Category Investments

Commodities - investing in an asset or a minefield?

23 August 2012 Nico-Louis Minnie - Investment specialist at Liberty Liberty Life
Nico-Louis Minnie - Investment specialist at Liberty Liberty Life

Nico-Louis Minnie - Investment specialist at Liberty Liberty Life

It is hard to avoid commodity companies on the JSE as they dominate the landscape. In fact, South Africa is often still considered to be a mining country and the JSE to be a mining exchange with about six of the 14 largest companies on the JSE being commo

Nico-Louis Minnie, an investment specialist at Liberty, points out that; "Commodity stocks are affected by factors other than the usual influencers in the market. For example, the gold price plays a bigger role in determining the share price of a gold stock compared to the general level of consumer activity in the market. However, consumer spending will have a big impact on the share price of retail companies i.e. Tiger Brands. Because of this, the commodity stocks are not perfectly correlated with the general market and will provide diversification benefits".

Minnie further points out that, “because commodities are priced in US$, commodity investments ensure that your investment holds its value in the said currency – which is commonly US$". Basically they act as a Rand hedge in case the Rand weakens against the USD.

Typically there are two types of commodity companies: a single commodity and diversified. Single commodity companies include gold miners, platinum miners and the like, as they only mine one commodity. This carries more risk, as their fortunes are tied to that one-specific commodity and how well it does. The diversified miners are headed up by the two largest listed commodity companies: Anglo American and BHP Billiton. Due to their diverse nature, they mine different commodities around the world and are able to offset weak prices in one commodity with the strength of the price of another commodity.

However, even the miners bring extra risk and reward to the table, as costs can increase ahead of revenue and mine closures can impact on mining production. So the underlying commodity that the company mines could be performing well, but internal issues at the mining company could reduce the profits.

With this in mind, many investors have turned to investing directly into commodities to reduce the risk of the mining company. Minnie offers a word of caution on this, "Individual commodities are very volatile and driven by factors not directly observable in the market. Hence, they are risky investments although they do come with a host of diversification benefits, as they are uncorrelated with the general market. Commodities also don’t pay dividends so the commodity has to increase in value for you to earn positive growth. Therefore they are not ideal as income generating assets".

So in a nutshell investing directly into commodities is riskier than a diversified miner and these large miners are well worth considering for a balanced portfolio.

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