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Brian Tora: Which way for emerging markets and commodities?

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One of the problems of being in the investment game is what I can only describe as information overload.

When I was an investment manager, working for one of the big independent houses, I felt buried under all the brokers’ circulars and economic reports that rained down on people like me with the intention, I imagine, of persuading me to buy or sell some shares and keep the salesman who’s task it was to telephone on a daily basis fed with commission.

When, some 30 years ago, I returned to my stockbroking roots and joined the great house of James Capel, I fully expected to find my in tray devoid of sales literature. How naive can you be? There was just as much material, even if it did come from a different source. And once Big Bang took place and the barriers between disciplines were dismantled, I felt I was back to life as an investment manager, which I suppose I was.

Today it is my computer screen that fills with research and opinion, reports and exhortations to act. The principal task of anyone engaged in the investment business these days must be to sift through the cornucopia of material despatched electronically and endeavour to cut it down to a concise, manageable and hopefully valuable selection which will add value to the process of deciding what action will achieve the desired results.

Where this becomes difficult and, I have to confess, more interesting, is when conflicting views arrive at pretty much the same time. My view has been that it takes two to make a market and disagreements over potential outcomes are an encouraging sign. Indeed, it is when all those commenting on a possible turn of events agree on what is likely to happen that an investor should start to be concerned.

So it has been with both commodities and emerging markets recently. There are bulls and bears in what seems like equal measure for both these sectors recently.

In the case of emerging markets, the bulls point to the undemanding valuation levels that have now been established. The bears underline the risks inherent from rising debt levels, the ending of cheap money, uncertainty over the strength of the global economy and potential political instability in a number of areas.

It is the economic argument that weighs most heavily in the debate over the likely direction of resource stocks. Earlier strength in demand for natural resources, brought about in no small measure by the rapid growth in China and other emerging nations, triggered the biggest surge in investment in mining industries ever. The economic slowdown reduced demand and led to a period of disappointing returns for investors. The crucial question is whether this is a setback in a bull market or the start of a major reversal of fortunes.

Much has been written of the so-called super cycle in commodities. According to Craton Capital, an investment manager which specialises in mining shares, there have been three super cycles in the past 120 years. They believe the recent boom in commodity prices, which has admittedly peaked, has all the characteristics of a super cycle which may have further to run.

The problem, though, is what is likely to happen in the short term. The investment cycle came to an end in 2012. The costs associated with bringing on extra capacity, which inevitably depressed mining profits, peaked a year ago. While this reduction in the cost burden should be beneficial, new capacity is coming on stream against a background of sluggish demand, so a supply glut is expected.

This will not continue indefinitely, of course, but the extent to which the market will look through this short term difficulty could be crucial for the performance of the FTSE 100 Index, given the importance of resource stocks in its makeup. I am looking for new high ground this year, so I hope Craton’s bullish take turns out to be right. There are plenty of an opposite persuasion, though.

Brian Tora is an associate with investment managers JM Finn & Co

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