Lock in the gains from 2003
Diversifying by investing in commodities
Andrew Robinson, Sunday Star Times
The holiest of grails for investors and indeed for fund managers is for their portfolios to generate more return for less risk. How can this be achieved? Certainly not by going into riskier and riskier asset classes or funds. A spin of the roulette wheel that comes up trumps would not score highly in the risk-return stakes, or promote a good night's sleep. But how does an investor take less risk and raise returns?
It can become a major problem when investing in the dominant asset classes like shares and bonds, where returns are so highly correlated with each other that when one falls in value, others often do the same. So, are there any alternatives to the dominant asset classes? The answer is yes, and soon New Zealanders will get a way of investing easily in them.
One area in which investors could consider placing money to diversify their portfolio which does not simply mimic the return on shares is commodities. Commodities markets are generally not correlated to the financial markets and also uniquely among asset classes, one commodity is not necessarily correlated to another. Commodities are raw materials of a wide variety of areas. Examples are precious metals: gold, platinum, sliver; industrials: cotton, copper; and softs: cocoa, coffee, sugar, orange juice.
The commodities market consists of the trading of forward contracts or futures contracts. (Forward contracts are contractual agreements to buy/sell any commodity between two parties. Futures contracts are market agreements to buy/sell commodities between two entities over a recognised commodities exchange.) Commodity prices have generally been in a very long-term bear market for the last 20 years.
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The last real bull market in commodities occurred during the 1970's stagflation time period, when inflation and economic stagnation went hand in hand. That has left many of the 17 commodities in the Commodities Research Bureau Index trading at their all-time lows. This may therefore indicate a strong buy signal for investors to take the plunge into this area. Aside from the price cycle, there are a number of drivers and current conditions that point towards the very favourable future environment for the commodities market:
Demand in Asia.
The 1997 depression in Asia led to very weak demand for commodities; however, as Asia 's economies rise back, there will naturally be a strong rise in demand for all types of commodities as the region grows. There is also a strong correlation between the performance of emerging markets and the performance of commodities.
Demand from China.
Another driver for commodities is China . China is one of the few countries in the world today with a steady, long-term growth rate. Many analysts conclude a basket of commodities is the safest way to play the emergence of China as the world's dominant economic power.
US dollar depreciation.
With the US dollar currently depreciating the question is what will it depreciate against and where will investors go from here. Most likely, investors will go to a hard currency, such as gold, and a basket of commodities. This would mean commodity price increases as the US dollar value decreases.
Deflation or inflation.
Commodity prices in the coming years will be influenced by the forces of deflation and inflation. If inflationary forces dominate, commodity prices will tend to increase. The current situation is somewhat like the beginning of the stagflation of the 1970's - with inflation in some areas and deflation in other areas. In particular, it appears as if inflation is appearing now in areas involving resources and this means rising commodity prices.
Geopolitical events.
Recent geopolitical events, resulting in unstable markets and potentially adverse commodity distribution (such as in oil from the oil producing countries) are causing commodity prices to rise.
My pick is that commodities are on the verge of making a significant comeback. But how do you buy into commodities? A funds management company in New Zealand is planning to launch a unique capital guaranteed commodities fund. Currently there's only the actively managed HCM Global fund run by Auckland-based Robert Holroyd.
The Liontamer fund would have exposure to a range of metals and oil with the investors' money being 100% capital protected at maturity. And the group? It's being coy because no investment statement has yet been posted, but the capital protection element of the product gives it away. The group is Liontamer, which only entered the market at the stat of the year, but it will be a welcome addition to investors looking to get more out of their portfolio for less.
Andrew Robinson is an investment strategist working for Auckland-based Montage Financial Services Ltd. The Montage group of companies can be viewed on their website www.mont.co.nz or contacted on (09) 373-0700.
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