Commodities’ surge raises prospect of bull market

By Elizabeth Wine in New York
As commodities continue to surge, with the price of oil hitting a fresh 13-year high last week and metals still near long-term peaks, many investors are beginning to believe the asset class is in the early stages of an enduring bull market. That means large blocks of money are poised to shift into commodities for the long haul.
State Street Global Advisors, which manages more than $1,000bn for institutional clients, is rolling out two new ways for institutions to invest in commodities. The first product, out this month, will be passively managed, tracking the Goldman Sachs Commodity Index (GSCI). A second, actively managed, is set to debut soon.


Alistair Lowe, head of asset allocation at SSGA, said the new offerings come in response to a flood of requests from clients all over the world for more commodities exposure. He added that his group has also fielded many commodities queries from pension consultants.
SSGA, one of the biggest money managers around, is not the first in the arena. Merrill Lynch introduced a new product for retail investors in March and the Citigroup Private Bank created one in recent years.
Heather Shemilt, head of global marketing for the GSCI, the most widely-followed commodities index, also reports strong institutional interest. She said new investment in the index is “in the pipeline” for approval by boards of directors of several large pension and insurance companies.
In 2000, the index had approximately $12bn tracking it. That figure is roughly $20bn today, and Ms Shemilt is confident it will grow considerably.
Bullish strategists and managers say that this is not merely the latest industry leap onto a hot sector bandwagon. Many investors still remember the infamous flood of technology funds to hit the market in 1999 and 2000.
Rather, the bullish say the commodities buzz comes from the increasly common view that the world’s economy is undergoing a sea-change. After 20 years of disinflation – which boosted financial assets while crushing commodities – many believe inflation is on the way back.
There are, however, those who believe commodities nearing the end of a cyclical boom. Jim Paulsen, chief investment strategist at Wells Capital Management, believes the robust stimulus in the economic system has been powering the commodities market, and when interest rates rise, it will cool.
But many observers are more focused on inflation, which has traditionally has been hard on both bonds and stocks – note the 1970s – but gives hard assets the opportunity to shine.
Clark Winter, chief investment strategist at the Citigroup Private Bank, says “People are looking for ways to protect themselves and are remembering commodities.”
But he stresses his clients, many of whom are the heads of large businesses, are not acting out of mere defensiveness. ” The high net worth are saying ‘I’m worried about the global economy heating up and undercapacity. I’m readjusting my portfolio to say: “This is what’s happening in my business.”‘”
Separately, the surge of the last few years has been based on too little supply and too much demand. Big investors are betting that this is a long-term imbalance that will not be sorted out, or arbitraged away, quickly.
With start of the global economic recovery metals have boomed as developing nations, notably China, have devoured supply to build infrastructure. The world’s economic engines also required much more oil. The supply of both is severely constrained.
The price spikes have been so sharp – earlier this year some metals hit prices they haven’t seen for more than a decade – because of a woeful lack of investment in infrastructure over the last decade.
It is that structural shortfall that companies are working furiously to rectify. But analysts say that it will still take years to bring new supply on-line.
However, some observers fret that the recent softening in metals prices, sparked by news China is moving to slow its economy, signals an end to the bull run. The cautious got support last week from Alan Greenspan, Chairman of the Federal Reserve, who said the slowing of China’s growth will mean an easing of commodities prices. But the optimists dimiss this, viewing it as merely a short-term dip in a long-term growth trend.
Strategic attractions aside, analysts say commodities are a smart tactical move. Because the asset class is not correlated with stocks or bonds, it provides portfolio diversification, reducing risk. The standard portfolio allocation advice for such an alternative asset class is 5-10 per cent.
The GSCI returned an annualised 12.1 per cent between January 1970 and March 2004.
Commodities tend to move with the business cycle, prospering when demand is booming, with its peak performance coming at the end of the cycle. In recession they do poorly. In 2001, the GSCI fell 32 per cent.
In 2002 during the short-lived recession, when commodities would ordinarily have been expected to post mild gains, the GSCI leapt 30 per cent, thanks to tight supply. Last year it climbed 20 per cent, and so far this year it is up 18.4 per cent.
However, commodities do not neccessarily need sharply rising prices to perform well. As long as there is volatility, they prosper.
In 2003, the oil price climbed just 4 per cent higher all year. But thanks to the severe volatility, the oil portion of the GSCI gained 26 per cent.
The index is world production-weighted, which is analagous to market-cap weighting for equities. Therefore, it has a hefty exposure to energy – 65.4 per cent. “We’d argue it’s the best indicator of real economic activity,” Ms Shemilt said.
Also, she notes, energy happens to the most negatively correlated commodity to financial investments, which increases diversification.
Source: Financial Times UK

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