Commodities: stick or twist or bust?
It is difficult at the best of times to judge the extent to which you should have an exposure to commodities. Prior to 2008 we played this asset class very well, buying on occasional weakness, quickly banking decent profits. Following a couple of wobbles in 2010, this asset class took off again from late August, coinciding with Ben Bernanke setting everyone up for QE2. There are reasons to be cautious in the period immediately ahead.
For example: China, a vital source of commodity demand, is trying to slow itself down; the Baltic Dry Index, a decent indicator of global economic conditions just ahead, has fallen very sharply; and the gold price looks to have rolled over and down.
Of course commodity prices could continue on upwards without much hesitation if the liquidity and confidence generated by QE2 doesn’t relent - but this is only a short term driver of prices, and increases the risks, which are already high when investing in this sector.
Our preference would be to buy on short term weakness, and waiting for this opportunity requires some patience. The long term reasons for buying commodities remain intact.
For example, the opening up of the world economy is allowing less developed nations to begin to enjoy new opportunities and higher standards of living, so more wealth is chasing limited global resources. Chinese demand for commodities has undoubtedly buoyed commodity prices for the last few years, but this cannot go on forever - however, India, with a similar population, is about 10 years behind China, and will gradually become the more significant source of demand, with other nations in its wake.
An investment in this sector will also provide some inflation protection. and the graph here highlights how the long term trend for inflation is turning up. For more inflation comment see Equity Income - rare opportunities abound.
We prefer a well diversified fund, and our undoubted favourite for years has been the JPM Natural Resources fund, which should be bought on significant weakness. A high risk fund.
(Taken from TopFunds Guide January 2011)