LONDON Investors' love-affair with commodities has cooled in the face of the global banking crisis but fund managers and analysts say strong long-term fundamentals for oil, metals and crops are still likely to attract money.
Desperate for cash, many investors dumped commodities this week after Lehman Brothers filed for bankruptcy and insurer American International Group was rescued in an $85 billion bail-out.
But they still see commodities as a major portfolio diversifier with a convincing long-term bull story -- the finite natural resources of the world struggling to meet insatiable demand from emerging countries like China.
"On a longer term basis I'm still very comfortable with the story," said Jonathan Blake at Baring Asset Management. "The fundamental drivers on a longer-term basis remain in place."
A bull market in commodities spanning oil, metals, gold and agricultural products helped these assets outshine sagging equities and bonds for most of this year.
The S&P GSCI commodity index gained more than 40 percent in the first half of 2008, according to Reuters data, when major equity indexes were down more than 10 percent.
But commodity prices started to lose ground in August as high prices started to crimp demand, particularly for oil.
Commodity prices have suffered steep losses across the board, apart from gold, a traditional safe haven in turbulent times. Bullion saw its biggest ever one-day rise in absolute dollar terms on Wednesday as investors ran for shelter.
The Reuters-Jeffries CRB index, a global commodities benchmark, is trading at its lowest level since last October, after markets like gold, copper, wheat, corn and soybeans gave back most of the gains they made earlier this year.
"Is this a correction or the end of the bull market -- this is the key question in investors' minds," said Nicholas Brooks, head of research and investment strategy at ETF Securities.
Pension funds which have commodity investments may have had to adjust them because sharp falls in the value of stocks and bonds will have affected their asset class allocations.
British pensions funds, for example, typically allocate about 70 percent of funds to equities, about 20 percent to bonds and 10 percent to cash and alternatives such as commodities.
China has been the demand power-house for commodities, with its population of more than a billion undergoing a massive industrialization and urbanization trend that requires raw materials for construction, fuel for new cars and grains for newly adopted Western diets.
"I don't think what we're going through now changes the urbanization process in China," said Jonathan Waghorn, Co-Portfolio Manager at Investec Asset Management, referring to the sell-off in commodity markets.
But it is not clear whether the financial market crisis that has already hurt growth in the United States and Europe will ultimately hit China and other emerging markets.
Trading on Russia's two stock exchanges was halted this week after falls of more than 20 percent.
"The growth we saw in emerging economies from 2004-2007 was extraordinary -- we may not get to that level again," said Tony Dolphin, director of economics and strategy at Henderson Global Investors. "I would be a bit cautious about investing in commodities at this juncture when the short-term outlook is so uncertain and the risks seem to the downside."
China's economy may not have developed sufficiently to insulate it from the troubles of the United States and Europe.
"There is a growing realization that the world economy is coupled and that the economic slowdown seen in the developed world will become more widespread," said Richard Batty, of Standard Life Investments.
China cut interest rates on Monday for the first time since February 2002 to boost its economic vitality.
However, a slowdown in Chinese demand could "derail" the commodities story, Investec's Waghorn said, but not stop it.
With many of these raw materials, supply growth is constrained. Geo-political tensions in resource-rich areas and climate change leading to flattening crop yields are just some of the factors impacting supply long term.
But the world will still need oil, corn and soybeans.
(Additional reporting by Barani Krishnan in New York; editing by Jon Loades-Carter)