Are the good times over for commodities market?

A super-cycle was predicted, so why are commodity prices off the boil, asks James Daley

hat has happened to the so-called commodities super-cycle? Six months ago, commodity experts claimed the world had entered a 15- to 20-year bull market. By May this year, the gold price had more than doubled in five years, while the price of oil and copper had risen more than fourfold over the same period. From wheat to nickel to coffee, almost all commodities at least doubled in value over five years, to this spring.

The good times were supposed to continue. And yet, suddenly, commodity prices have come off the boil, as fears of a slowdown in the US economy have given investors the jitters. The Reuters/Jeffries CRB commodity price index is now down almost 20 per cent since May, despite continued demand from Asia, supposedly the underpinning for the super-cycle.

Ian Henderson, manager of JP Morgan's Natural Resources fund, says that the past few months have been a blip. "A lot of very fast money enhanced the commodities market in 2005," he says. "My view is that [short-term movements in prices] are the wrong thing to focus on - the focus should be on what's going on in China."

Although speculating investors have helped to boost commodity prices over the past 18 months, most fund managers and analysts agree that it is the rapid growth in developing countries such as China and India that is behind the recent bull-run.

Henderson points out that the International Monetary Fund has just increased China's growth forecast to 10 per cent for both this year and next year - almost four times the rate at which the UK economy is growing. "The super-cycle argument remains as true today as it was a year ago," says Graham Birch, who heads up Blackrock Investment Management's natural-resources team and manages the Merrill Lynch Gold & General fund.

"The drivers behind it are still the industrialisation and urbanisation of big developing economies, such as China and India. With these countries growing at 8 or 9 per cent a year, they're consuming more of the world's resources.

"We've seen weakness in the market recently because the US economy has slowed down a bit. But you don't expect markets to go in straight lines. This looks like a soft patch in what is a relatively strong market."

Mark Mathias, of Dawnay Day Quantum, which runs specialist commodity investments, is convinced that the recent fall in prices has created a fantastic buying opportunity, though he dismisses the notion of a super-cycle. "The super-cycle suggests we're in a bigger cycle than normal, but commodity cycles are all like this," he says. "The last commodities bear market lasted 20 years, so it's natural that the bull market might go on just as long."

Even so, for most investors, it's sensible to allocate just a small amount of your portfolio to the sector. Commodities are a good way to diversify, as they tend to have a low correlation with other asset classes. While stock markets plummeted in 2001-2, for example, commodities made strong annual gains.

Dan Kemp, head of fund research at Williams de Broë, warns that investors shouldn't get carried away because of recent strong returns: "The enthusiasm we've seen for commodities has very little to do with diversification benefits, and everything to do with the fact their prices have been going through the roof."

Graham Tuckwell, chairman of ETF Securities, says that non-specialist investors should probably begin by allocating 3 to 5 per cent of their portfolio to commodities.

Four ways to invest

* Most private investors get exposure to commodity markets through funds such as Merrill Lynch Gold & General, JP Morgan Natural Resources, or Investec Global Energy, all of which invest in commodity-related stocks such as miners or exploration companies, and are run by specialist managers. See www.trustnet.com.

* ETF Securities launched a range of Exchange Traded Funds (ETFs) last month, which track either baskets of, or individual, commodities. These can be traded like normal shares, and track the price movements of their target. There are 19 individual commodity ETFs, tracking everything from oil to soybeans to cattle. See www.etfsecurities.com.

* Some firms offer capital-protected products. For example, Dawnay Day Quantum launched two such products this week, which qualify for inclusion in an individual savings account and guarantee to return a minimum of 90 per cent of investors' capital. See www.dawnaydayquantum.com.

* You can invest directly in the shares of commodity-related companies, or in the commodities themselves, via derivatives markets, but investing directly is more risky than using a fund manager.