Commodities moving into the mainstream

Long regarded as risky alternatives, commodities are moving into the mainstream as ever more investors buy into the asset class and bouts of selling are viewed as consolidation in an enduring bull trend.
Since around 2002, commodities have been gaining popularity as alternatives to equities and bonds and now account for record investment of around $14 billion by US mutual funds alone, analysts say.
"What used to be alternative assets are now much more in focus ... and commodities are moving to the top of that list based on very strong performance," said Kevin Norrish of Barclays Capital.
Barclays Capital says investment flows are continuing to grow and estimates new money entering commodities-linked mutual funds so far this year has totalled $4.48 billion, compared with $4.26 billion for the same period a year ago.
Increasingly, commodities are viewed as vital to balancing an investment portfolio and analysts say the supposedly negative aspects of commodities, such as their volatility, can be turned into positives.
"Strategically, having some exposure to commodities can go far in terms of reducing risk and increasing the overall returns of a financial asset dominated portfolio," said Arun Assumall, executive director and head of European commodity investor sales at Goldman Sachs.
"Commodities can also act as a hedge against rising inflation," he added. "Tactically, the outlook for the asset class continues to be positive."
Among commodities, oil is crucial because it typically performs strongly when many other assets are under pressure from the inflationary impact of high fuel prices.
Oil prices hit a peak of $70.85 a barrel for US light sweet crude at the end of August and have since fallen back by around $10.
Many analysts predict oil prices will stay high over the long term, though there is evidence that the recent price retreat has encouraged a shift towards other commodities.
Sugar futures this month hit their highest level for nearly 10 years on expectations sugar will be diverted for use in the biofuel ethanol.
Investment in gold, which like oil is traditionally used to protect against inflation, hit record levels last week and copper has notched up successive all-time price highs as funds have poured money into the market.
"Commodities are a more popular alternative and a better recognised alternative than a couple of years ago," said Bob Greer of Pacific Investment Management Company (PIMCO). But, he stressed commodities were a very small part of overall investment.
While the number of investors is growing, investors typically only allocate between three and five percent of an investment portfolio to commodities.
"The number of investors in this market has increased significantly. The number of potential investors considering a three to five percent allocation to the asset class is also greater compared with three years ago," Assumall said.
Reliable data is hard to come by, especially as more financial instruments are created to cater for increasingly sophisticated commodities investors.
Investment by the US mutual funds, operated by companies who invest in a group of assets, are viewed as the best gauge of commodity flows and is the measure Barclays Capital has used in compiling its estimates.
It said commodity-related assets under management had risen from less than $500 million at the start of 2003 to almost $14 billion.
That pales by comparison with the total mutual funds investment of $2 trillion.
The mutual funds, dominated by PIMCO, whose CommodityRealReturn Strategy Fund has $11.6 billion in assets, use indexes to gain commodity exposure.
The benchmark is Goldman Sachs Commodities Index, which delivered a 17 percent return for the full year in 2004 and for the year to date has delivered a roughly 30 percent return.
The Dow Jones-AIG, which is less energy dominant than the GSCI, has gained around 20 percent in 2005. That compares with gains of less than one percent for the Standard & Poor's 500 Index.