months and stockpiles have run down considerably. China and India So, what's the outlook for the near future? There are various views, bullish and less so, and all are speculation. But it's a fair bet that the urbanisation process in both China and India will continue. That will mean ongoing demand for industrial commodities, including base metals, rubber, cement and energy. Gold has enjoyed a new lease of life in recent years. People worldwide become better off, and they start to buy gold jewellery and invest in gold. The jewellery effect is a major influence and accounts for two-thirds of global gold demand. In India - which alone accounts for 18% of world demand - gold is central to marriages and naming ceremonies, so it is not particularly price-sensitive. Meanwhile, Chinese demand is growing as the government has made it easier for people to buy gold. But Birch adds: "Central banks are certainly not going to increase their sales because they are restricted by international sales quotas, and may want to sell less now that the market is rising." Volatile stock At the same time, global gold production has been getting more expensive and output is falling by 2% a year, according to Ian Henderson, manager of JP Morgan's Natural Resources fund. Commodities are inherently volatile, as a quick look at any price chart showing the second half of 2006 will confirm. Birch puts it into perspective: "We talk about volatility as a good thing, but it can be bad for investors - our fund may lose 10% or 12% in the course of a month at least once or twice a year, and they need to be prepared for that." Like most IFAs, Paul White, a consultant at IFA Belgravia Insurance, recommends investing no more than 5% or 6% of your portfolio in commodities. The difficulty for small investors is that many fund supermarkets stipulate a minimum investment of £1,000 a fund. On the basis of a 5% allocation, putting £1,000 into commodities amounts to overexposure, unless you already have a portfolio of £20,000. Get exposure to natural resources markets Sophisticated investors make use of the futures markets, essentially betting on the future price of a commodity without actually committing themselves to taking possession of the real thing. This involves either buying individual shares in commodities companies or using commodities funds that invest in companies involved with commodity production. The problem with an equity-based route is that you lose some of the benefits of low equity correlation. Setting aside the correlation issue, expert managers, coupled with exposure to the equity market, can potentially add considerable value to commodity price movements. Over 10 years to the end of March, for example, gold bullion is up 59%, while Graham Birch's Blackrock Merrill Lynch Gold & General fund is up 251%. If you want active fund management, then you have a limited choice of onshore unit trusts. JP Morgan Natural Resources is invested roughly a third in base metals and 30% in gold, with a quarter in energy and the balance in diamonds. First State Natural Resources is similarly diverse, while the Blackrock Merrill Lynch Gold & General focuses specifically on precious metals, mainly gold but also including other precious metals such as platinum, silver and diamonds. Remember, however, that these funds may well hold major mining and oil companies that are already in your portfolio as part of more mainstream funds. This means that if they have a bad run, you'll know all about it. For investors looking for pure exposure to commodities as a separate asset class, one solution is to use exchange traded funds (ETFs), which track the price of a specific commodity through an index, but are traded like shares on the stock exchange using an ordinary stockbroker. ETF Securities launched a whole series of exchange traded commodities (ETCs) last autumn, making it possible to buy directly into a wide range of more than 30 commodities. The company also launched 10 baskets of commodities such as energy, precious metals and agriculture. Both ETFs and ETCs can be held in ISAs, PEPs and SIPPs. What counts as a natural resource? So-called hard natural resources - those for which you have to mine or drill - include oil and gas, base metals such as copper, zinc, aluminium and lead, and precious commodities such as gold, platinum, silver and diamonds. It's these resources - which are non-renewable and cost a lot to extract from the earth. The prices of soft resources, including grain, rubber, timber and coffee, have risen less spectacularly (although still significantly), because they are renewable.
Interestingly, says Mark Dampier, head of research at Hargreaves Lansdown, corn has doubled in value over the past year partly because it can be used to make ethanol, a hot contender in the growing biofuel market.
|
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Send Article by Email