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Commodities Update

03/06/2012
The 2012 “annuity rally” continues, defying the overwhelmingly obvious need to incur a price correction to work off deeply overbought conditions. That said, risk assets continue to shake off any form of perceived bad news -- incredibly impressive and buying time for an eventual reallocation out of Treasuries to further appreciate risk assets (equities in particular).
 
Early Monday morning, March 5, global risk assets teetered on the brink of a correction after the news from China that Premier Wen Jiabao had cut the domestic growth target from 8.0% to 7.5% during a speech at the National People’s Congress. Certainly the boom times in the year leading up to the 2008 Beijing Olympics are a distant memory, but I still expect China’s contribution to global GDP growth to remain a tailwind for global risk assets. 
 
China GDP:    2011: 8.9%            2005: 9.9%
                      2010: 9.8%            2004: 9.5%
                      2009: 10.7%          2003: 9.9%
                      2008: 6.8%            2002: 8.1%
                      2007: 11.2%          2001: 6.6%
                      2006: 10.4%          2000: 7.3%
 
In the wake of China’s announcement, I expect investors need to focus on the commodity sector. Last week on CNBC I suggested that the time had come for select commodities to identify which of them can continue to appreciate. Now, however, further appreciation will be based solely on fundamental strength; paper asset demand is not enough. To that point, here is a simple breakdown of what I expect from the commodity space.
 
•  Oil and its refined products (gasoline, diesel, heating oil) remain my favorite commodities investment with strong fundamentals. Over the past year, I have moved weightings between “overweight” and “market weight.” In either instance, allocations to the energy space remain mandatory.
 
•  Precious metals should be investment vehicles NOT trading vehicles. To that point I am concerned with the price action in the precious metal space over the past week. Those that have dared to trade “PMs” face near-term vulnerability. I continue to offer – portfolios with allocations that mirror the jersey numbers of New York Yankee legends (4% to 8%) and consistent ownership of PMs will do better in the long run.
 
•  Base metals. Both copper and aluminum prices have appreciated in 2012. The long-term fundamentals for copper are much stronger than for aluminum.  However, given the current balanced inventory picture and year-to-date strength in copper, we await further easing from China before suggesting an increase to copper holdings. I am neutral on copper and aluminum.
 
•  Soft commodities. Despite news from India that exports of cotton will be banned to insure domestic supplies the soft commodity space is well supplied. Coffee, sugar, cotton, and cocoa should not be the focal point for commodity investments at this time.
 
•  Coal and steel holdings should continue to be held to a minimum; again, there is not enough global fundamental demand or M&A interest is present to increase holdings.
 
•  The agriculture sector is my second favorite commodity investment. Historic global easing on the part of U.S., U.K., Japan, Europe, and China central banks will keep global agriculture prices strong for many more months. In addition, rising demand from the emerging world is favorable.
 
•  Natural gas investments should be considered. Focus on non-dry gas plays. Focus on LNG and domestic natural gas producers that have proven by a diversified balance of oil and natural gas that they can withstand sub-$4 spot natural gas prices.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.