Published May 27, 2009

Commodities turning from dross to gold

Analysts warm to asset class as prices continue to rise steadily across the board

By OH BOON PING

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(SINGAPORE) Commodity markets seem to have turned the corner, with market indices climbing more than 16 per cent from their troughs in the first five months of the year.

Yesterday, the S&P GSCI commodity index traded at around 412 points - up 34 per cent from the low of 306.774 points seen on Feb 18, while the Commodity Research Bureau (CRB) index hovered at 356 points last Friday - up from its year-to-date trough of 305.59 points on March 18.

In the first quarter, tonnage gold demand jumped a strong 38 per cent to 1,016 tonnes, representing a 36 per cent rise to US$29.7 billion in value terms.

The sharp rebound in prices came as fears of a prolonged recession eased, while investors generally poured their monies back into equity markets.

Citigroup analysts told BT that the rise in commodity prices resulted from a combination of cyclical and structural factors.

On the cyclical front, the significant amount of fiscal stimuli injected into the global economy has soothed the nerves of jittery investors.

'The rising commodity prices reflect a reversal in expectations to a more sanguine one that has built in an improvement and stabilisation in global growth moving into 2010,' said Norman Villamin of Citi Wealth Management.

On the structural front, commodities have broadly benefited from an apparent strategy by countries such as China to diversify their reserves base by building commodity inventories. Specifically, China recently announced an increase in gold holdings.

As the signs of recovery emerge, market watchers have also grown bullish towards commodities as an asset class.

At an investment seminar yesterday, John Tilney of UK-based Armajaro Commodities Fund said that the asset class is now an excellent investment tool, as there are signs that recovery may come as early as the third quarter of this year.

The driving force in this case is China, which will restock its inventories, while US commodities demand may recover at around the same time.

Mr Tilney said: 'So these will include copper, oil, platinum, soybean, iron ore and nickel.'

Already, the price of copper - a leading indicator for economic activity - has risen some 28 per cent in April, partly driven by demand from China. Early this week, copper futures also rose in Shanghai after London prices gained on a weaker dollar, which boosted the appeal of alternative investments.

In the longer term, others pointed out, commodity prices will see a rebound as the factors that drove them to pre-recession spikes are still intact.

In a report, Harold Sirkin and James Hermeling of Boston Consulting pointed out that rapid growth of the middle class in emerging markets means that spending on cellphones, consumer electronics and automobiles will continue to be strong.

'Prior to the downturn, purchases of tractors by India's 306 million farmers were increasing at 20 per cent per year. Such purchases push up demand for steel, rubber, fuel, seed and fertiliser,' they said.

Plus, rural-urban migration will prompt further investment in housing, roads, railways and other infrastructure projects.

Merrill Lynch estimated last year that the developing economies would invest some US$2.25 trillion annually over the next three years to meet their infrastructure needs.

While the recession may slow investment in some countries, China has responded to the slowdown by increasing its planned infrastructure spending.

The East Asian giant lacks the raw materials it needs to produce steel, and this has turned it into the world's largest importer of iron ore. It has been accounting for 40 per cent or more of the international iron-ore trade in recent years. For these reasons, funds like Armajaro and Schroders believe there is value in gaining exposure to the asset class now.

Indeed, Schroders points out that the current expansionary policy being undertaken by central banks and governments around the world may well lead to an inflationary environment which will have a positive effect on commodity markets.

Furthermore, the key fundamental components of increasing long-term demand and insufficient supply that have been driving commodity prices higher since 2001 remain firmly in place.

In the short term, however, Citi's Mr Villamin feels that 'the opportunity in commodities will be more compelling as clearer evidence emerges on the sustainability of global economic recovery closer to the end of this year'.

Meanwhile, the World Gold Council says that jewellery demand and industrial demand for gold are likely to struggle in the current weak environment, but 'investment demand should remain well underpinned'.

'Although we have significant doubts as to the sustainability of recent signs of 'green shoots', if further signs of economic recovery do emerge, inflation concerns would probably intensify - which is also gold-supportive,' the council added.