MLC on commodities: maybe this time it’s different

While Australia’s fortunes have been closely linked to commodity prices over the very long term, Australian investors have been wary of commodities as an asset class – perhaps until now. MLC has issued a briefing note as to whether the latest bull market in commodities is a fad or here to stay.

According to Susan Gosling, general manager implemented consulting for MLC, historically, rapid rises in commodity prices have substantially reversed rather than persisted. Commodity prices have risen 84 per cent in $US terms since their trough in 2000, and the rise has been fastest in the past three years. In $A terms, the five-year rise has been 65 per cent, as rising commodity prices are often accompanied by a stronger $A. Unfortunately, in the past at least, a big rise in commodity prices has fed into rising inflation in Australia and the boom has inevitably been followed by a bust. But Gosling questions whether this will be the case with the current boom. While she says that the current pace of commodity price rises is unlikely to persist, and additional supply is likely to be forthcoming, the longer-term drivers of commodity prices may well be robust. The huge prospective economic development in China and other Asian countries will provide a buffer. And the economic management of the world has changed since the last big commodities booms and busts. “Some of the fundamentals of the economic environment that existed during previous commodity price booms no longer exist today, and this may mean that the current commodity price cycle is very different,” she says. During the Korean War boom of the 1950s, for wool in Australia, the nickel boom of the late 1960s and the energy crisis of the 1970s, Australia had a fixed exchange rate – until 1983. Many other countries introduced floating exchange rates prior to the oil price shock of 1974. Gosling says it was not until Paul Volker took office at the US Federal Reserve in 1979 that central bankers around the world declared war on inflation. This time, as well, an important offset to the inflationary impact of commodity prices is the burgeoning supply of Chinese manufactures. “This supply … appears to be reducing the flow-through of higher input prices into consumer inflation. Again, this reduces the risk of a boom-bust cycle and makes a substantial commodity price reversal less likely.” MLC has had an exposure to commodities in its diversified funds, through one of its debt managers, for some time. However it has not had a specific allocation to commodities, largely because of the very long price trends for commodities, which does not match well with the tendency for investors to evaluate performance over shorter periods. With its new “Long Term Absolute Return Portfolio”, which includes a range of long/short and other strategies which aim to maximise returns over 20 years, MLC has made a strategic allocation to commodities.