Throughout the first half of this year, investors in
commodities fretted about China. They worried that its economy was in
for a hard landing, as construction, property values and equities all
seemed to be overheating.
Such a landing could be disastrous for commodities
companies, which have profited from some of the strongest global demand
for resources in decades. Much of that demand has been driven by China,
which now accounts for 30 percent of world coal consumption and 40
percent of steel consumption.
So far, however, the fears have generally not been
borne out. Loan growth in China slowed by 7 percent from August 2003 to
August 2004, and while inflation has remained strong, it has been below
forecasts. China's consumer price index rose by an annualized rate of
slightly more than 5 percent in August. Many analysts now say that
China's economy will grow 9 percent this year.
As a result, said Phil Flynn, senior market analyst
at Alaron Trading, a futures and options brokerage in Chicago,
commodities and shares of mining companies around the world, which have
posted sizable gains over the last two years, are still a solid
long-term bet. "We're in an era of tremendous opportunity for
commodities, and it's going to be one of the biggest sectors not for one
year, but for 5, 10 years," Mr. Flynn said.
Moreover, commodity companies do not have to deal
with the same headaches as manufacturing or service businesses supplying
China. After all, commodities like coal are tough to pirate, and their
producers do not need to worry about winning over Chinese consumers to a
What's more, said Thomas K. McKissick, managing
director at TCW Asset Management and lead manager of TCW's Galileo Large
Cap Value fund, commodity prices have been so low for so long that even
recent demand has not bolstered supply enough. "You were in a
20-year bear market for commodities," which reduced capacity, he
said, noting that China still had little of its own manufacturing and
transportation infrastructure in place.
Some analysts say a slight decline in Chinese demand
may help commodities in the longrun. According to Merrill Lynch's recent
report on metals, "Some slowing in Chinese demand is good for the
metals market, because high prices always lead to too much supply being
brought on the market."
Indeed, though the London Metal Exchange index, a
predictor of commodity demand, fell nearly 15 percent in April and early
May on fears of Chinese cooling, it has largely recovered. Michael
Bradshaw, a senior analyst covering basic materials at Pioneer
Investments, said he believed copper was in the shortest supply of all
commodities, because there were no easy substitutes for it in industrial
processes. China's copper imports were up 20 percent in August, versus
the same month in 2003.
Accordingly, Mr. Bradshaw favors Phelps Dodge, a
mining company with significant copper assets. Phelps Dodge posted
second-quarter earnings of $2.30 a share.
He also likes the Rio Tinto Group, a diversified
miner with bases in Australia and Britain. Rio Tinto, whose American
depository receipts trade on the New York Stock Exchange, sells its
iron, coal and other products directly into China, Mr. Bradshaw said.
(Roughly 70 percent of China's energy is derived from coal.) The company
posted record profits for the first half of 2004.
By comparison, the mining giant Freeport-McMoRan
Copper and Gold, based in New Orleans — which Mr. Bradshaw also
favors, though less than Rio Tinto — sells onto the open market,
rather than directly to Chinese companies, and thus benefits less from
Aluminum has also remained strong, and several metals
market analysts predict that worldwide demand will climb 8 percent this
year. Mr. McKissick said the aluminum giant Alcoa "is one of our
"They manage capital well and they benefit from
demand in China," he added.
Rather than focus on companies, some investors may
put money directly into commodities. But Mr. Flynn of Alaron cautioned
that this could be risky, especially for people who are not willing to
track the commodities daily. "Futures and commodities are highly
leveraged and very volatile," he said. "Go in with your eyes
Individual investors interested in exposure to
commodities can invest in a fund based on a commodities index.
Dan McNeela, senior natural resources analyst at
Morningstar Inc., prefers the Pimco Advisors' CommodityRealReturn
Strategy fund to its main competitor, the Oppenheimer Real Asset fund.
"Pimco has a more diversified basket of
commodities," he said. "Oppenheimer's fund is skewed much more
heavily toward energy commodities; this increases the level of
volatility for investors and makes oil prices dominate the fund."
The Pimco fund is up more than 30 percent in the past
year. Still, he cautioned, commodity funds are more volatile than
natural resources funds, which invest in shares of mining and energy
companies and thus have less direct exposure to volatile raw-materials
prices. Mr. Flynn says commodities should be no more than 10 percent of
an average investor's portfolio.
The commodity sector, after all, can have risks other
than volatility. Mr. McNeela says he has "geopolitical concerns,
worries about commodity supply disruptions" from terrorist attacks
and other causes.
And several large mining companies, like
Freeport-McMoRan, have major operations in countries with high potential
for political instability, like Indonesia, where nine people were killed
and more than 180 injured in a terrorist attack this month. Still, Mr.
Bradshaw said, Freeport has been operating in Indonesia for 30 years and
understands the local environment.
—Courtesy New York Times