What does the year have in store for commodities?

Published by Cherry Reynard on 11 January 2011.
Last updated on 19 January 2011

gold bars

Phenomenal gains have been recorded in 2010 for certain commodities, notably coffee, cotton and some precious metals, suggesting the much-heralded multi-year super-cycle remains intact.

But these gains have been supported by considerable economic momentum and their sensitivity to economic news may yet prove a problem as growth slows in 2011.

Almost all commodities saw double-digit returns in 2010. Particular areas of strength included precious metals, seen as a bulwark to weakened currencies, and anything in demand in developing markets, including China, such as coal. Agricultural commodities showed strong gains as adverse weather hit supply.

However, with a few exceptions, commodities remain at 2007 levels or below. In spite of strong growth in 2010, corn futures peaked at more than $700 in 2008 but now trade around $530. Copper only hit the highs it achieved in 2008 in November 2010.
Many key determinants of commodities' performance in 2011 are likely to remain the same - the strength of China and the outlook for inflation. Ian Henderson, manager of the JPM Natural Resources fund, says: "The commodities story is still very much one of China, and that is unlikely to change a great deal. The emerging world will continue to grow."
While China's growth is not disputed, the rate of growth is open to debate. But even if China slows, it is unlikely to stall. The same is true of the other large emerging markets. Henderson says: "Although there are concerns about the world financial system, emerging markets are unlikely to go into recession and now consume more than 55% of the world's commodities."

Developed markets are a different matter, with economic recovery precarious. It is impossible to ignore developed market demand altogether, but certain commodities are more affected by US demand, in particular, than others.

US consumers are an important determinant of the oil price, for example, whereas demand for steel in developing nations has a major influence on price.

A rise in inflation will also drive commodities upwards. They are traditionally seen as offering protection against inflation and there are signs of inflationary pressures building in the global financial system, particularly in developing markets but also in the UK.
While the trend in commodities appears to be largely one way, investors need to be prepared for significant volatility. Commodities attract speculative money, which can create extreme movements.

Richard Robinson, a European investment manager at Ashburton, says some speculation can be healthy: "It is healthy if you get speculators holding up prices because it means you have projects being passed.

"However, volatility needs to be controlled. The oil price has been more stable over the past two years, but other commodities have been more spiky."


Agricultural commodities saw strong gains in 2010. Cotton was up 66.81% on the previous year, corn up 41.16% and coffee up 54%.
Gert van der Geer, manager of Pictet Agriculture fund, says there are still constraints on supply: "Many agricultural commodities have stabilised at a high level and are now starting to rise again. This has been accelerated by some borders closing for international trade and some problems with the weather.

"Certain soft commodities still have very tight inventories. As soon as people start to worry, volatility creeps into prices."
Agricultural commodities also have a number of long-term drivers on the demand side. Van der Geer says general global population growth - currently running at around 1% per year - is helping demand, as is a change in dietary patterns, notably in Asia, as increased wealth drives the adoption of a more Westernised diet higher in meat and other protein.
"As people join the middle class, they begin to eat things from outside their region. Also, meat requires a lot of grain as an input," says van der Geer. As such, China, which has traditionally been a net exporter of agricultural commodities, is slowly becoming an importer.
The risks for agricultural commodities are less related to GDP growth than they are for other commodities. Pictet points out that during recessions, food prices have not tended to fall significantly. He is more concerned about governments erecting trade barriers, which could lead to a build up of agricultural stocks in certain areas and a lack of supply in others, distorting the overall price.

Temperamental weather conditions and water availability may also affect the agricultural market.

Henderson generally avoids the agricultural commodities market for this reason: its dependence on things ultimately outside his control.


Precious metals have seen the most significant gains in 2010, as investors have used them as a store of value in the face of weakness in the major currencies.
Although gold has been the most widely discussed, it is only up 18% over the year to 1 December. In comparison, palladium, which is used in catalytic converters, is up 163% over the same period. Even silver, which is often ignored by investors, is up 47%.
Henderson believes precious metals have further to run, and his fund is invested in gold, silver, palladium and platinum companies. He says: "We aren't outright gold bulls, but we think there is still plenty of demand, particularly in a zero interest rate environment."

And talk of 'competitive devaluation' between the major economies and the resumption of quantitative easing in the US continues to usher people to the safe haven of gold. However, Stephen Barber, head of research at stockbroker Selftrade, urges caution: "Everyone knows gold is going up and investors have to be careful of something that has no real utility."
To illustrate just how far the gold price has soared, a lump of gold the size of a pack of butter now costs the same as the average UK house.

China is the key determinant of the coal price. Ashburton's Robinson says: "China went into the previous cold snap with reserves to last two to three months. This time, it is closer to 14 days. This could produce a price spike in coal. The same is true for natural gas and fertiliser, where China has low reserves."

He is also bullish on oil, which lagged behind many other commodities in 2010. He believes non-OECD countries will continue to support demand at the same time as the productivity of individual wells falls. For instance, BP's problems in the Gulf of Mexico have held back projects, which has, of course, constrained supply.

It is just as difficult to find bears on base metals. The sector has been given a boost by news that providers are to launch physically backed ETFs in base metals, especially copper and aluminium. These launches have been credited with pushing up prices as the market anticipates a tightening in supply as stocks are diverted into these funds.

There are fundamental reasons to expect strength in this area, according to Bradley George, Investec's head of commodities and resources. He says: "In the base metals space, the copper supply out of Chile has been disrupted by strike action at some of the big mines and safety concerns after the recent mine disaster at the San Jose mine, near Copiapo. Supply is not improving, yet demand is high in China."

If anything, the biggest worry about commodities is that everyone is positive about them, which goes hand-in-hand with a belief in the growth of emerging markets.

But the shadow of weakening developed market demand lurks in the background. Investors are advised not to bet against the sector, but, as always, they need to be prepared for volatility.

How to take a punt on commodities

There are two main ways to invest in commodities: invest in the commodity itself or in a company that mines, distributes or services it. With the direct route, the main way to invest is via exchange traded funds or commodities (ETFs or ETCs).

Five-minute guide to exchange traded funds
There are physical ETFs and derivative-based ETFs. Non-physical ETFs will generally operate a rolling futures strategy, which means they never buy at the spot price and can have a higher tracking error than physical ETFs. But they avoid storage costs so can be cheaper to run.
As commodity prices can be extremely volatile, spreadbetting on commodities is a popular way to take bets on the rise or fall of commodity prices.
Spreadbetting groups allow bets on most major commodity markets. They also offer controlled risk features. This means investors can bet on a fall in the price of gold, for example, but cap their losses at, say, 10%.
Commodity markets have distinct trading characters. Agricultural commodities, for example, will have quiet and busy seasons and will be affected by weather conditions. Investors contemplating commodity spreadbetting should familiarise themselves with these trading patterns before entering the market.

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