Investors can shake off oil slips and metal fatigue

Fears that the Chinese dragon has lost its puff have led to a dip in prices. But commodities are still good value, says Simon Hildrey

With oil prices falling from their recent peak in the past few weeks, the feverish attention paid to commodities is cooling.

Now that Opec has promised to increase oil production by 800,000 barrels a day to more than 27 million, the price of a barrel has fallen 10 per cent from its high of $42.45 (£23.33) at the beginning of June.

Gold isn't faring much better: after climbing to $431 an ounce on 1 April, it is now hovering around the $395 mark.

One of the main driving forces behind oil rising above $40 a barrel has been China. The country has been an economic powerhouse among emerging markets, using, for example, some 40 per cent of the world's supply of cement last year. It was also one of the main drivers behind the oil price rising above $40 a barrel. But concern over the country's prospects has dampened investors' enthusiasm. Some economists have predicted Chinese economic growth could slow by 2 per cent over the next year.

Nevertheless, many fund managers and advisers still believe that, over the medium term, commodity prices will rise. Tim Price, senior investment manager at Ansbacher, argues that investors with a balanced portfolio should have 10 to 15 per cent in mining stocks such as Anglo American, BHP Billiton and Rio Tinto. This is designed as a defensive measure against a possible fall on Wall Street.

"We are concerned about the overvaluation of the US stock market," says Mr Price. "If there is a correction in the US, investors will head for real assets such as precious metals and gold. We believe the stock market has underpriced future oil prices and thus revenue for companies in this sector."

Hugh Hendry, manager of the Odey Continental European fund, believes commodities offer good value. "There are only five asset classes people can invest in: property, equities, bonds, collectables and commodities," he says. "All asset prices have been pushed to high valuations except commodities. Gold is $395 an ounce compared to $850 in 1980, and wheat is $350 against $750 in 1973. Oil is the same price it was in 1980. Commodities will do well because the supply is finite and demand is rising."

Rus Newton, director of hedge fund manager Global Advisors, also believes demand and supply factors point to price rises. "In 2003, China imported 2.1 million barrels a day; it will be 2.9 million in 2004 and 3.4 million next year.

"Supply is constrained, however. Russia is already producing half the 1.3 million barrels a day increase in non-Opec production, Venezuela will struggle to raise production after its strikes, while Iraq has to be written off for the moment. There are also doubts about whether Saudi Arabia can fulfil its pledge to increase production by 10 million barrels a day."

Graham French, manager of the M&G Global Basics fund, believes metal prices will also rise over the medium term. "Demand from China may slip if the economy slows, but the situation remains very positive," he says. "New capacity is being developed, notably in copper and iron ore, but this will need to be on a large scale if demand is to be met."

The longer-term story for commodities may sound compelling but it is a notoriously volatile sector. People who want to reduce the risk could buy into a fund investing in different companies and commodities. Among these are First State Global Resources, M&G Global Basics and Merrill Lynch Gold & General.