Time it right and strike it rich
Alison Eadie explores commodity funds
Saturday 02 November 1996
The answer, according to Mark Lawson-Statham, who manages Fleming Natural Resources investment trust and Save & Prosper's Energy Industries unit trust, is twofold. Firstly by buying equities investors are tapping into the process and not just the commodity price.
"We are looking for well-managed companies that can keep volumes rising and costs under control. If volumes double or treble each year, the commodity price can halve." He points out that the correlation between share and commodity prices is anyway limited, except in the case of gold.
The second argument in favour is that, although commodity prices are notoriously cyclical, cyclicality is now imposed on an upward sloping line due to rising demand from developing nations. Demand for commodities traditionally falls when recession hits the developed world, but it rose during the last recession in OECD countries, due to the healthy appetite of the fast-growing economies of China, India and elsewhere.With populations and living standards rising fast in Asia, massive growth in demand for oil and other natural resources is expected.
The counter-argument centres on the state of commodity prices, which have given little scope for long-term growth whatever the underlying demand.
Brian O'Neill, whose responsibilities include Gartmore's Gold and International Resources unit trust, says: "We look on commodities as a cyclical phenomenon and have only recommended our fund seriously to investors once in the last 10 years."
That was in 1987 when gold was soaring. He points out that the index of commodity prices compiled by the Commodities Research Bureau stood at 218 in 1973 and at 245 in mid-October, a rise of 12 per cent in 23 years.
In the short term timing is also crucial. Mercury launched its World Mining investment trust in December 1993 in the expectation that economic recovery among developed nations would fuel demand for metals and minerals. Destocking and other difficulties like the Sumitomo copper scandal have, however, kept prices subdued. The trust's asset value at the end of September was up 16.6 per cent since inception, substantially underperforming the UK stock market. The trust's shares are still trading below launch price.
Everyone agrees commodity prices are impossibly hard to predict. The recent bounce in the oil price was not expected, but it has worked wonders for energy funds. If the experts cannot forecast with accuracy, what hope for the lay investor?
David Hutchins, manager of M&G's Commodity and General and Gold and General unit trusts, says the sector has been much maligned because private investors have piled in at the top of the cycle and not necessarily picked quality vehicles.
He argues there is a case for a broadly based commodity fund in a diversified portfolio, but accepts it has to be monitored carefully. It cannot be bought and locked away like a low risk UK equity income or tracker fund.
Despite the roller-coaster image of natural resources companies, Mr Hutchins points out that RTZ has never cut its dividend. The way to manage risk, he suggests, is to invest in a collective vehicle with a mix of blue chip and speculative or even unquoted stocks.
The performance of commodity funds over the years varies not just with economic cycles, but according to the manager. Micropal shows that over the past five years to the beginning of October the best performing unit trust was Mercury Gold and General, up 313.8 per cent, and the worst Allied Dunbar Metals, Minerals and Commodities, up 42.2 per cent. In the same period the gold price rose 20 per cent and the oil price 21 per cent.
Since launch in 1976 to half-year results in August, M&G's Commodity and General Fund grew by an average annual compound rate of 11.6 per cent, or 13.8 per cent, with net income reinvested, compared with inflation at an average annual 7.1 per cent.
The best way to secure long-term gains, suggests Mr Hutchins, is via a regular savings plan which ensures that fewer units are bought at times of boom and more at times of bust.
Single commodity funds are much more risky than broadly based ones, and gold dances to a different tune from the rest. Its use as a safe haven in times of war has diminished with the ending of foreign exchange controls and the rise of financial futures.
Although there is a demand for jewellery, especially from Asia, gold is not subject to the same supply and demand fundamentals as commodities with an industrial use. If it is difficult to get commodity prices right, experts agree it is impossible to forecast gold accurately.
That said, several fund managers believe now is a good time to look at commodity funds. The opening up of hitherto closed parts of the world, including countries in the former USSR, means there are more accessible and plentiful reserves. Exploratory risk has been swapped for political risk, which is more quantifiable from a portfolio viewpoint, says Mr Lawson- Statham.
Metal stockpiles are getting low, the world's big economies are growing and the renewed risk of trouble in the Middle East could trigger a sudden leap in prices. Stock market sentiment is still bearish and both Mercury's and Fleming's investment trusts are trading at substantial discounts to net asset value. But the outlook is improving.
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