InvestmentsJun 6 2016

Can commodities sustain their rally?

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Can commodities sustain their rally?

Figures from the World Gold Council show the gold price rallied 17 per cent in the first quarter of the year in dollar terms, its best performance in almost three decades, while demand for the precious metal increased 21 per cent year on year, according to the organisation.

TD Direct Investing has also recorded a 24 per cent increase in the number of customers investing in gold in the past four months.

Michelle McGrade, chief investment officer at TD Direct Investing, notes: “Gold is often considered a hedge and a ‘safe haven’ investment when stockmarkets are volatile or when there is wider economic uncertainty. The rally of the past four months links back to this need for security, coupled with the fact that more experienced investors will trade into the price fluctuations – and so must believe the price will continue to rise.”

But David Coombs, head of multi-asset investments for Rathbone Unit Trust Management, questions how much of a hedge against inflation gold actually is, noting that while it is a very good ‘hyperinflation’ hedge, when inflation is in double digits, “it’s not really a good hedge for the normal inflationary cycle”.

He adds: “Gold, like any commodity, has no earnings stream so there is a higher risk. Without that income stream, the asset is likely to be more volatile. That’s not a bad thing if the correlation is in your favour. The problem is the correlation of gold changes all the time.”

Commodities can provide inflation protection and diversify your sources of return within a portfolio Kevin O’Nolan, Fidelity Solutions

For example, Mr Coombs points out it tends to have a negative correlation with the dollar owing to the interest rate cycle, so typically rising US interest rates are negative for gold.

Christopher Mahon, director of asset allocation research at Baring Asset Management, notes: “Precious metals such as gold and silver have been the clear winners in our portfolios this year. Yet from here with interest rate rises on the cards, the best returns are now behind them.”

Meanwhile, oil has also enjoyed a rebound with the price of Brent Crude breaking the $50 a barrel mark at the end of May, compared with the low of $27 a barrel in January.

Adrian Lowcock, head of investing at Axa Wealth, notes that supply has fallen more quickly than anticipated largely because of “uncontrollable and unpredictable events as wildfires in Canada cut production by about 1m barrels a day and militant action in Nigeria also affected supply there”.

He adds: “The price of Brent crude is up about 80 per cent from its January lows and the outlook for the price has improved. However, supply issues remain because Iran has been increasing production while Saudi Arabia has indicated it might raise production further in 2016. As the price rises, oil producers will begin to bring rigs back online, adding more supply. Given this outlook, the oil price is expected to stabilise at about the $50 mark for the rest of the year.”

Meanwhile the natural resources sector overall “has staged something of a revival” according to James Sutton, client portfolio manager of the JPM Natural Resources fund. As to whether the rally has legs, he points to the cyclicality of the sector, which stems from the typical expansions and contractions in the global economy, which is compounded by extreme investment cycles that push commodities from undersupply to oversupply and back again. “It is these investment cycles, rather than fluctuations in demand that have a greater impact on commodity market fundamentals.”

But is there a place for the asset class in a multi-asset portfolio?

Kevin O’Nolan, portfolio manager at Fidelity Solutions, says multi-asset investors can benefit from an allocation to commodities.

“Commodities can provide inflation protection and diversify your sources of return within a portfolio. The oil supply/demand balance has been improving and this is boosting the wider complex.”

Mr Coombs agrees commodities can have a place in a portfolio, with agriculture and industrial metals also potentially good inflation hedges. But he points out: “You have to be very careful because of the future curves in these areas. That is why I approach commodities with extreme caution. Overall, we think global growth will be relatively subdued and below trend so it’s not a great backdrop for commodities. We don’t see it being particularly inflationary or deflationary, so there is no real compelling reason for me to consider using commodities at the moment.”

Nyree Stewart is features editor at Investment Adviser