Which of these is the next gold?

Harvey Jones

• Last Updated: November 21. 2009 2:30PM UAE / November 21. 2009 10:30AM GMT

Gold has been dazzling investors this year, breaching all-time highs and trading at US$1,119 (Dh4,109) an ounce at time of writing.

But gold isn’t the only commodity that glitters. Plenty of other natural resources have enjoyed an equally sparkling year without attracting anywhere near as much attention.

Precious metals, energy, base metals and agricultural commodities have enjoyed rapid price increases since the global economy picked itself up off the floor in March.

And there are plenty of reasons to add these assets to your portfolio. Some investors seek to cash in on growing demand for natural resources from rapidly industrialising countries such as China and India. Some commodities are increasingly scarce, or difficult and expensive to extract, and this should also drive prices up in the longer run.

Another attraction of commodities is that they typically retain their value in times of inflation, which some analysts believe is set to return next year.

Commodity prices have been soaring recently. In the first six months of this year, copper rose 76 per cent, crude oil rose 57 per cent, sugar rose 49 per cent, nickel rose 48 per cent, and silver and platinum rose about 30 per cent. Stocks in many commodity companies have also shot up, particularly in the coal, steel, mining, oil and gas sectors.

So forget gold for a moment.

Should you be investing in these lesser-known commodities?

Silver

Gold is currently being outshone by silver. The price of silver rose 29 per cent in the six months to June and now stands at about $17.80 a troy ounce. During the same period, gold rose just 9 per cent.

It has been a good year for silver, says Mark Dampier, head of research at the financial advisers Hargreaves Lansdown.

“When investors are bullish on gold, they are bullish on silver as well,” he says. “The two often rise in tandem, but silver typically rises faster than gold. That has certainly been the case this year.”

Silver isn’t just a precious metal, it also has industrial uses. So there is a double reason to invest.

Nervous investors have been buying silver as a traditional store of value. But as the global economy recovers, demand from industrial users has also picked up. Silver is in a sweet spot, but it won’t last forever.

“If the economy recovers, fewer people will buy silver as a safe haven,” Mr Dampier says. “But if it falters, industrial demand will fall. You can’t have it both ways. The silver price may still strengthen further, but there are no guarantees.”

You can buy silver bullion, either as silver bars or coins, or invest in an exchange-traded fund (ETF), a low-cost investment fund traded on the stock exchange like a share. BGI iShares Silver Trust, an ETF from Barclays iShares, has risen 43 per cent in the past three months and 68 per cent over the past year. Another fund manager, ETFS Securities, also has a series of funds investing in silver.

Or you could invest in the stocks of silver mining companies, such as Pan American Silver or Silver Wheaton. But do your research carefully.

Silver remains a long way off from its all-time high of $49.95 a troy ounce way back in 1980. In historical terms, it is far cheaper than gold.

There is another reason why silver might be a good long-term hold: they aren’t making any more of it. Silver production is dropping by about 5 per cent a year and less than 1 per cent is recycled. The laws of supply and demand suggest that although the short-term price may fluctuate, any passing cloud should ultimately have a silver lining.

Natural gas

There are plenty of reasons why now doesn’t look like the ideal time to invest in natural gas.

The price has fallen more than 35 per cent this year, even though the price of a barrel of crude oil has more than doubled.

By historic measures, natural gas is now much cheaper than crude oil – and it’s likely to stay that way, says David Donora, the head of commodities at fund manager Threadneedle. 

“This gap is likely to persist and even widen until such time as gas can be used as a transport fuel substitute at a meaningful level and begin to erode demand for crude oil,” Mr Donora explains.

Mr Donora also points out that the US has abundant resources of natural gas and has developed a cheap way of extracting gas from shale. This could dramatically increase the supply of gas, forcing prices down further. 

Lauren Ellberger, investment strategist at Barclays Wealth, says gas storage levels are well above average, and even a bitterly cold winter may not force up prices. 

“I don’t expect any significant natural gas price appreciation over the next six months,” she says.

Ironically, all these factors could make investing in gas worth a punt, if you can accept the risks.

Commodity prices typically move in cycles, driven by the laws of supply and demand. Too many private investors enter at the top of the cycle, when the gains have already been made. With natural gas, you will be entering at the bottom, which leaves plenty of potential upside.

Rock-bottom gas prices could make now a good time to invest, provided you take a longer-term view.

Ian Henderson, the manager of JP Morgan Natural Resources investment fund, says low gas prices have cut off finance to exploration companies, forcing them to mothball drilling projects. This may eventually lead to a shortage and force the price up. 

There have been one or two signs of a recovery. In September, prices spiked 13 per cent in a single day.

Brave investors could invest in the shares of gas exploration and development companies such as US companies Southwest Energy and Range Resources. 

