Investors seek shelter in commodities: DIVERSIFYING AWAY FROM EQUITIES: An unobtrusive sector has suddenly become popular as investors seek alternative havens, reports Adrienne Robert
Financial Times; Sep 29, 2001
By ADRIENNE ROBERTS
Commodity fund managers have been receiving a steady flow of investor enquiries since this month's attacks in the US plunged the markets into turmoil.
"During the 1990s, people didn't feel the need to invest in things like gold bullion or gold shares. Why would they want to diversify away from the biggest bull market that anyone had ever seen?" said one manager. "Now diversification is looking a lot more attractive."
Commodities act as a hedge because they are affected by a different set of factors from those which drive bonds and equities.
At the top of an economic cycle, shares and bonds decline because investors are worrying about future profit growth and rising interest rates. But commodity prices peak as demand runs high and inventories run low.
Even in a recession commodities can offer a hedge against economic shocks. For example, many analysts believe that oil prices will remain weak, however few of them rule out the possibility of a price spike if something something happens to disturb the supply-demand balance in the coming months.
"Tactical asset allocation is about what you think is going to happen. Strategic asset allocation is about a respect for error. I think anyone who doesn't have a tremendous respect for error at times like these is making a mistake," said Steven Strongin, head of commodity research at Goldman Sachs in New York.
"Commodities are part of the hedge to make sure that portfolios perform well over a variety of economic environments."
At times like these, defensive investors start looking to things like physical gold.
Analysts point out that bullion is the only financial asset that does not represent a liability on someone else's balance sheet.
Gold has risen 7 per cent since the attack on the US while oil and base metals have fallen. Gold has also outperformed equities, illustrating its negative correlation with most other asset classes.
World Gold Council calculations suggest that when long-term bonds decline, there is tendency for gold to go up. When equities decline, there is agreater tendency for gold to go up.
For less risk-averse investors, the easiest way to get exposure to commodity prices is buying into a unit trust fund or selecting shares in a resource company.
Gold shares seem to be attracting the most attention. UBS Warburg, for example, likes the North American gold mining shares at the moment and has recently upgraded its recommendations on both Newmont and Placer Dome to "buy".
Gold funds are looking good too. By last week Merrill Lynch's Gold & General Fund was the best performer in the UK, and by last Wednesday its offshore MST World Gold & Mining fund was up 30 per cent in the year to date.
The price of gold shares tends to be more volatile than that of gold itself, partly because there is a leverage effect.
Crudely put, with gold at
Dollars 270 a troy ounce before the US attacks, a company producing gold for a total cost of Dollars 250 an ounce made a profit margin of Dollars 20. Now with gold at Dollars 290 the company's cost of production has not changed, but the profit margin has been doubled by a7 per cent rise in the gold price.
Graham Birch, who manages Merrill Lynch's Gold & General Fund, says gold shares are most suitable for people who believe the gold price is going to rise.
A number of analysts have recently upgraded their gold forecasts. Mitsui's Andy Smith, once known by the industry as "The Arch Bear", is predicting a gold price of Dollars 340 an ounce by year-end. "UBS Warburg expects that gold will trade between Dollars 270 and Dollars 325 an ounce over the next six months, with the risks of a break-out of this range skewed towards the upside," said John Reade at UBS Warburg.
For investors who want to pick one or two shares for their own portfolio "the most important thing to look at is how sensitive a share is to changes in the gold price", said Birch.
Mines which hedge less, like Newmont or South Africa's Harmony, have greater exposure to rising prices. (The flip side is that they offer less protection against falling prices.)
For the really intrepid investor, the futures and options markets offer more direct exposure to commodity prices than equities. Some active private investors believe that this can be a highly profitable pursuit.
It is also possible to trade the GSCI Futures Price Index on the Chicago Mercantile Exchange or the CRB Price Index on the New York Board of Trade.
Still, derivatives tend to remain the preserve of institutional investors and high net worth individuals. Most private investors find that unit trust funds offer an acceptable alternative to braving the derivatives markets.
Copyright: The Financial Times Limited
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