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Bubbling along

Commodity prices are again rallying after some sharp falls in recent weeks.

July was a strange month in which the former darling sector of commodities and the dreaded financials area seemed to switch places in performance terms. Just how long that will last is the question. Still it has also reignited the the debate of just how long the bull run in commodities can last.

The main news in commodities in the past few days and weeks has been the climbdown of the oil price – falling from the peak of $145 a barrel. Gold prices have also come down, as have other commodities and mining stocks have been affected.

Considering how prevalent these stocks have become in many mainstream UK equity portfolios as well the knock-on impact that commodities have had on the performance of emerging markets, it will little surprise to see how far reaching these falls will be on everyday investments.

Michael Rawlinson, of Liberum Capital, discussed whether the commodity story had further to go or was it a bubble waiting to burst at a recent meeting hosted by investment boutique Waverton.

Rawlinson is head of research at Liberum Capital and is the firm’s specialist for mining, resources and energy. He believes global markets are just in year four of a 20-year bull run in commodities and does not consider there is a comparison with the technology bubble. For one, he notes that many technology stocks were priced on little or no proven earnings from companies – not exactly the case in the commodity sector.

There are parallels between the two asset classes. Strong, rising prices seemingly without end, dissenters and pros on either side and a myriad of fund launches, sparking claims of providers jumping on a bandwagon to take advantage of interest in the area.

But Rawlinson says the trend in commodities is neither a bubble nor a new paradigm, just a cycle that the market has not seen in some time.

He illustrates his point using the price of copper, one of the most liquid industrial metals. Looking at copper prices since 1885, he notes there are periods of 20-30 years of price appreciation followed by declines and the moves upward are generally accompanied by big global GDP events such as industrialisation or rebuilding Japan after World War II. Today the urbanisation of China and India are such events. He says: “A lot of people do not understand that mining has the longest lead time of any sector, including pharmaceuticals. It takes 10 years from first establishing a mine to start to recover the metal and another 10 years after that for full development. This is why we see 20 years of good and 20 years of bad in commodity cycles.”

Fund launches in this area are not necessarily jumping on a bandwagon either. For one – there has certainly not been as many commodity funds enter the market as there were, say, property funds a year ago.

In the IMA’s specialist sector, there are 13 funds that could come under the banner of commodities and these cover a broad spectrum from natural resources to gold and oil-specific portfolios. Of these 13, only one has just a three-month track record and five have one-year performance figures to July 21 while the remainder all have been running for longer periods.

There are several more offshore and many of these are new entrants. Schroder’s $4.9bn agriculture fund, which is now closed to new investments, has been very popular among fund buyers over the past couple of years and the firm has more recently launched an agriculture land trust. In May, Sarasin set up its AgriSar fund and over this summer Credit Agricole added a global commodities portfolio, as well as Allianz Global Investors. Six months ago, BlackRock launched a soft commodities hedge fund and is looking to launch a long-only version into the UK market.

Some could see this launch as marketing-led but BlackRock argues that agriculture and soft commodities are a natural extension of its resources team, considering the firm already manages the long-running gold & general fund as well as a number of mining and energy portfolios. It also points out that it sees soft commodities, as well as demand in the resources area in general, as a long-term theme.

Looking at metals, the demand from China is easily understood but Rawlinson points out it is the supply constraints that have not fully fed through yet that some may underestimate. There has not yet been a shortage in supply but the constraints on that side are being felt in more ways than one.

Consolidation is being seen among mining companies as the expense of exploring and developing new mines continues to rise. It is this move by the industry that is one of the factors that will continue to underpin mining companies, notes Rawlinson.

The outlook for soft commodities is not yet bleak either. Schroder AS agriculture fund manager Rodolphe Roche says there is a strong likelihood of a continuation of the powerful bull market in commodities. The firm believes the performance of various sectors within soft commodities will vary, for example, wheat and corn are expected to have suffered over the summer but are forecast to correct in early September.

Roche says: “Among the soft commodities, the coffee market should continue to be supported by extremely low stocks. Sugar prices are expected to benefit from a strong reduction in the global surplus in the 2008/09 season, coupled with rising ethanol consumption in Brazil. The cotton market should benefit from lower US acreage, lower than expected yields and sustained demand from China. Long-term fundamentals remain very supportive.”

In the main, despite the recent volatility in prices, from mining through to food, the theme of commodities is a broad one and is expected to be around for some time yet. How individual fund managers, advisers and investors play it is another matter.


Yield to the rules

When is a rule not a rule? It appears to be when it is applied to the UK equity income sector as more than half of the funds in the sector do not meet the required level of yield set by the Investment Management Association.


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