* Reuters
* Tuesday February 26 2008
By Amanda Cooper
LONDON, Feb 26 (Reuters) - Commerzbank money managers believe the explosive rally in commodity prices ranging from wheat to gold will make this the top performing sector of 2008 and have positioned their largest fund of funds accordingly.
In light of the uncertainty over the global economic outlook and the ongoing difficulties in the credit markets, Commerzbank's Alternative Investment Group, which manages $540 million, is avoiding too much exposure to any one asset class.
But the stellar rise in the price of commodities from wheat to gold in the last two years, along with share-boosting merger and acquisition activity in the basic resources sector has made commodities the play for 2008.
"Within the equities space, we've been trying to find managers who are actively managing the whole commodities complex. That is one area of equity exposure that has been maintained or increased versus a year ago," said Michael Kane, a senior portfolio manager for the fund of funds -- an investment vehicle which holds other funds in its portfolio rather than individual assets.
Severe drought in many parts of the crop-growing world and booming levels of consumption in emerging economies have pushed the price of basic foodstuffs such as wheat, soybeans and corn to record highs.
Adding to this is the development of green fuel technology that has unleashed record demand for a variety of soft commodities such as grains, vegetable oils and sugar to convert into biofuel -- a potential substitute for traditional fossil fuels.
"The one that is really in play at the moment is anything related to food," said fellow senior portfolio manager Edward Hands.
"The reason they go up together is because they're all fighting for acreage. You can increase the supply of arable land slowly either by taking conservation land off line and turning it into arable land but all this tends to be rather marginal land."
He said adding crop yields in these areas tended to be poor, while years of intense use of pesticides and other chemicals had degraded top soils in other more fertile parts of the globe.
"Nobody has really kept their eye on that ... all of a sudden, we've had a drought for wheat, we've got biofuel demand for corn and sugar and suddenly inventories are down and everybody is getting worried and that means higher prices."
"I think they're in play and I think they will be the top performing asset class this year."
Among the so-called hard commodities, gold and platinum have hit record highs this year as demand from hedge funds and consumers such as jewellers or chemical companies alike has flourished.
Gold, which has soared by 80 percent in the last two years, has also benefited from the shift in interest-rate and inflation expectations, while platinum, which has doubled in value in that time, has seen unprecedented interest from hedge funds.
The entire commodities was languishing in a 20-year bear market until about three years ago, depressed by a glut of supply and erratic demand. Mining companies in particular curtailed production capacity and froze expansion plans in order to survive.
Now that demand has reignited, many companies are struggling just to keep up.
That said, in the current environment of heightened volatility, Commerzbank's fund of funds is wary of betting too heavily in one direction or one asset class, be that shorting, or selling U.S. mortgage-backed securities, or adding commodities-heavy funds to its portfolio.
"We are a little hesitant to put new money to work, finding good investments and good managers with a good outlook for the next six to 12 months is difficult at this time," Kane said.
"We've also focussed on hedge fund managers with experience, we're not really focussing on new launches ... and tended to focus on more traditional equity hedge fund managers with low net exposures who've lived through tough market conditions before," he said.
Ultimately, the fate of the equity markets is linked with that of the investment banks and their ability to revive the credit markets and shift some of the battered subprime-linked assets from their books.
Tough credit conditions and soaring prices for anything from gasoline to milk must prompt a shift in thinking among individuals as well as the investment community.
"The prevailing theme ... I think is how much people's incomes in the Western world get eaten up by the basic essentials in life and how people will be forced to review their lifestyle," Hands said.
"Related to that is the credit unwind," Kane said. "Whether it is at an individual level .. or on the banking side, credit tightening has happened in an abrupt way in the fourth quarter and I don't see it ramping up again aggressively in the near future." (Editing by Jason Neely)
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