September was a big month for commodities. Is there more to come?
Friendship, they say, is a rare and precious commodity. Fair enough. But then so are gold, silver, oil and industrial metals, and with prices and demand rising, they are set to become even more rare and precious. Should you be buying now?
Gold and mining companies, agriculture stocks, metals and oil have been flying lately. FTSE 100-listed miners such as Xstrata (LSE: XTA), Rio Tinto (LSE: RIO) and Antofagasta (LSE: ANTO) have driven the recent market recovery.
The S&P Goldman Sachs Commodity Index rose 8.5% in September, led by agriculture and metals, but growth has been strong across the board, with energy also performing well.
Send QE2 victorious
You can put some of this down to good old QE2, which seems to rule the markets these days. A fresh bout of money printing should see funds flow into both emerging markets and commodities, driving up prices and demand. All praise the Fed.
QE2 has also driven down the dollar, and this has also forced up commodity prices. Most commodities are priced in dollars, and when the greenback gets cheaper, the buying power of rival currencies gets stronger. As buyers have more money to spend, prices rise.
This process also works in reverse. If QE2 doesn't happen, or the dollar rebounds for some other reason, commodity prices could retreat. I don't see that happening for a while.
Now they're motoring
QE2 has also cured analysts of their deflation phobia, and got them panicking about inflation instead. The money supply in the West has tripled over the past year and that surely has to leak into the real economy at some point. This will be good news for commodity prices, which are traditionally seen as a hedge against inflation, because their prices tend to keep pace with accelerating inflation.
Plenty of one-off factors are driving commodity prices. In September, China imported 5.7 million barrels of crude oil, a monthly record and 35% more than a year ago. Oil now trades at $83.78 a barrel, up from $73.66 on 17 September. That's a rise of 13% in less than a month. A strong China could also drive up mining and metals prices.
The gold price edged up to $1,382 after Goldman Sachs predicted it could hit $1,650 in the next 12 months. Extreme weather in Russia and the American corn belt has sent grain prices soaring, while the floods in Pakistan have led to a surge in the price of cotton. Food inflation in the UK is soaring.
Blame it on Rio Tinto
So should you be filling your garden shed with gold bars, oil barrels and wheat bushels? Commodities tend to be cyclical, so I always prefer to invest on the back of weakness rather than strength.
That's why I bought Rio Tinto back on 13 May at £33.70, after it fell more than 20% on fears of a new Australian mining supertax. It was a clever move, or would have been, if I hadn't set a tight stop-loss that bounced me out five days later at £30.25. Rio Tinto now trades at £40.37. I'm not so keen to pile in at this new price, but that's a personal thing.
It's the same with gold. Goldman Sachs may be right and the price will rise higher, but I'm worried that when sentiment changes, it has a long, long way to fall. That's one for traders, rather than investors.
Increasingly precious metals
Yet the figures suggest you haven't left it too late. Despite a strong September, the S&P GSCI index was still down across 2010, with a year-to-date loss of 4%.
Some commodities have done better than others. Industrial metals have reversed all of their first half weakness, and have now grown 21% this year, against 6% for precious metals.
Agriculture "was the Q3 stud", as S&P puts it, advancing 31% for a year-to-date gain of 7%, driven by strength in wheat and cotton. But there are still plenty of opportunities out there.
Last week, Morgan Stanley said that continuing growth in emerging markets will push up commodity prices for the rest of this year and into 2011, especially metals such as copper, nickel and tin. It named Xstrata and Kazakhmys (LSE: KAZ) as its favourite London-listed miners, and suggested that gold bugs should consider African Barrick Gold (LSE: ABG).
It's only natural
My favourite fund in this sector is JPM Natural Resources, up 28% over one year and 125% over five years, broadly in line with the Commodities & Natural Resources index.
Investment trust fans (I'm one!) may prefer BlackRock Commodities Income (LSE: BRCI), but it has delivered a relatively disappointing 20% over the past year.
There are also a host of low-charging ETFs tracking any commodity index you can imagine.
Rising commodity prices will be bad news for many companies. For example, Unilever (LSE: ULVR) expects its bill for raw materials to rise for the rest of the year, squeezing profits. Many other food and consumer businesses will also suffer.
It won't be good for the UK economy either. Higher food prices and a record jump in the cost of clothes kept inflation well above target in September, and woe betide us if oil prices continue to rise.
Investing in commodities could help offset problems elsewhere in your portfolio. Even if prices remain volatile, the long-term story looks strong, as natural resources become an increasingly rare commodity.
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