Long term outlook for commodities highlighted

Commodities are in a long term trend of solid demand growth and a recent sell off in natural resources markets is likely to prove a technical downswing, it is claimed.

Long term fundamentals in China, south east Asia and other BRIC countries and their need for infrastructure means the sector is going to be in demand for some time, according to Investec fund manager George Cheveley.

‘I believe in the long term story. I look at the need for infrastructure repair in the western world and new infrastructure to deal with climate change,’ he added.

Cheveley, who co-manages Investec's £326.5 million Enhanced Natural Resources Fund, a broad commodities resource equity fund, keeps his sights firmly on the longer term in times of volatility, but he did pause briefly when commodity investors stampeded out of markets two weeks ago as worries mounted that global economic growth was slowing.

‘I think what is slightly more worrying about this one is that it's not quite so clear what the cause was. What we have to decide is, is this one of those technical downswings or is this something more major? Odds would say it's the former,’ he added.

One reason cited in the most recent sell off was the general concerns about efforts in China, the world's biggest commodities consumer, to slow growth and fight inflation.

‘I think the market had been expecting China's tightening of the first half of the year to stop and possibly start loosening quite soon. The market is now thinking that it might go longer than they thought,’ Cheveley explained.

‘But I still can't get too bearish on the macro side if all we're worrying about in China is inflation, because it's all a function of growth and I can't see how that is bad for commodities,’ he added.

He believes that oil prices at current levels are sustainable and that European oil companies including France's Total and Norway's Statoil offer good value.

‘We feel the European oil companies have been slightly unloved over the past year, because people have been worried about Europe in general and have sold European indices which include big oil companies,’ he said.

‘But their earnings are not related to European sovereign debt. They're dollar earners generally, and they're paying high dividends. They have performed well this year, and we think there is further upside with the oil price where it is now.

‘We also like their aluminium earnings. We've seen aluminium and energy prices rise this year, and we think people are underestimating the earnings power Rio has on the aluminium side of the business,’ he added.

Last month, Rio forecast full year iron ore production to total 191 million tonnes, roughly in line with market expectations. Its alumina production fell 4% mainly due to heavy rains in Queensland, Australia, while bauxite and aluminium production were broadly flat.

Cheveley likes copper's fundamentals but does not include it in the fund. He sees the price of the metal remaining solid this year and next, dipping to the low $8,000s from around just below $9,000 currently.

‘If I put that in my models, what does look good value is copper equities. Some of the copper companies have good growth, solid production, and have costs at least under control. I think some of those companies, especially after the recent sell off, look pretty cheap,’ he explained.

The fund is bearish on nickel, zinc and steel, which he said are in oversupply. ‘Steel companies are being squeezed by tight raw materials on the one side and not a lot of pricing power on the other due to oversupply,’ Cheveley said.

After the recent fall off, zinc has a fairly firm base around $2,000 per tonne, because that's probably where the marginal cost of production is, he said. ‘At $2,100 I wouldn't want to be short, but at $2,500 I'm happy to be short.’ Nickel has further to fall, as new supply comes on stream, he added.