Nicholas Brooks, head of research and investment strategy at ETF Securities

Investors should hedge risks

Download the special report Commodities 2013 Part 2: Outlook for funds and exchange traded products

Interview with Nicholas Brooks – “I would argue that some of the higher beta sectors will perform best in the near-term: within commodities, those that we like best are those with a tight supply/demand balance and that can benefit from a pick-up in US and Chinese growth. Platinum, palladium, copper, and to a lesser degree crude oil, could all benefit this year,” suggests Nicholas Brooks (pictured), head of research and investment strategy at ETF Securities.

With both the US and Chinese economies expected to grow over the coming months, there is cautious optimism to believe that the global economy should see a stronger recovery than last year. That’s a view that Brooks and his team take, although he is quick to caveat the point by admitting that significant market risks still remain: “The European economies will likely lag in 2013 but historically if you see two of the key drivers of global growth picking up, it often feeds through to other parts of the world economy and ultimately Europe will benefit from that. But their immediate structural issues remain severe.

“Another key factor supporting cyclical assets is that interest rates will likely remain low in 2013. Although growth is picking up, there are still a lot of vulnerabilities in the global financial system, meaning central banks will maintain low interest rates and continue with quantitative easing.”

If, therefore, the US and China continue to lead the way economically, and interest rates are kept low, this would create a fairly positive scenario for cyclical assets such as broad equities, broad commodities, and high yield credit, according to Brooks. With platinum, palladium and copper, not to mention crude oil and silver, all geared in to stronger economic activity, the potential for upward price support is well placed.

Copper, in particular, is a good barometer of industrial activity: stronger economies make for stronger demand and price. This was evidenced last month, with ETFS Copper and ETFS Physical Copper attracting USD85million and USD31million in net inflows respectively: the largest inflows for any single commodity.

However, this is only half the story: “The number one market risk in 2013 will be European sovereign risk. Spain could be the next sovereign risk event; with unemployment at 26 per cent the likelihood of them hitting their fiscal targets is quite low. That’s a risk that investors have to be prepared for because if it does happen, it will hit cyclical assets,” says Brooks, who adds that the other significant risk is if the US debt ceiling is not properly dealt with and results in another downgrade.

Investors should therefore hedge their positions accordingly to protect against these tail risks says Brooks.

“In this environment investors should continue to hold gold. The upside might be limited in an environment of accelerating growth, but if something goes wrong in Europe, or with the US fiscal cliff, its price could spike sharply.

“Secondly, investors should hedge their risk positions by going long oil, in particular the shorter end of the Brent curve. We have a Brent 1-month tracking ETP, for example, which tracks the front-month Brent contract. If anything goes wrong in the Middle East you’ll see a sharp reaction in the front-month, making it a useful tail-risk hedge.”

This is already happening. Whilst ETFS recorded outflows of USD30million for WTI crude last month, its Brent 1-month ETC (OILB) attracted USD23.5million of inflows.

 

Further reading


Download the special report Commodities 2013 Part 2: Outlook for funds and exchange traded products


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