May 4, 2008

Time to sell oil and buy shares

Investors have poured millions into commodity funds, but did they pile in too late for a market upsurge?

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Investors have poured millions of pounds into commodity funds this year just as City analysts have warned that the sector is at its most overheated for decades.

Commodity funds, which invest in oil and mining shares, were bestsellers at the height of the Isa season in February as investors sought a shelter from the turbulent equity markets.

Crude oil touched a record peak of $119 a barrel on Monday, but dropped by nearly 3% over the week to close at $116.32 as the dollar strengthened, making oil more expensive for international buyers.

Meanwhile, industrial metals have dropped by 14% this year and gold, the traditional safe haven, has slumped by 16% since its peak of $1,012 in March.

Even agricultural commodities, this year’s hot sector, have not been immune, with milk, cotton and wheat all slipping in recent weeks.

The sell-off, which has come as US investment bank Merrill Lynch has warned that commodities are at their most overheated since 1973, has hit some of the most popular Isa funds. The £1.7billion JP Morgan Natural Resources fund, for example, has fallen 67% over the past six months and 2% since the start of the year.

Some City analysts predict that professional investors could soon start selling commodities and buying banks, especially now that the Bank of England has signalled that the worst of the credit crisis could be over.

Sir John Gieve, deputy Bank governor for financial stability, said last week that prices in the credit markets had now fallen so far they were “likely to overstate the losses that will ultimately be felt by the financial system and the economy as a whole” and that “some assets look cheap”.

Kevin Gardiner, head of global strategy at HSBC’s investment-banking arm, said that while he would not recommend investors sell oil and buy banks just yet, that moment was not far away.

He said: “There is a risk that later in the year investors will start to think about booking profits from the oil and mining sector and putting the money in sectors that have not done so well like global financials.

“We are not there yet, but we expect to see it later in the year. You could see what happened this week almost as a dress rehearsal for that.”

One analyst has even drawn parallels between the commodity boom and the tech bubble of 1999. Tobias Levkovich, Citigroup’s respected US strategist, said last week: “In the late 1970s, the energy sector soared to more than 30% of the S&P500 and the same thing happened in the tech sector in the late 1990s. The commodity and global growth theme is bordering on 30% now and yet few seem to be concerned, which raises our anxiety levels.

“Agricultural stocks’ strength, in particular, is reminiscent of the internet craze. There are some scary similarities between the stock-price activity of fertiliser and seed stocks relative to dotcom names back in the late 1990s. We remain very worried about these incredibly crowded trades that could unwind quickly.”

Even oil giant Shell, which last week reported record first-quarter profits of $7.8 billion (£3.9billion) admitted that it did not know why prices had shot up to their current levels, because there was no real shortage of supply.

Crude could fall further later this year if the dollar begins to recover as the tax rebates being given to American consumers start to have a positive impact on the US economy.

Simon Wardell at Global Insight, an economic analysis group, said: “The dollar is now looking like it could strengthen later this year, although we believe it will continue to weaken until June.

“Opec [the Organisation of the Petroleum Exporting Countries] will try to control what happens, but there would have to be a pretty severe supply disruption – or a total dollar collapse – to push the price of a barrel up to $200 as Opec president Chakib Khelil has suggested.”

Meanwhile, fund managers say that UK shares, particularly banks, are at their cheapest for years. Jeremy Tigue of Foreign & Colonial said: “There is not going to be a general systemic collapse. That risk has gone, so now the opportunity is greater than the threat. Although there are severe problems in the banking sector, share prices are starting to reflect this.

“We expect to take up our rights in Royal Bank of Scotland because we will be buying shares at 200p rather than the 650p they were trading at this time last year.

“In 2000 the FTSE 100 index had a price earnings multiple of 28 and a dividend yield of under 2%. Today the multiple is under 12 and the yield just under 4%. I do not know of any bear market that has begun with valuations at these levels.”

Private investors such as Sophie Sanders, 31, are following suit. She is already investing in the stock markets via an Abbey child trust fund for her 11-month-old son Barney’s future and wants to increase her investments because she feels now is a good time to put money into the UK stock market.

Sanders, an account manager who lives in Beckenham, Kent, with Barney and her husband Rufus, a 34-year-old teacher, said: “I have been watching the value of the stock market fall over recent months. However, I am going to be investing over the long term – probably about 18 years – and I feel that this is a good point to buy shares as they are looking so cheap.”


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