COMMODITIES have long offered investors an attractive opportunity to diversify their portfolios, providing a potential safe haven from the uncertainty of economic events, political unrest and high inflation. The ongoing perception is that commodities are to be bought as a “hard-asset” hedge against the sinking US dollar. Expectations for gains in commodities throughout 2010 have increased on speculation that the US Federal Reserve’s stimulus programme will weaken the US currency as economic growth accelerates, boosting the attractiveness of raw materials, which are priced in US dollars. A stronger currency makes US crops more expensive for importers and saps demand for commodities as an alternative investment.

Commodities continue to be the foundation of the global economy with the population heavily dependent on metals, energy and agriculture to satisfy the most basic daily needs. As a result, commodity prices have historically rallied, outperforming both stocks and bonds since 1959. Currently, global stocks are still about $11 trillion short of the record $62.6 trillion of market capitalisation reached in October 2007, according to Bloomberg data. Over the same period, commodity assets under management rose about 80 per cent to $354 billion, and will attract a total of $60 billion in new money this year, the second most after 2009.

Notably, the recent global recession resulted in a crash in commodity prices; however, as economies rebound, the demand for commodities has also regained momentum. The main drivers behind the commodity boom have been the rapid urbanisation and industrialisation of China and India. As these economies continue to power ahead, they will require unearthing amounts of commodities in upcoming years. Metals and energy will be needed to build cities and food will be in great demand as the over two billion Chinese and Indians acquire more wealth.

The rebound in commodity prices has also been driven by the impetus of investors to hedge against currency risk as a few major currencies have been fluctuating on mixed economic data. Commodities tend to increase in value as currencies lose value, thus reducing a portfolio’s long-term volatility. However, this does not mean that your portfolio will glide calmly higher; commodity prices can fluctuate dramatically due to factors such as bad weather. Commodities by themselves are a fairly risky asset class –they either do really well or they don’t; but they are great for diversification. In the current economic climate, prudent investors will take a position in commodities as a wealth preservation strategy.

When there is significant demand for raw materials and supplies are extremely tight, commodities make headlines all over the world as prices soar. Over the past 200 years, there have been five major booms in natural resources with the most recent starting in 2001. The current bull market is not in favour of financial assets, but rather commodities. While commodity supply has historically surpassed demand, commodity prices are now peaking as demand steadily increases.

Taking a look at the performance of a few of the most popular commodities, gold has gained approximately 26 per cent year-to-date (YTD), touching a record $1,432.50 an ounce on December 7, 2010. The precious metal is heading for the 10th straight annual gain on bets that the Federal Reserve’s stimulus plan to bolster the US economy will erode the value of the US dollar. The current financial uncertainty in Europe is helping gold challenge its normal Christmas season slump, as the weakness in the euro prevents a larger sell-off in gold. In addition, China’s gold imports jumped almost fivefold in the first 10 months of the year when compared with last year as concern about rising inflation increased its appeal as a store of value. Imports gained 209 metric tons in 2009.

Similarly, crude oil also jumped to its highest level in more than two years and topped US$90 in December 2010. Copper soared to a new record of US$4.2705 per pound last week in New York and is up 28.3 per cent this year. Inventories of copper in warehouses monitored by the London Metal Exchange (LME) have declined 27 per cent this year to the lowest level since October 2009. Barclays Capital expects copper demand to outstrip supply this year by 455,000. Wheat prices have surged 45 per cent this year, after drought destroyed Russian crops and wet weather this year prevented planting of Canadian grain.

Commodities provide a viable option for investors to diversify their portfolios and as an asset-class, provide lower volatility when compared to stocks. Some believe that they will have to get “down and dirty”, rearing livestock, digging for oil or mining in search of copper or gold to “rake” solid returns. However, commodity mutual funds, Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs) give investors a broad exposure to a wide range of natural resources without the hassle of holding the physical underlying asset. Examples of top performing commodity securities include iPath Dow Jones UBS Grains Total Return Sub-Index ETN (JJG), up 28 per cent, iPath Dow Jones — AIG Copper Total Return Sub-Index ETN (JJC), up 25 per cent and SPDR Gold Trust GLD (GLD) up 28 per cent.

Despite this robust performance of commodities in 2010, the outlook remains bullish going into the new year. There are still concerns over currency stability and emerging economies, which continues to drive demand for commodities. As investors make their resolutions for 2011, they should consider including commodities as part of their portfolios as they seek to achieve their long-term investment goals.

Sutanya Chedda is Research Administrator at Stocks & Securities Ltd. She can be contacted at schedda@sslinvest.com.