LONDON (Reuters) - Tailwinds from U.S. monetary stimulus and a quest for an inflation hedge will drive commodities in 2011, and the big gains will be for those who root out the raw materials in shortest supply, a fund manager said.
Commodities drew added momentum in the final months of 2010 as U.S. quantitative easing spurred a wave of investment across financial markets and weakened the dollar, which can be bullish for dollar-denominated raw materials.
That trend is likely to continue, and even a weakened euro will do little to offset the impact of a sagging dollar as European demand for raw materials is insignificant compared with that from China and the United States.
“What’s the best thing about commodities? Bonds. If you’re a pension fund, you should not be involved in bonds because inflation is destroying the yield,” said Patrick Armstrong of London-based Armstrong Investment Managers, which oversees $220 million in assets.
Copper, which has struck a series of records, could rise by another 25 percent next year, supported by Chinese buying and shrinking stocks, he said.
Oil by contrast is as likely to trade between $80 and $100 a barrel as it is to exceed $100 as inventories remain comfortable in the first part of the year.
Chinese interest rate rises, designed to prevent the economy overheating, could strengthen the yuan, decreasing the cost of imports for the world’s second-biggest oil market and biggest copper consumer.
Armstrong dismissed that impact as negligible and saw Chinese demand, especially for copper, remaining high.
“In a big year, you’re talking about 6 percent to 10 percent moves versus the dollar (for the yuan). Commodity moves in a big year are 30 to 50 percent, so it’s (stronger yuan versus dollar) almost immaterial,” he said.
“Some of the bears are talking about interest rate rises, but demand is so high.”
PORTFOLIO DIVERSIFICATION STILL VALID
For commodities as a whole, the pursuit of a portfolio diversifier for pensions and other institutional investors, which began early this decade, will continue into the next after commodities assets under institutional management this year reached new highs.
“People are turning away from bonds and looking for things that deliver real returns,” said Armstrong.
“It’s about strategic investment, what OPEC would call speculation.”
The Organization of the Petroleum Exporting Countries has stood by a two-year-old set of output curbs even though U.S. crude this week hit a 26-month high of nearly $92 a barrel, well above top exporter Saudi Arabia’s preferred $70-$80 bracket.
Even prices of $100 would not mean OPEC should pump more oil if they resulted from speculation rather than any shortage, ministers and officials have said.
OPEC’s stance gives a spur to the market bulls to aim for $100 a barrel, but Armstrong is relatively bearish on oil. U.S. inventories are higher than a year ago, and OPEC holds several million barrels of spare capacity.
“I would not be surprised to see $100 in Q1, but I would not be surprised to see it between $80 and $100 either,” said Armstrong.
Spikes, he said, would only come from shortages.
“I don’t see how we get to that in the first six months of this year.”
His favored oil trade is to short the front month S&P GSCI basket of commodities, which is heavily weighted toward oil, and go long further along the curve.
The front of the U.S. oil curve has been locked in a stubborn contango, meaning crude for near-term delivery is cheaper than that for later delivery -- a market structure symptomatic of plentiful supply and one that encourages stock-building.
Armstrong Investment Managers prefers to take long positions in markets with the opposite structure -- backwardation -- and with tightening inventories.
“Copper is pretty much perfect from that point of view,” said Armstrong. “It’s got a lot of things working for it.”
Armstrong is also positive on gold and silver, although his allocations have fallen in the fourth quarter to 4 percent gold and 2 percent silver, from 8 percent and 4 percent respectively, as new money entered the Armstrong funds. Copper represents 3 percent.
“The reason we’re continuing to hold gold and silver is as an alternative to currencies,” Armstrong said. “Gold is a pretty reasonable alternative to the U.S. dollar and 10-year bonds.”
Editing by Jane Baird
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