30th September 2010
Uncertainty about the outlook for developed economies like the US and UK remain palpable, with investors still fearful of the dreaded ‘double-dip’, especially in the US.
Yet commodity prices have bounced strongly in the wake of the financial crisis and are testing recent highs. Silver for instance is now close to US$22/oz, higher than at any time since March 2008 when it touched $D22/oz. Brent crude oil was down below USD73/barrel in late August and is now up at almost USD79/barrel
Philip Poole, global head of macro and investment strategy at HSBC, says the strong performance of commodities despite the woes of developed economies is due primarily tom the continuing robust growth of emerging economies like China and India.
He adds: "It is worth remembering that neither China nor India suffered from a contraction of output during the crisis, just a moderation in pace of growth. In reality, for the most part the ‘Great Recession’ was a crisis endured by the industrialised world not by many emerging markets."
Poole believes the robust performance of emerging economies, with their per capita consumption growing rapidly off an extremely low base, means demand for hard commodities – those that are extracted through mining – and energy commodities like oil and gas will likely remain strong for the foreseeable future.
Another major factor likely to provide support for prices relates to supply side constraints. Poole points out that during the crisis period a raft of investments in the commodity sector were shelved. With the long lead times for projects in the commodities sector, the result of that investment hiatus is that there will be little new supply coming to market in the coming years.
Commodity analysts at Standard Chartered estimate that as a result of the financial crisis nearly US$200 billion worth of investment projects were suspended in iron ore, copper and coal (thermal and coking) alone. The analysts reckon this is likely to have the effect of severely limiting new supply in these areas through to the end of 2013.
Soft commodities – those that are grown- are not excluded from Poole’s general argument. Grain supply for instance has been badly disrupted by adverse weather. The fall in wheat and barley production as a result of drought in Eastern Europe is just the latest example.
‘The combination of medium term demand-side pressure against a background of a limited short-term supply response in many commodities looks set to keep commodity prices supported in my view,’ says Poole.
Investors looking for exposure to the sector can consider a range of options as in recent years commodities have become an efficient, tradable asset that engages retail, institutional and leveraged investors. These options include not only exposure to relevant listed equities but also investment in commodity-related currencies and external and local sovereign debt of countries where payment potential is geared to commodity-related tax revenue.
For the forex side, Poole says there is a choice of developed and emerging market currencies for investors to consider. For the former there is the Australian dollar, Canadian dollar and Norwegian Krone; while the basket for emerging market offers Brazilian Reais and Russian rouble.
For sovereign debt there is Russia again, alongside Nigeria and Venezuela which offer an almost pure play on the oil price.
On valuation grounds Russia remains HSBC’s favoured BRIC equity market mainly because equity stocks trading on that market are trading on attractive multiples.