Risk-wary traders pummelled commodities including oil and industrial metals in the first half of this year, but gold shone, helping to build a strong case for selective investment over the next six months.
Together with silver and platinum group metals (PGMs), gold was among the top performers among global commodities, rising more than 13% in the six months to the end of June.
It is well-placed for further gains as the reasons for its strength so far -- a hedge against mounting European debt, sluggish economic recovery and anticipation the US dollar will lose strength -- remain intact.
By contrast, on the biggest commodity market, US crude futures fell nearly five percent and the outlook is cautious. A Reuters poll in June showed a lower consensus monthly forecast for the second time in a row after a year of bullish numbers.
Buy gold
Gold traders, who increasingly view the metal as a capital protection vehicle, are targeting psychological levels above the June record high of USD 1,264.90 .
"Both gold and silver are likely to remain strong and strengthen further in the second half -- there is no question that they are behaving this way because of the debt crisis and because of the lack of confidence in paper currency," said Alex Allen of London-based Eddington Capital Management.
"With governments refusing to address the debt time bomb in any adequate way, it is difficult to put a cap on how prices could rise."
For PGMs, economic weakness could dent demand from the auto-sector, but fund managers were still fairly positive.
"As long as you will see some mild increase in car production in emerging markets, platinum will certainly be needed," said Pau Morilla-Giner of London and Capital Asset Management.
Losing streak
Like oil, base metals declined in close correlation to falls on stock markets and as economic weakness implied less need for industrial commodities.
Some see the falls as a buying opportunity and cite future demand from commodity-consuming giant China. The bears disagree.
"There's a weak outlook for some of the base metals, copper, aluminium and zinc," said Morilla-Giner.
"Incremental demand from China is really beginning to fade quite quickly. There's a little bit of evidence the restocking cycle for China has finished and they could go on for about 18 months without having to buy an ounce more of those metals."
Diversification argument holds
Risk aversion across asset classes has meant nearly all markets -- with the exception of precious metals -- have fallen.
Those taking a longer view expect raw materials to recover their traditional value as a portfolio diversifier, rising when other assets fall, and as a hedge against sudden events.
"We don't find valuations particularly attractive, but true diversification is about holding something you dislike and so we suggest a small allocation," said Alasdair MacDonald of Towers Watson consultants.
"This is supported by commodities being a potential hedge for some extreme events: e.g., oil price shock, Middle East tension."
Oil also offers exposure to emerging markets, which are producing countries and future consumers and have become fashionable as an asset class.
"The bottom line from an investor standpoint is that commodities are so-called risk assts. What you get is exposure to emerging markets. Just don't buy the front month," said Mike Wittner of Societe Generale.
Don't be passive
Wittner is far from alone in advising against exposure to the contango at the front of the oil curve and against the passive long-only commodity indexes.
Institutional investors have often used these as one of the most obvious ways to enter commodities without running the risk of taking physical delivery.
Their returns have been weakened by a protracted contango structure on oil (dominant among the indexes) meaning the promptest contract is cheaper than those for later delivery, which wipes out the potential gain from rolling positions to later contracts.
"Starting the year at close to USD 80 a barrel in a contango structure means that passive investors need to have the front WTI (US light crude) ending 2010 above USD 95 just to be at the money," said Olivier Jakob of Petromatrix.
He saw little chance of that and instead a likelihood of "investing fatigue" in passive indexes.
"We remain in an environment of spare production capacity both on the upstream and the downstream, and that means that crude oil does not have to trend but to trade a range instead."
Still, the big indexes look to rising Asian consumption to boost nearly all commodities over time.
"Commodity indices have had a rocky time lately most notably as a result of the global crisis and subsequent economic slowdown," said Michael McGlone of Standard and Poor's, provider of the S&P GSCI.
"The world is not going backwards though and the fact that more cars are sold in China now than the US is a clear indication of where things are going."
Agriculture and blocks
From urbanisation to agriculture, pension funds have increased their investment in farmland from a low base and moved to active strategies. Fund managers say the growth could continue as they seek inflation hedges and diversification.
For soft commodities, the outlook is fairly neutral.
Coffee and cocoa gained solidly over the first half. Cocoa is considered to have the most scope to rise further, but a structural decline in all-important West African output is largely priced in.
Interest in sugar waned after prospects for a bumper harvest from Brazil and India offset expectations of supply shortages.