“Gas company share prices may have also priced in potential future price increases, so you aren’t necessarily picking up a bargain,” Mr Henderson says.

BG Group, formerly British Gas, could also benefit from any gas price recovery. Although the UK’s resources are dwindling, it is diversifying into countries such as Egypt, Nigeria and Trinidad.

Other factors may force up the price of gas in the longer run. It is the cleanest burning fossil fuel, and demand is growing at twice the rate of the demand for oil. 

Low energy prices may also stifle investment in nuclear and renewable energies, again, leading to a long-term gap that gas will have to plug.

But there is also a fair chance that prices remain low for a long, long time. Do you feel lucky?

Diamonds

A diamond is forever, but its price isn’t set in stone. Prices crumbled as demand plunged during the credit crunch, forcing the troubled diamond producer De Beers to slash production by more than 90 per cent in a bid to support the price and stabilise the market.

Diamonds may be eternal, but they aren’t rare. Producers keep diamond prices high by restricting supply, while individuals hold an estimated 500 million carats of gem diamonds. If cash-strapped owners started selling their diamonds in any number, the price would quickly collapse.

Mr Henderson, of JP Morgan, says the diamond market is “flat on its back”, but that could change.

“De Beers and Russian producer Alrosa have both been struggling, but as the recovery comes, wealthy people will want to buy diamonds again,” he says. “There are signs that the market has started to recover in the last two months.”

Mr Henderson says you can invest in companies such as the jewellers Tiffany’s or Harry Winston, the producer Gem Diamonds or the mining company Petra Diamonds.

But if the diamond market doesn’t recover, any losses you make could also be forever.

Agriculture

Early last year, grain prices soared. Surging oil prices and a widespread drought forced up the price of staples such as rice and bread. Major producer countries such as India and Ukraine refused to export wheat after poor harvests because they needed to feed their own people.

Agriculture is a volatile asset because it is heavily geared towards the weather cycle, says Jonathan Bell, the chief investment officer at the asset management firm Stanhope Capital. “Climate change and natural disasters can also cause sudden shortages.

“Last year it was grain, this year it is sugar, which is up 50 per cent. That is something nobody can accurately predict, although people try.

“The difficulty is that any shortages are typically short-term, and spring up suddenly, which makes it difficult for investors to benefit.”

Another problem is that you can’t invest in the commodity itself, unless you have a place to store bushels of wheat. “We play commodities by investing in the Schroder AS Commodity Fund, which invests across more than 60 different commodities.”

ETFS Securities also offers a range of agriculture ETFs.

Mr Bell says agriculture could be a good long-term investment. “As Asian countries such as China develop, they will adopt western consumption patterns and this could push up prices.”

Water is the one thing we can’t live without, which makes it the ultimate commodity. The World Bank has warned that water is likely to become increasingly scarce, particularly in the Middle East.

“You can’t buy water on the futures market, or anywhere else, although you could invest in a company such as Summit Global Management, which invests in companies that make seawater drinkable, or improve water efficiency,” Mr Bell says.

The future

Commodity prices rose 33 per cent between March and June of this year, but the rally has slowed since then, says John Greenwood, the chief economist of Invesco.

“Oil prices followed a similar pattern, rising from $34 per barrel in February to almost $75 in mid-June, then fluctuating in the $60 to $75 range. But oil is starting to pick up.”

Mr Greenwood says two factors drove the recovery.

“The initial upswing reflected aggressive purchases of raw materials and commodities early in the year by Chinese state-owned enterprises and financial speculators predicting the demise of the US dollar as a global reserve currency.”

Commodity prices are still far below their peak of last year. Whether they recover more lost ground depends on what happens to international trade and the wider global economy.

Some analysts warn private investors away from investing in commodities altogether.

Clem Chambers, the managing director of stocks and shares website Advfn.com, says you are at the mercy of dramatic price swings.

“Commodity prices go up, then go down, often for completely unexpected reasons. In the long run, it is very difficult for investors to come out on top.”

Yet commodities offer plenty of attractions. As a hard asset, they are a good hedge against inflation and currency default, especially during times of economic uncertainty. However, in times of deflation, prices could plummet.

Commodities can also help investors balance their portfolio, because price movements don’t always correlate with equities and bonds. For example, a soaring oil price is great news for oil companies, but bad news for many other industries. Gold has the biggest non-correlation of all, typically shooting up when investors are nervous and markets falling. Agriculture correlates primarily with the weather.

The biggest single factor attracting investors to commodities is the emergence of China and India as economic superpowers. They are hungry for commodities to drive industrialisation, and in the long run, this should sustain demand and prices.

Investing in a specialist sectors such as commodities is risky. Only experienced investors with large portfolios should invest, and then with only a small portion of their cash. To overcome short-term volatility, don’t invest money you are likely to need in the next five or 10 years.

To view the performance of five central commodities click here