Christian Nolting, regional head of portfolio management and lead strategist for Asia-Pacific at Deutsche Bank Private Wealth Management, suggests that investors pay closer attention to commodities. Nolting is responsible for leading a team that advises the bank's clients on investment strategy, asset allocation and discretionary portfolio construction. His role involves monitoring portfolio managers on their investment strategies, performance and risk management. He shares his views on the asset class with AsianInvestor.
Commodities appear to be back on the radar screens of investors. What do you think of this asset class?
Nolting: While the 1980s and the 1990s witnessed above-average returns on the equity and bond markets, the 2000s until 2008 were clearly the decade for the forgotten asset class. Commodities have experienced a renaissance, with several driving forces at work. The strong demand for commodities from the developing countries, as well as from emerging countries especially from China, has pulled prices significantly higher. At the same time, supply was limited by nature and bottlenecks in the production appeared due to negligence of investments.
Financial investors have also rediscovered the forgotten asset class. Investments in commodities not only offer the possibility of expected price increases but also reduce the risk in a portfolio since commodity returns have historically shown to have either a very low or a negative correlation with the traditional asset classes of equities and bonds, although the correlation between asset classes increased in 2008. This diversification effect can be amplified further by investments in different commodities since the price of each commodity reacts differently to driving economic forces at work and commodity returns appear to display a low correlation to each other.
Against the background of the financial turmoil in 2008, commodity prices have corrected sharply. One of the biggest corrections has been observed in the oil price. After reaching a record high in July 2008 at $147, the price of the black gold dropped to $32, a fall of almost 80% within just 5 months. On a broader basis, the CRB Commodity Index, one of the most recognized Index to track commodity prices, has also shown a significant loss of 58% after reaching a record high in July 2008 as well. The main reasons for that sharp correction were global recession trends, a stronger US dollar and rising risk aversion among financial investors. As everyone was discussing the sharp fall in equities, commodities slumped even more. Considering the recent strong equity rally, some people start to look at equities again. It might also make sense to rethink of commodities, since reaching the bottom late in 2008, so far most commodities could recover from these multi-year lows.
Which particular commodities are you most bullish over?
Given our base case forecast that the global recession will likely extend through 2009, a broad-based, sustainable rally in economically sensitive commodities such as energy and industrial metals is unlikely. In addition, deflation and demand destruction will continue to place downward pressure on prices in the near term. We continue to monitor traditional indicators such as the Baltic Freight Index, leading indicators and Chinese demand to signal a rebound in commodities. Given the significant declines from many of their peaks, much of the economic slowdown has likely been priced in. Supply reductions such as Opec cuts and the expectation of a weaker US dollar are supportive. Selectivity remains critical. Currently, we prefer less cyclical commodities such as gold and agricultural commodities.
In the short-term, negative real interest rates, flight to quality, investment demand such as ETF demand, the potential for geopolitical conflicts and financial turmoil are supportive of higher precious metals prices. In the long-term, expected US dollar weakness, increased commercial demand and rising inflation from aggressive monetary and fiscal policy should support higher gold prices. Our 12-month forecast is $1,100.
Why are you so positive about gold?
Gold also acts as effective hedge against deflation, which we believe will be the most likely scenario during the course of 2009, and will usually outperform other asset classes in this type of environment.
Gold can also act as a hedge against inflation especially if the source of that inflation is loose monetary policy as many governments spend vast quantities of money, and potentially start the printing presses to produce more currency to fight deflation. However, in our main scenario the inflation outlook is moderate despite expansionary policies. Inflation rates are negative at first, with strong basis effects, especially oil price basis effects in summer 2009. Core inflation rates, which have been relatively stable in the last month, should continue to come down. All in all, inflation rates are expected to remain comfortably within the central bank targets up to and including 2010.
What about industrial metals, which appear to be witnessing a resurgence in demand?
The recent rally in industrial metals has been primarily driven by strategic buying in China. In our view, the current rally is unsustainable as long as Chinese demand is only for reserve building. While prices may continue to move higher in the medium term, we believe a fundamental economic recovery is required for long-term strength.
What about the prospects for agriculture?
As the new crop year in the northern hemisphere begins, selectivity within agriculture is paramount. In the near- and medium-term, price fluctuations will most likely be driven by farmer's planting intentions such as acreage allocations and weather. Longer term prices of agricultural goods should remain supported by low global inventories, climate change, growing demand and higher input costs.
What is your outlook on crude oil?
At current levels, we believe crude oil is likely range bound between $43 and $58/barrel. High correlation to equity markets and sensitivity to fluctuations in the US dollar should drive oil prices in the near-term. Longer-term, we believe a recovery in global economic activity, driven by the energy intensive Emerging Markets, will support higher oil prices. Looking forward, delayed non-Opec oil exploration projects may lead to slow expansion of production capacity in the future.