COMMODITIES have been hogging the headlines recently. Before last Thursday's sell-off, they were largely seen as safer bets in the wake of the plunging US dollar and volatile performance of other asset classes.
According to Terence Tan, marketing and membership officer at the Singapore Commodity Exchange (Sicom), there was plenty of interest in rubber and coffee contracts last month.
'Open interest for our TSR20 rubber contact increased from 31,400 tonnes on Jan 2 this year to 52,140 tonnes on Feb 29,' he said. 'Our average daily volume for all contracts was 8,558 tonnes in 2007, (while) the Feb 2008 average daily volume was 13,298 tonnes.'
Even with the recent fall in commodity prices, prices of many commodities such as gold and oil are still generally higher than what they were at the beginning of the year. It may pay to start understanding what commodities are all about and the investing options available.
Interesting markets
Commodities fall into three main categories: agriculture (such as grains, rubber, coffee), metals (precious metals including gold, silver and platinum, and base metals such as copper, zinc, tin and aluminium), and energy (crude oil, gasoline). Indeed, they serve as a good diversified portfolio of investment, said Jeffrey Christian, managing director of CPM group, a commodities research firm based in the United States.
'Commodities are very interesting markets in which to be involved,' he wrote in his book, 'Commodities Rising' (John Wiley & Sons, 2006). 'Their tangibility, the concrete nature of these markets make them much more interesting than stocks or bonds. Equity market analysis can often devolve into forensic accounting, and bond market research is virtually all quantitative. Commodities, however, force you to pay attention to real life - to people's consumption habits for agricultural commodities, housing and transportation ... to many other aspects of human nature and world development.'
One of the more common ways to trade commodities is to set up a futures contract account with a broker that manages such contracts, for example, Phillip Futures, UOB Bullion and Futures and Goldman Sachs. A major advantage of futures trading is that it works on the principle of margin and leverage - that is, a futures transaction does not require a full advance payment for the commodity; only a margin deposit.
For example, the initial margin required for Sicom's RSS3 and TSR20 contracts, both rubber contracts, is $115 per tonne each. The margin for one lot of the TSR20 contract - equivalent to 20 tonnes - would then come up to $2,300 or US$1,619, said Sicom's Mr Tan.
On the other hand, the current full contract value, assuming one trades 20 tonnes of TSR20 first contract month, is approximately US$54,300.
'Thus, the margin paid is (only) about 2.9 per cent of the contract value,' he explained.
Margins vary from contract to contract. A Tokyo Commodity Exchange rubber contract, for instance, requires a margin of about 60,000 yen, while the margin for a crude oil contract from the New York Mercantile Exchange may reach US$8,000, said Avtar Sandu, manager of Asian Commodities at Phillip Futures. The small margin deposits serve as a leverage which could, however, prove to be a double-edged sword, as price movements may result in losses for the investor, cautioned Mr Tan.
'This small percentage gives you a huge leverage, because the profit and loss are based on the price movements of the whole value of the contract itself,' he explained. 'That gives you a huge potential for profit, but on the other hand, you must be aware that (when) somebody wins, someone else pockets, so if you're on the wrong side of the investment, you'll be the one who pays for their wins.'
Another alternative for investors is to buy into a commodities fund listed on the Singapore Exchange, also known as an exchange-traded fund (ETF). The Lyxor ETF Commodities CRB exposes investors to 19 commodities - including energy, metals, agriculture and livestock - through the Reuters/Jefferies CRB Index, which is regarded as the benchmark for commodities markets. Meanwhile, gold enthusiasts, in particular, can invest in the streetTRACKS Gold Shares.
Investors can also buy the equities of commodity producers such as Olam International, which supplies agricultural products including cocoa, coffee and nuts, and agricultural and mining firm Noble Group.
A look into the future
Annie Koh, dean of executive and professional education at Singapore Management University, attributes the rise in commodity prices to the fact that the world is becoming 'too industrialised'.
'It's back to the theory of demand and supply. Economies like China and India are growing fast, they are converting arable land into factories and buildings, so from a supply angle, you're getting less supply. From a demand angle, you get buildings coming up fast, so (there's a) demand for steel, sand, cement,' she explained. 'People are also living longer as the standard of living goes up; so (there's also) a demand for food resources.'
With these countries looking set to continue rising as economic powerhouses, will the current commodities boom last then?
Renowned investment guru Jim Rogers thinks so. At a recent Investment Management Association of Singapore conference, he noted that commodities bull cycles have historically lasted between 15 and 23 years, and predicted that 'the current bull market will probably last until 2020'.
In 'Commodities Rising', Mr Christian sounds a cautious note.
'There is money to be made investing in commodities, but careful research and a lot of detailed analysis are required to do it right,' he wrote in his book. 'Investors also need a healthy dose of scepticism about all the hype circulating about commodities markets today. Some commodities will see lower prices over the next few years; other commodities are likely to see higher prices.
'Realistic analysis of each individual commodity will help investors discern which is which.'
