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Commodity comeback

The commodity boom does not appear to be over and some believe that the falls in the autumn were simply a breather before entering round two of the bull run. Lately, the price of industrial metals has been creeping back up while recovery has been seen in numerous commodity-related stocks.

Investors may be nervous about getting involved, considering the steep falls seen in this asset class over the final quarter of 2008, but those falls have provided a buying opportunity. One that many fund managers have been looking to take advantage of to shore up positions in this sector.

Anthony Eaton, manager of the CF JM Finn global opportunities fund, says commodities across the board are “compelling” and believes the run this time could be stronger and last longer. His fund, which invests in a variety of commodity-related companies and is in the global growth sector, is ranked 130th out of the 2,276 funds in the UK onshore unit trust/Oeic universe over one month to May 7, according to Trustnet figures.

The UK smaller companies portfolio Close special situations is also placed quite highly over the same short time-frame, ranking second across the entire onshore open-ended funds universe.

Undoubtedly, the fund fared well with its focus on smaller companies, which have done well in recent weeks as investors’ appetite returned but the fund also appears to feature a significant bias at the moment towards commodity areas.

The portfolio has more than 20 per cent in miners, with a further 11.7 per cent in gold miners as well as 10.4 per cent in food producers and 9.8 in oil and gas equipment services and distribution. It has 3.7 per cent in oil and gas producers and 2.4 per cent in electricity supply.

Waverton UK manager Russell Wallis is overweight in miners in his portfolio at 13 per cent and although he generally writes calls on overweight positions, he is not looking to do so at the moment as he does not want to cap the upside potential he sees.

Wallis is not the only Waverton manager to see potential in comm-odities and mining. Colleague Katrina Norris is moving the Waverton European fund out of defensives and into industrials, preferring steel producers.

Speaking at a recent Waverton conference, Mike Howell, founder and head of research at CrossBorder Capital, compared today’s market situation with the 1930s. He noted that the path out of the Great Depression was marked by commodity price inflation, with the gold price doubling, oil rising by 50 per cent, copper by 93 per cent and steel by 132 per cent.

Howell said the effect of the massive quantitative easing done by Western governments is feeding through and global markets are in the fourth stage of a recovery, where industrial markets start to stir. The beneficiaries of such a move are bound to be commodity areas.

Howell pointed out that over each liquidity cycle dating back to the 1960s, at the troughs there have always been financial crises while the peaks involved asset booms – just the asset categories and the names of the failed banks change.

Eaton attributes the current upside he sees in commodities to the unusual events of the final quarter of 2008. Although demand for commodities fell off in the autumn months, supply also fell quite sharply. As the world plunged into a global recession, companies shut down projects, halting production. But demand has returned faster than expected and the supply is still not there as companies move to restart projects and production.

Eaton says the resulting liquidity being pumped into Western econ-omies as they effectively move to print money to solve their current problems has meant that the recessionary environment has eased. At the same time, the Eastern economies, such as China, continue to expand and with that is increased demand for commodities. These two situations have combined to see resumption in demand while supply has been slow to follow.

Eaton says that in round one of the commodity boom, there were three phases. The first meant investors wanted to be exposed to companies which enable production such as maintenance. During the second stage, where demand exceeds supply, investors wanted to be holding the asset itself or companies which own the asset while in phase three the turn was towards cap expenditure, companies which enable greater production. It was this third stage where the markets were for much of 2008 and then the implosion occurred. He says: “We have tumbled all the way back to phase one again and now we are drifting back into phase two.”

But just how high will commodity prices get and will we see a repeat of the oil highs of last summer? Eaton does not believe that the oil price will again reach the high 100s as it is quite destructive. Neither does he think that food prices will soar as part of the second part boom for the same reason – too high a price damages the industry.

On May 7, it was reported that oil reached its 2009 high at $58 a barrel, still some way off its July 2008 peak of $140 but still significantly up from its autumn lows. Copper has also risen sharply, up by more than 50 per cent so far this year.

But while prices may not become exorbitantly high, Eaton believes we are likely to see around five to six years of pricing strength in commodities.

He says: “There is simply not enough stuff, so prices will go up until more is produced. In theory, a price reverts to a price marginally over the cost of production and costs are rising.”

But Eaton says there are already some anomalies with that pricing theory, with the price of copper already well above the cost of its production. “It would seem that commodities are wanted in their own right at the moment because they are tangible assets,” he says.

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