Commodity managers warm up to metals as world economy improves

10/10/2013

* Miners boost hybrid equity and futures funds

* Optimism on China, U.S. lifting cyclicals

* Managers stick with gold as QE3, debt wrangling persist

By Claire Milhench

LONDON, Oct 10 (Reuters) - Base metals are back in favour with commodity managers after a long period in the dog house, reflecting a new enthusiasm for growth-oriented assets as the global economy picks up.

"The key economic regions of the world have either resumed a slight upward trend or have at least put the worst behind them," said Ronald Wildmann, an adviser to the GFP Long Mining Fund , which returned almost 15 percent in the third quarter. "In China, the hard landing feared by many has not come to pass."

Commodity prices as indicated by the Thomson Reuters-Jefferies CRB index rose 3 percent in the third quarter, compared with a 6 percent fall in the second quarter.

This turnaround meant the average actively-managed fund in the Lipper Global Commodity sector was up 1.94 percent, compared with a loss of 9.58 percent in the second quarter.

But it was hybrid funds, which invest in natural resource equities and commodity futures, that topped the Lipper league table, as these benefited from a rally in the mining sector.

"Mining stocks outperformed commodities, which is usually the case when the markets rally from the bottom," said Wildmann.

He attributed the fund's strong third quarter performance to investments in Rio Tinto, Glencore Xstrata, Teck Resources, Vale and Freeport. "We were overweight in iron ore and copper holdings," he said.

His favourite picks remain miners in copper and iron ore segments, as well as direct investments in palladium and platinum.

"We are also interested in stocks with a connection to met coal, as we think coal prices have bottomed for the time being," he said. Metallurgical, or coking coal, is used to make coke for the iron and steel industry.

The bigger hybrid funds also benefited from their stock exposure, such as the $385 million BlackRock Commodities Strategies Fund, which invests about 50/50 in commodity equities and futures and returned 4.81 percent.

Portfolio managers Catherine Raw and Poppy Allonby said the mining sector had been a particularly strong performer for them.

"A pick-up in the Chinese economy led to an increase in industrial commodity prices such as base metals and iron ore, but also improved market sentiment towards the sector," they said in an e-mailed response to questions.

They see improving economic data out of China, Europe and the United States continuing to provide support for industrial metal and energy prices into the end of the year.

Pure commodities futures managers are also upbeat about the prospects for the more cyclical commodities, although these have yet to benefit from the same level of uplift as mining stocks.

"The performance in the equity space has been partly due to improving prospects for global growth, but these improvements have not yet been priced into the commodity space," said Mikael Simonsen, a director with eQ Asset Management, whose eQ Raaka-aine commodities futures fund returned 4.9 percent.

He expects markets to move sideways in the fourth quarter in general, but added: "On any news of positive growth surprises in China the industrial metals sector will improve, but the same goes for announcements of stimulus to the economy from the central government."

He was more cautious on the energy sector, saying he had reduced his overweight there to a slight underweight at the end of August. He said the sector was range-bound for the moment, but would relive upside in a benign growth scenario and if Middle East geopolitical tensions suddenly escalated.

Simonsen attributes some of his outperformance to option positions in gold, which rallied throughout July and August. It started to come off in September but received a fillip mid-month when the U.S. Federal Reserve surprised the markets by saying it would continue its monetary stimulus programme.

STICKING WITH GOLD

Managers such as Peter Frech, of the hybrid Quantex Commodity Fund, said they were retaining their precious metals positions, while recognising that performance would be volatile over the next few months as uncertainty around QE3 and the wrangling over the U.S. debt ceiling continues.

The Quantex fund returned just over 7 percent, which Frech attributed to an overweight position in gold mining stocks. He retains "a relatively large bet" on precious metals in case of deflation, and even more aggressive money printing.

BlackRock's Raw and Allonby added that the fourth quarter tends to be a seasonally strong period for jewellery demand, so they are not expecting prices to trade below their June lows.

Gold is currently at around $1,301 an ounce, up from around $1,180 an ounce at end-June.

But Frech also believes the industrial metals miners will deliver the goods. "There is a reasonable chance for a continued recovery of the global economy. So I am more inclined to hold on to more cyclical sectors like the base metal producers than before," he said.



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