Commodities - where next?

By Meera Patel | 27 Aug, 2008 

If you looked at the commodities market in isolation for the first half of this year, you wouldn’t have thought that we were heading for a recession. In the last couple of months commodity prices have eased and this has relieved some of the pressure central banks have faced in their interest rate decisions.
 
In the broadest sense, strong economic growth leads to higher commodity prices and vice versa. Therefore the recent softening in prices is to some degree linked to the weaker growth we have been experiencing. Additionally, the strength in the dollar has also been a contributing factor for the weakness in prices.
 
Short term weakness in commodity prices is inevitable, particularly after such a strong period for the asset class. However, the long term case for investing in commodities has not changed. Demand for commodities, particularly from the emerging economies remains strong. Oil consumption per head in the US is 25 times higher than India’s, yet India’s population far outstrips that of the US. As economies like India and China develop, their need for natural resources is only going to increase further.
 
Remember, commodities have a finite supply and extracting more resources requires more efficient use of existing sources or the development of new sources. In both cases this is likely to lead to higher costs and also higher prices.
 
Invesco Perpetual believes a good way to gauge the extent to which demand and supply forces may lead to a rise in commodity prices is to track the behaviour of a basket of commodity prices against general consumer prices. Going back to 1960, they can illustrate in simple terms that commodity prices lag consumer prices by as much as 25%. Whilst there is no direct link between the two, we believe that demand from emerging economies gives commodities scope for further upside going forward although we cannot rule out short term swings in sentiment.
 
We are believers in the long term case for commodities. For investment ideas in this area, please refer to the Wealth 150 list of our favourite funds in each sector.