The volatility in the price of silver and other commodities over the past few weeks has made investors sit up and pay attention. Questions have already begun to be asked as to whether or not the commodity super-cycle is over-played and exchange-traded funds have come under fire, used as scapegoats for the pull-back in commodity prices.
However, resources managers believe the long-term fundamentals for the sector remain sound and that recent price falls represent a good buying opportunity. They say silver may be experiencing a rocky time but the fortunes of one precious metal are not linked to others, particularly gold.
The price of gold also fell back in early May but its relatively modest 5 per cent drop has already proven short-lived. Some are even forecasting it could soon hit even greater highs. Bradley George, head of commodities and resources with Investec, says: “The retreat of oil, gasoline and diesel prices, which was significant, could improve already strong margins for gold equities.”
Overall, the sharp sell-off across commodities in the opening weeks of May was the sector’s worst correction in two years, says George. There were many reasons for the correction, such as the European Central Bank’s decision not to raise rates further, but George attributes it mostly to fears of an end to the Fed’s second bout of quantitative easing.
He says: “We doubt the end of QE2 will lead to a shift in interest rates and growth expectations in the US. Consequently, we believe composure will return to commodity markets as underlying long-term fundamentals remain bullish in our view.
“Furthermore, we see China as holding the key to the end of the current period of resource stock underperformance. Once it becomes clear China has successfully engineered a soft landing and the end of the Chinese tightening cycle is in sight, we expect Asian risk appetite to return and, with it, investor interest in resource stocks.”
Whatever the ultimate cause of the commodity falls, there is no doubt they were severe and have shaken investors, with some pundits talking of a commodities crash.
The poster child of the story has been the rise and dramatic fall in the price of silver. Just over a month ago, the metal saw its highest price since 1980, having risen incredibly rapidly in less than 12 months to hit almost $50 a troy ounce.
In 2010 alone, the metal’s price rose some 70 per cent, making it one of the best-performing commodities last year, outstripping gold even as the latter hit new all-time highs. It was said that gold had lost some of its lustre and it was time to invest in silver. After all, like gold, the demand for silver is considered solid but a decline in mine production has also restricted its supply. In addition, silver is more affordable and as Adrian Lowcock, senior investment adviser at BestInvest, adds, it has broader uses.
“Unlike gold, silver tends to have an industrial use, which accounts for about 40 per cent of the demand, with the rest being made up from jewellery, coins and investments such as ETFs.”
So why did the shine suddenly disappear from silver? Lowcock says the meteoric rise of the price of silver can be explained by its undervaluation compared to gold but also as a result of speculators who can access the investment much easier these days. He is not alone in looking to ETFs and speculators, a point seemly substantiated by May’s price falls being higher in some exchange-traded commodities than in nonexchange traded bulk ones.
In March, the Telegraph reported that holdings in the iShares silver trust, one of the largest silver ETFs in the world, increased by 179 tonnes on the back of increased interest in the metal. By the start of May, the situation had reversed and vehicles such as the iShares fund claimed record redemptions. CNBC reported the ETF saw $1bn redeemed in the week to 5 May, which, in turn, helped to feed silver’s price fall.
John Husselbee, chief executive of multi-managers North, says he has yet to be convinced of the degree to which speculators play a role in commodity prices, at least beyond the short term. “Speculators do create opportunities for fund managers as they drive prices from one extreme to the other.” However, the long-term drivers of prices remain fundamentals such as supply and demand and right now that picture is still intact for commodities, he says.
Lowcock notes the sudden dropoff in silver highlights the fact that individual commodities have a different balance of characteristics and therefore have the potential to perform differently. As a result, BestInvest favours open-ended, actively managed resources funds. “For me, investors should get exposure to the sector through a fund where the managers can benefit from falling as well as rising prices. This would help reduce the risks, while still benefiting from exposure to what remains an interesting sector,” says Lowcock.
Husselbee also favours active managers in this space but he is not negative on commodity-based ETFs. That said, he says: “You do have to know what you are doing with ETFs.” He adds that if authorities are so worried about the potential for ETFs to impact asset prices, then restrictions will likely be levied, something that has yet to happen.
What has been interesting about the commodity falls has been the reaction of equity markets. As Husselbee points out, much has been written this year about the potential negative effects a spike in commodity prices will have on the continuation of the global recovery, growth and equity markets. And yet May saw the reverse of what many had been fearing. “That did not cause equities to take off,” he says, adding that they do have other concerns dampening their progress.
If markets and economies have been worried about the impact of higher commodity prices, perhaps this correction will be seen in a positive light. It is typical of fund managers to note that price corrections offer buying opportunities but, in this case, perhaps it goes beyond that. The drop in commodities may well be interpreted as easing one of the market’s biggest concerns regarding the progression of global growth.