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From Special Report: Global Opportunities - May 2012

Have investors missed the commodities boat?

With an uncertain economic outlook it seems 2012 will be a mixed year for commodities

By Nyree Stewart | Published Jun 06, 2012 | comments

Unexpected natural and geopolitical events in 2011 including the earthquake and tsunami in Japan, the Arab Spring in the Middle East and North Africa (Mena) meant last year was a strong year for commodities.

The S&P GSCI Spot index, which tracks spot prices paid for the immediate delivery of a range of resources, ended 2011 up 2.83 per cent, according to FE Analytics. The index is predominantly weighted towards industrial commodities, with 70.5 per cent in energy, 6.6 per cent in industrial metals and 3.5 per cent in precious metals. Among the sub-indices that make up the overall index, Brent crude oil, gold and precious metals all outperformed with returns of 13.73 per cent, 11.05 per cent and 7.98 per cent respectively.

The strength in commodities has continued into 2012. The S&P index recorded a 4.91 per cent gain from the start of 2012 to April 26, although the month of April resulted in a slight loss of 0.92 per cent.

S&P notes: “Energy has been the best performing major sector index in 2012 and remained the best performing in the second quarter, as measured by the S&P GSCI Energy index month-to-date decline of 0.31 per cent, [making] for a year-to-date gain of 6.98 per cent.

“The S&P GSCI Brent Crude index April decline of 1.72 per cent lessened the year-to-date gain to 13.37 per cent, just behind the S&P GSCI Unleaded Gas index year-to-date increase of 14.96 per cent.”


Angelos Damaskos, chief executive of Sector Investment Managers and adviser to the £49m Junior Oils and £28m Junior Gold funds, points out oil is an essential input into the world economy, primarily as a transportation fuel. In spite of economic difficulties in developed countries, he says there is unlikely to be a slack in demand for related sectors.

“At the same time we have China and India which are continuing to demand more oil, and there have also been reports that China in particular has been building a very large strategic petroleum reserve. In the short term they are demanding more oil than they consume to build up this reserve, which is going to be many millions of barrels of oil.”

In terms of geopolitical factors, Mr Damaskos highlights that Libya’s oil supply is still more than half offline. Short-term potential instability around Iran and other Mena countries such as Syria could also cause a “super-spike” in oil prices, with Brent crude already sitting at $112 a barrel.

Natural gas, by contrast, has seen its price fall, with Henry Hub Natural Gas Front Month Futures falling from a peak of $13.53 per million British thermal units (MMBtu) in July 2008 to $2.44/MMBtu in May 2012.

Mr Damaskos notes: “In the case of natural gas, there is a very large divide between what is happening in the US and what is happening in the rest of the world.

“The rest of the world prices natural gas very closely to the Brent crude oil price because it’s seen as a direct energy input into industry – whereas in the US, because of the discovery of these massive gas shale reserves in Canada and the US, the price has been extremely weak and has been declining for the past four years.”

This is supported by data from the IMF, which shows the Henry Hub natural gas spot price in March 2012 was $72 per thousand cubic metres, while the Russian natural gas border price in Germany in March 2012 was $450.36 per thousand cubic metres.

The manager notes: “We will have to wait and see how the supply/demand pattern develops in the US, because at this price most of the shale gas plays, particularly in Canada, are uneconomic. But over the long term it is likely [the] industry and power generation will start switching much more towards gas usage rather than heavy oil or coal, as gas is more efficient, more environmentally friendly, cleaner and easier to use. This in turn will raise the demand profile and potentially slightly raise the prices to make sure the shale gas plays become economic.”


Meanwhile, on the precious metal side, gold has slipped from its highs of more than $1,800/oz in September 2011 to teeter on the edge of falling below the $1,600/oz mark in May 2012, with markets closing at $1,602/oz on May 8.

Steve Cohen, investment strategist at iShares, says in spite of the lower price of gold there is still a strong strategic reason for allocating to gold to offset zero or negative real interest rates.

“The other driver is that central banks have changed their approach to gold. From the late 1990s early 2000s onwards central banks were generally a net seller of gold. In the past three years, driven by emerging market central banks, we have seen that turn to a positive. So there are two real drivers for having a strategic allocation to gold.”

Mr Cohen notes that gold has traded in line with risk assets so far in 2012, performing relatively well in the first quarter before starting to dip from the beginning of March when it peaked at $1,781/oz on February 28. “One of the drivers of that is central bank comments about how quantitative easing (QE) may or may not come. As real interest rates are the main driver for an allocation to gold, the actions of central banks on whether or not they may embark in the next round of QE has an impact on sentiment. I think that is clearly a key thing to watch throughout the rest of the year,” he says.

Rupert Elwes, director and portfolio manager at JO Hambro Investment Management, agrees the behaviour of central banks can affect gold prices, but notes there has also been renewed demand from private investors in the past few weeks.

“This is partially driven by a belief that the euro crisis is still far from resolved and that a Greek departure from the euro remains a possibility. Alongside such demand is a continuing lack of newly mined supply, further supporting the longer-term prospects for the yellow metal.”

Mr Damaskos adds: “The next time we have another crisis, whether it’s a sovereign crisis or a banking crisis, investors are likely to look again to gold as a safe haven and buy significantly into it regardless of price. We think this scenario is likely to play out in the next year and could very quickly push the price of gold beyond $2,000/oz.”

Silver, gold’s cousin, has a somewhat different profile. Roughly 50 per cent of the demand for silver is driven by its industrial uses. A weak outlook for growth suggests a lack of demand to support silver prices, which are trading much lower than their peak in April 2011 of $48.7/oz. The price on May 8, by contrast, was $29.6/oz.

Other precious metals, such as platinum, which is mainly used in automotive parts, have also seen prices dip in recent months. Platinum fell from a peak of $1,729/oz in February 2012 to $1,514/oz on May 8.

Bradley George, co-manager of the Investec Enhanced Natural Resources fund, notes: “While short-term demand for platinum remains uncertain, we believe the long-term story remains intact. This, coupled with supply that continues to disappoint, will deliver a tight market in a few years’ time.”

Meanwhile the price of base metals such as copper have been mixed. Comex Copper High Grade front month futures reached a peak in July 2011 at $4.48 a pound, but after dipping to a low of $3.04 a pound in October they have rallied slightly to roughly $3.65.

Mr George notes: “With China still the dominant consumer and thus driver of the market, it is difficult to see a strong price rally from these levels unless buying returns in that region. Also, over the next few months, we may see supply recovering as some of the larger mines return to more ‘normal’ production after a very poor 2011.

“Therefore, any demand recovery in the second half of 2012 should be met by increased supplies, and we think prices are most likely to be range bound over the coming months.”

With an uncertain outlook in Europe and possible signs of slowing growth in China and emerging markets, 2012 will be a mixed year for commodities. However, in specific areas like platinum, this year may represent a low point in the market and hence, in the long term, an opportunity to buy.

Nyree Stewart is deputy features editor at Investment Adviser

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