Credit Suisse says the long term trend in energy and commodity prices should continue in 2006 and the recent price corrections represent a good opportunity for institutional investors to invest in commodities for the first time, or to expand exposure to the sector.
The Swiss investment bank believes positive fundamental data is likely to lead to rising oil and base metal prices over the longer term. Within the energy sector, the supply situation remains tight in the face of increasing industrial demand from emerging economies such as China.
Excess production capacity continues to be limited as OPEC is the only organization with any depth of spare production capacity. Meanwhile, oil companies, with record profits, continue to return capital to investors in the form of higher dividends and stock repurchase programs instead of investing in new capital projects such as research and exploration.
Precious metals are also likely to benefit from the growth in the emerging economies. Credit Suisse expects that demand will increase for precious metals in 2006. Prices are likely to be underpinned by rising demand for jewelry as the economic rise of Asia makes these luxury items more affordable to a broader section of population. Credit Suisse anticipates a 33% increase in demand for gold from India alone this year, the world’s largest consumer of the metal.
With regards to base metals, further growth in industrial production should have a positive impact on prices. Rising energy prices are likely to lead to production shortages of aluminum in the face of continued strong demand. Nickel is also expected to experience a leap in demand with production potentially boosted by the recent consolidation in steel prices.
Commenting on the benefits of the asset class, Terry Mellish, director of UK institutional sales and relationship management at Credit Suisse, said: Commodities can provide valuable diversification for institutional investors who can benefit from the historically low correlation that commodity returns have shown compared to the returns of stocks and bonds. It may also be a very useful inflation hedge.
Commodity prices have tended to rise with inflation while the value of financial assets typically has declined. In addition, investing in a commodity fund reduces volatility by offering a diversified exposure to different commodity sectors.
As institutional investors become more aware of these benefits, we have seen notable interest in the asset class from UK pension funds through our own commodity funds, and expect this to continue throughout 2006, Mr Mellish added.