Commodities - bull or bear?

I know one should not look at short-term volatility to be a gauge for the longer term, but is there an argument to invest into commodity stocks or funds that include oil and base metals just now? The price of zinc has fallen around 23 per cent over the last six months and aluminium down 12 per cent but mining stocks have risen sharply. What are the reasons for investing into oil and mining companies over the next three to five years?

Over the next 20 years, China intends to build 200 new cities, housing over one million people in each, with more new roads being built than North America has already.

The rural to urban migration, which is expected to bring a further 200 million people out of the countryside into the towns, will require an unprecedented level of building and infrastructure to make it successful. China's emergence as a global economic power is accompanied by a significant need for raw materials.

Demand from China is by no means the only factor currently driving commodity prices. The population of India is now over one billion people and its economy is also showing sustained growth, as are other populous countries such as Indonesia and Brazil. These countries highlight the rise of developing countries and their increasing importance in global economics. India also highlights another key consideration for commodities - that of demographics.

The world population is rising - and is predicted to increase from around 6.5 billion people today to more than nine billion people by 2050. Global GDP is also growing strongly, and is forecast to more than double between 2000 and 2025 - leading to a huge increase in consumption, and consequently in demand for commodities.

The global increase in demand for commodities is well documented. The peculiarity of mineral-based commodities is that supply can take a long time to catch up with demand. For metals and minerals in particular, this is because it takes years to sink new mines, drill oil wells, build pipelines, etc. Supply constraints today are exacerbated by the fact that there was a 20-year period of underinvestment in commodities over the 80s and 90s.

This helps explain why the current commodities bull market, in common with most previous ones, is likely to last for many years. Oil has become increasingly difficult to find: not one major oil field has been discovered in the world for more than 35 years. Further, many of the major reservoirs are 50-70 years old. At the same time, global oil consumption continues to increase, year after year.

Inventories of industrial metals are also extremely low. Many mining companies have chosen to bid for competitors that have proven mineral reserves, rather than spend their cash flow on exploring for new sources of supply. This helps explain the rise of takeover activity in the mining sector.

It also helps explain why investment in new mining capacity has lagged far behind demand, leading to inadequate supply and rising metal prices. In addition, the mining sector is facing rising prices in all areas. Labour unrest has become a part of the landscape, in the mineral rich areas of the developing world, with regular strikes in Chilean copper mines and mines across the world, as workers seek to share the benefits of the rising prices of minerals.

There are chronic shortages of capacity in all areas of the exploration and production of minerals from shipping, to the production of trucks and mining equipment. These rising costs are serving to drive the prices of minerals still higher, and the shortages of equipment are keeping supply tight.

Commodity prices and the companies that explore and mine, offer tremendous upside for many, many years to come. Commodities should form part of most investor's portfolios. Whether that is a small exposure of five per cent or a higher weighting of 20 or 30 per cent will depend on your individual risk profile. (Source: Dawnay Day Quantum)

Mark Hollingsworth is the director of Hollingsworth International Financial Services Ltd, licensed by the MFSA to provide investment services under the Investment Services Act 1994 and enrolled insurance broker under article 13 of the Insurance Intermediaries Act (Registration No. C32457). Tel: 2131-6298; e-mail: mh@hollingsworth-int.com; www.hollingsworth.eu.com.

Past performance is no guide to the future and, except where amounts are guaranteed, the price of investments (and the currency in which it is denominated) may fall as well as rise. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.