Four Ways to Play the Commodities Boom

03/19/2008 12:00 am EST

Focus: COMMODITIES

Alexander Young

Equity Market Strategist, S&P Capital IQ

Alexander Young, Standard & Poor’s international equity strategist, says the commodities boom will continue and he finds some ETFs that help you play it.

A broad variety of raw material prices are flirting with record highs, and many market forecasters expect the trend to continue.

The Standard & Poor’s GSCI Commodity index, a diverse commodity benchmark that incorporates industrial metals, precious metals, energy, and agricultural commodities, rose sharply over the past 12 months.

Though we think it's likely that increasing concerns about a US recession, and a subsequent slowing of demand, will lead to short-term profit taking, economic drivers across the world will [likely] sustain the advance for the foreseeable future.

We think many investors are more focused on continued emerging-market demand than slowing American consumption. In addition, years of underinvestment have constrained global capacity, and this makes traders inclined to believe commodity prices can overcome any obstacles this year.

Currency trends are yet another factor supporting commodities, in our opinion, as most are denominated in greenbacks. The US dollar's long-term down trend continues apace—domestic interest rates are falling, while overseas rates remain relatively stable, by our analysis.

In addition, low interest rates reduce the opportunity cost of holding commodities, which don't pay dividends. Additionally, we believe commodity prices are benefiting from some investors' worries that inflation, which has begun to inch up globally, will continue to rise.

In the eyes of many commodity investors, increasing investment demand is yet another bullish driver. S&P believes the negative long-term correlation between equities and commodities has increased the appeal of this asset class for many global money managers. With global equity volatility elevated, it's more important than ever to find asset classes that can "zig" when stocks "zag," in our view.

While comprehensive data is difficult to obtain, The Wall Street Journal reported increased commodity allocations by pension funds, sovereign wealth funds, mutual funds, and the growing list of resource based exchange traded funds (ETF) as partial drivers of the recent rally.

Lastly, commodities, most notably precious metals, benefit from increasing geopolitical strife. With the timing of these unfortunate events impossible to predict, we believe it behooves investors to have permanent "portfolio insurance" built into their allocations.

Direct exposure to a diversified basket of commodities, such as the S&P GSCI Commodity-Indexed Trust ETF (NYSEArca: GSG) or the iPath Dow Jones-AIG Commodity Index Trust ETN (NYSEArca: DJP), is not the only way for investors to participate.

From an equity investment perspective, we think the iShares MSCI Canada Index ETF (NYSEArca: EWC), and the iShares S&P Latin America 40 Index ETF (NYSEArca: ILF) equity exposure represents another way to leverage potential continued commodity price gains.

Canada and Latin America's 46% exposure to materials and 48% [exposure] to the energy sector have led to positive consensus earnings revisions this year, helping offset fears of slowing exports to the United States. S&P believes that if commodity prices continue to climb, these stock markets stand to benefit.

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