Raw materials whet investors' appetites in unsavoury times

PUBLISHED : Sunday, 09 March, 2008, 12:00am
UPDATED : Sunday, 09 March, 2008, 12:00am

The local stock market has been bogged down in negative news, but runaway prices of raw materials have sent stocks in the commodities sector rocketing.

And investors seem to have caught on.

The benchmark Hang Seng Index has fallen 4.07 per cent since the beginning of last month, while the Hang Seng Materials Index, a measure of 14 commodities-related companies, has climbed 11.01 per cent.

Prices of commodities have surged, and oil, gold and select base metals have all recently touched records because they have benefited from a demand increase and also offer an attractive hedge against rising inflation and US economic woes. While price rises will cost companies that use raw materials, they will reward those that extract, distribute and sell them.

'In the near term, the commodities sector is likely to be the safe play because we are looking at commodity prices rising,' says Patrick Yiu Ho-yin, associate director at Cash Asset Management. That would stimulate commodity shares.

Jiangxi Copper, the mainland's No1 copper producer, has surged 25.07 per cent since February 1, tracking strong gains in the price of copper. Futures for the raw material hit a record in London on Thursday at US$8,820 a tonne.

Aluminium Corp of China (Chinalco), the world's No3 alumina producer, has jumped 31.99 per cent since February 1 as the price of May-delivery aluminium futures in Shanghai reached the highest since June 2006.

Record oil prices have also propped up blue-chip energy companies like CNOOC, the mainland's largest offshore oil producer, which has advanced 11.31 per cent since February.

Commodity stocks like CNOOC and PetroChina, the mainland's largest oil producer, may also have been supported by bargain hunting since they were oversold in January because they were considered among the most exposed to a global economic slowdown and demand drop, Mr Yiu says.

But demand for most raw materials has picked up, supporting a bull market for commodities prices, says Christopher Wyke, a commodities product manager at Schroders. 'There's a constraint on new supply and none of that would matter if there wasn't a sharp increase in demand, and there clearly is,' he says. 'We think the outlook for commodities remains very strong.'

Investors can get access to the commodities market through different channels. They can directly purchase futures contracts for raw materials ranging from palladium to rough rice at bourses like the Chicago Board of Trade or Tokyo Commodity Exchange.

But because of the intricacies involved in futures trading, it is usually a realm left to seasoned investors.

'For a lot of people, volatility in commodities understandably really worries them,' Mr Wyke says. 'I know if I mention the two words 'commodities' and 'futures' to my mother, she will hide her purse away.'

In that case, investors can turn to commodities-based products developed by private wealth managers or institutional fund managers.

Timothy Lo, CIC Investor Services' managing director, has developed a soft commodities-based product for high net-worth individuals and institutional investors that allows them to bet on a range of soft commodities such as wheat, milk and bacon. The investor can make a return of as much as 80 per cent, but losses are capped at just 5 per cent of the original investment, he says.

'With the increasing price of commodities, especially soft commodities, clients would like to invest in those commodity products,' Mr Lo says. 'I see more and more interest from investors looking for guaranteed downside protection.'

But not all investors have the appetite or the means to make those types of investments.

In that case, they could put their money into stocks that stand the most to gain from price changes in raw materials.

While most investors and analysts see upside potential for commodities themselves, some say that price gains may not translate in the long run to the companies that handle them.

Chris Tang, chief investment officer at Marco Polo Pure Asset Management, says that betting on companies in the commodity sector is not a sure thing because they are facing rising costs that could sap some of the windfall from increased prices of the raw materials that they handle.

'I don't think it's a safe haven at all. There's more risk to come,' she says.

A measurement of the costs for Chinese producers jumped in January at the fastest in more than three years.

The mainland's producer-price inflation surged to 6.1 per cent from a 5.4 per cent gain in December. February's data is scheduled for release this week.

While Cash Asset Management's Mr Yiu has a long-term positive view on companies handling oil and base metals, he advises caution when buying into these companies in the near term because raw materials may have gotten ahead of themselves.

'I think it is better to wait for more pullback for the entry price,' he says. 'The overall trend keeps rising, but in the short run, I don't think it will rise and rise, and there may be some consolidation.'