Inflation fears fuel demand for commodities

The massive demand for commodity assets since the beginning of the year has been driven by investors' efforts to hedge against inflation according to Marius Botha, Deputy Manager of the Threadneedle Commodities Crescendo Hedge Fund.

Despite inflation figures across the world looking benign right now and central banks preoccupied with tackling deflation, commodity prices are being pushed up as early movers anticipate inflation. Retail and institutional investors have allocated significant money to commodities in a bid to hedge inflation and Botha expects these inflows to continue.

Botha comments: "The rapid inflow of money into commodities in the last few months has been significant and has pushed up prices in the futures market. As we saw in 2006 through to 2008, the relative size of real money investors have put into the commodity markets makes it self-fulfilling. A good example of this can be seen with oil. With US and European crude oil and product inventories at their highest levels in almost 20 years, oil is currently showing extremely bearish fundamentals. But despite this bearish backdrop, the price of oil has rallied from US$45 in April to a six month high of US$68 in May. This is not so much driven by the expectation of an economic recovery, but to new money seeking a macro inflation hedge. To an extent this can also be seen in the performance of commodity related equities versus the underlying commodity, where equities have outperformed the underlying commodity they represent.

"Demand from the emerging markets, especially from China and India, continues to grow. Although the economic growth rate of these countries has slowed - it is by no means over. The current global downturn has merely slowed growth and their increasing demand for commodities will certainly return. In fact, there have been a number of economic indicators that suggest ‘green shoots' are already starting to emerge in China. One of these indicators has been the loosening of restraints in its money supply by lowering bank reserve requirements and encouraging lending. This has already led to an increase in loan growth by 39% year on year. This has been directed at infrastructure and urban fixed asset investment which will improve the fundamentals for some global commodities, especially base metals which are particularly leveraged to construction and industrial production."

"Investors who want to invest in commodities now should invest in essential hard assets through actively managed long-only funds or commodity hedge funds. Anybody investing in commodity related stocks and shares themselves should make sure they understand the fundamentals of each commodity and exercise more investment discrimination if they are looking to outperform commodity indices."