Investors attempt to benefit from metal revival

Serious Money: Growth concerns could lead to a sell-off Japan, but also also an opportunity to buy, writes Chris Johns.

Metal prices have soared over the past year following a decade in the doldrums and investors are looking for ways to benefit from the upturn.

One way to invest in this boom is through a specialist natural resource or commodity fund that holds shares in companies producing natural products such as iron ore, nickel, steel or copper.

JPMF Natural Resources has been the top performing fund over the past year, climbing 84 per cent before charges, according to figures from TrustNet, a financial data provider. Over three years it has risen 120 per cent and over five years 211 per cent. The FTSE All Share, in comparison, only rose 25 per cent over the past year and if you had invested over the past three years in the index your investment would have fallen 11 per cent.

"Shares in mining companies have been delivering impressive performance due to the current strong demand for raw materials," says Ben Yearsley, an investment manager at Hargreaves Lansdown, the financial advisers. "Commodity inflation was one of the phenomena of last year, fuelled by economic recovery and the spectacular growth of China's manufacturing industry in particular."

He says that prices have leapt as economic growth has picked up, boosting demand for metals used in manufacturing. Aluminium, for example, is used by carmakers and copper is a key component of piping and plumbing.

Evy Hambro, manager of Merrill Lynch Mining & Gold Fund, is very bullish about the commodities market and believes this growth will continue. "Countries like Brazil, Russia and of course China are expanding and as they grow they are competing for a greater share of the world's resources. But production capacity among companies is lagging, which is in turn pushing up prices," says Hambro.

Peter Charrington, UK managing director at Citigroup private bank, agrees. He says: "The lack of interest in the sector in the last 15 years or so has meant there has been chronic underinvestment in the commodity infrastructure.

"This combined with increasing demand has resulted in a large supply/ demand imbalance which is likely to continue expanding. This has led us to be bullish on the sector mid to long term," he says.

For private investors, the easiest way to benefit from the boom is to invest in one of the few commodity funds, which include M&G Global Basics, JP Morgan Fleming Natural Resources, Merrill Lynch Gold & General and, most recently, First State Investments Global Resources Fund. All are among the top performers in the specialist funds sector.

As the gold price has risen sharply over the past few years so the Merrill Lynch Gold & General Fund has been an outstanding performer. It has risen 236 per cent over the past five years.

Other natural resource funds tend to have a bigger emphasis on base metals. M&G Global Basics holds both mining companies and stock involved in secondary industries or those converting raw products and services for the end consumer.

This fund has risen 24 per cent in the past five years.

First State Global Resources, the most recently launched fund in this area, is focused on base metals. It posted returns of 86 per cent over five years. "Over the last few years there has been substantial consolidation in the oil and gas, iron ore, aluminium, coal and gold sectors, which has created more robust, leaner and focused global resources companies, generally leading to better opportunities for investors," says David Whitten, head of global resources at First State Investments.

The big question is whether the rally can be sustained. Optimists argue that supply will not catch up with demand for some time, which should keep prices firm. They also expect the emerging markets of China, India, Brazil and Russia eventually to become global superpowers.

Pessimists think the expansion in Asia and Latin America could come to a sudden halt. They are also cautious about any sector that has made such gains. Advisers also warn the funds may be more volatile than the average equity fund as they are concentrated in such a narrow sector.

Despite this, advisers recommend that commodities form part of every investor's portfolio, not just on performance grounds, but to hedge risk as their performance is unrelated to that of equities, gilts and even property.

"The diversification power of commodities comes from their low correlation with equities and bonds," says Charrington. "This means they are a good natural hedge as they rise in line with inflation whereas equities and debt holdings typically lose value during periods of unexpected inflation.."

Advisers recommend that you put not more than 5 per cent of your portfolio in commodities.

However, a recent analysis of asset returns by Barclays Capital suggests 10 per cent.