Commodities

As if things were not bad enough in the banking world, one of France’s biggest banks, Societe Generale, seems to have uncovered a fraudulent trading loss of $7bn at its Paris headquarters.  This news may bring a wry smile to the faces of some of Wall Street’s bankers who have found themselves bearing the brunt of the criticism from many European banks about the dodgy investments they have been sold.

If it were me, I should probably keep quiet about the fact that I had been foolish enough to buy billions of euros of these products for my investors without understanding anything about them, despite having the resources of a major modern bank at my disposal.

Continental Europe, it seems, views the current credit crises and its associated problems as something of an Anglo-Saxon creation so it must be sobering to wake up to some good old fashioned in-house fraud.  Everyone can understand that.  Outsiders, like myself, do wonder how so much money can just disappear over a couple of years without being noticed, it is not reassuring.

For those holding cash, now could be a fantastic time to pick up some stock market investments at a knock down price, while some commodities (previously, the darling of investors)look overpriced.  Of course, it is perfectly possible that markets could drop further, after all, even if markets are efficient, they are not always rational.  At the moment, however, the stock markets, in particular, are volatile because investors are finding it hard to gauge the full extent of the sub-prime problem and its longer term impact on corporate profitability.

For those looking to hold investments for the long term, the FTSE100 looks a bit of a bargain at around 6300 when it has traded above 6700 only a matter of months ago.  The cautious, though, will be mindful of the fact that the index has yet to regain the heights of 1999 when it exceeded 6900.  It is always possible that we are in the early stages of a protracted bear market but many will find it hard to believe that the banks, even with all their problems, are as bad a profit prospect as their price would suggest.  Now, more than usual, we are seeing the benefits of diversifying.

For some investors, the January Sales have come early in the Stock Markets.

I know it makes me sound like an old duffer but I am sure fashions come and go quicker these days.

The latest must have investment accessory is the Inverted Index Fund.  These return the opposite of the index and allow investors a way of shorting.  There are not many ways for private investors to take advantage of a belief than an index (or other investment) will go down in value, other than not investing in it, so some will welcome there arrival.  A number of fund groups are scheduling launches, almost certainly in equities and commodities so watch this space.

Whether there is a place for these in the portfolio of a long term investor, I am not so sure, but they are certainly of interest.  Technically, many things are becoming possible and I am sure we have only just seen the start of much innovation but as investors we shall need to be careful not to be sucked into the hype.

If, however, you have been waiting for a simple tool to allow you to make money (we hope) from shorting, it may be that your waiting days will end soon.

In these uncertain times, it is hardly surprising that some investors are turning their attention to Gold, the traditional refuge.  Gold has outperformed most major stock markets this year (up about 20%) as well as many other indices, although Sterling returns are hampered by the fact the Gold, like most commodities, is quoted in US Dollars.

For most investors, though, Gold presents a few practical problems.  Firstly, it is expensive and I doubt many bullion merchants would be happy to sell a small piece of an ingot.  Secondly, it is costly to store and insure; it is hardly much of a refuge for your money if it lying about the house.  Also, most investors would not know where to go to buy it.  On the plus side, allocated bullion represents no credit risk and it does represent a traditional preserver of real value, even if its track record in this is patchy.

Access to gold has recently become easier; a number of ETFs (Exchange Traded Funds) now exist, some of which give access to allocated gold bullion.  This means that investors can include Gold in their portfolios, whether it is a good idea or not is another matter.  

It seems impossible to open the finance pages without having the commodities boom (or story, as the product manufacturers would have it) rammed down our throats.  As I have written before, I look favourably on including commodities as part of a well diversified portfolio but, to read the press, you would think that we had just started eating as a species or driving cars.  The population has doubled over the last century but, apparently, only now do they need feeding.

I do not wish to be too cynical but, also, I don't want to get to easily drawn into the next bad news investment story.  Only now are the products available to give easy access to these markets and it cannot be a coincidence that we are hearing a lot of the underlying markets and why they are this seasons must have investment.

It is quite likely that soon every conceivable investment niche will have been covered as Barclays has just launched an ETF tracking Timber and Forestry.  This fund will track the S&P Global Timber and Forestry Index and will come as a welcome relief by all those stressed by their lack of ability to do so.  Most, however, will not find their world rocked by this arrival but it does illustrate a trend, that of Alternative investments.

Alternatives, which include Hedge Funds and Private Equity as well as art and forestry, amongst others, have become much talked about in the last five years, or so.  Popularised by their successful inclusion in the influential Harvard Endowment Fund, they have spread out into many Wealth Management portfolios.  Their supposed benefit is high returns uncorrelated with equities.  There are one or two problems, though.  Firstly, as with all diversification, if everyone does it, the benefits of the diversification are reduced.  Secondly, any prospect for excess returns disappears when everyone piles in, certainly if you are not the first.  Harvard benefited enormously by getting in early and waiting for their imitators to pile in and drive up values.  Thirdly, what works for a multi-billion dollar fund with an indefinite timescale, may not work for those of us with fewer resources at our disposal.  Harvard went out and bought forests, not funds tracking the fortunes of forestry companies.  It is unlikely that forestry shares will exhibit the same characteristics in terms of returns and volatility as actual forests.

However, do not underestimate the power of marketing and investors desire to buy into a bandwagon after it has left town.  That is not to say that their may not be a place for it, it is just wise to manage your expectations.  For those with deeper pockets, their are funds which give access to forestry ownership, albeit with higher costs than Barclays iShare levies; currently a modest 0.65% per annum.

Investing in commodities, by which, it is normally meant the raw materials for industry such as minerals mined, metals refined or agricultural produce, presents a number of practical obstacles.  Private investors can hardly take delivery of several tons of wheat, for example.  

Traditionally, institutions have made money from the commodities markets by trading in forward contracts, futures and options.  These markets are notoriously difficult territory for smaller investors and not generally appropriate for a long term strategy of buy and hold.

So why the interest in commodities?  Well, they can provide the opportunity of an uncorrelated return to add to an investment portfolio, i.e., they do not go up and down at the same time as equity markets much of the time.  Diversification is central to portfolio construction and the search is always on for assets which increase this.  However, as everyone rushes to diversify, assets can start to become correlated.  That said, there is still a case for the inclusion of commodities, even though they have no income generating prospects, important to many investors.

Most will obtain some interest in the commodity markets by investing in companies which derive their earnings from producing them, mining stocks, etc.  Now, however, there are increasing numbers of Exchange Traded Funds (marketed as Exchange Traded Commodities, ETCs) linked to commodities indices.  These give the opportunity to access returns on a broad range of commodities from platinum to oil to livestock and are worthy of consideration for inclusion in a well diversified portfolio for the long haul.