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The best play on commodities right now
A sliding US dollar and continued demand is giving commodities a massive shot in the arm. So how can you cash in? Here, Bengt Saelensminde explains a simple way to play surging commodity prices.
The French can be a surly lot. We drove into the village yesterday, greeted by long and haggard faces. The village seems to be carrying a collective burden.
Something's upsetting the locals. But happily that something is making me some serious dough right now. Of course, I don't want it to look like I'm revelling in their misery (which I'm not). But I will let you know their plight and how you could profit from the situation too.
Why the Languedoc has turned sour
Our place in the Languedoc is in the heart of the vineyards. In fact, the village carries the only prestigious 'cru-class' appellation of the Minervois. Around here wine is the essence of life.
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You ask these guys about stocks and finance and you'll be dealt a look landing somewhere between incomprehension and disdain. Those are the subjects of Parisians, a hated bunch of money grabbing foreigners. An Englishman can at least be forgiven for being dumb.
But if you want to talk currencies, then that's a different matter. Here the peasant farmer could be mistaken for a City trader in front of his Bloombergterminal.
Why? Because the business here is exporting. The Languedoc is known for its cheap plonk, but they've got more serious stuff too. Either way, they earn the real bucks from exports (the local market is subsistence). These guys know exactly where the dollar, rand and pound are trading.
And right now the pound and the dollar are tanking and the vignerons know what it means for them. Weak exports spell lean times ahead; they're pretty glum.
Make hay while sterling tanks
Now, the thing that I'm not telling my neighbours here (and ssshhh, because they don't know about my 'Right Side' hobby) is that I've got a way of taking advantage of this changing currency environment. As the dollar tanks (and sterling too - as it trades like a pseudo-dollar) it's giving commodities a massive boost.
I made this very argument last week and recommended commodities and gold as a great way to take advantage. But what I didn't have time to tell you was my favourite play on commodities. So let me set the record straight.
I have mentioned the Close Brothers Enhanced Commodities Fund (LSE: CED2) investment trust before. And if you got in on it, I'm sure you won't mind a bit of repetition, as you'll be sitting on a profit. If you missed it last time, you'll be pleased to know that though the price has gone up, I reckon it's never been a better buy.
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This is a very interesting fund. Set up three years ago, investors were asked to put up £1 per share. In return, Close Brothers said they'd give investors back their £1 insix years' time, plus double the return on a basket of commodities.
I'm not going to go into how Close Brothers have structured this deal; but the bottom line is that this fund will cost you £1.07 (16 October 2010) to buy today and it will get wound up in three years time.
Here's how the trusts shares have performed since its launch in 2007:
If it were wound up today, you'd be paid £1.36 per share. That's because the commodities basket is up 18% (at the end of September). So you'd get paid out your £1 plus double the 18% uplift (equating to 36p).
So, for instance, if by June 2013 when the fund's wound up, the basket of commodities has gone up by 100% (which isn't ridiculous given today's commodities inflation), then the shares should be redeemed at £3 (that's the initial £1 plus double the increase in the commodities).
Whilst the weak dollar is causing the Languedocian vignerons heartache, it's giving this fund a serious boost.
But of course with reward, there must be some risk.
Potential flies in the ointment
Commodities have been doing very well indeed. And this fund is exposed to eight of them (oil, copper, aluminium, zinc, nickel, sugar, corn and wheat). Now, it's quite possible that the market has overheated on commodities. Remember the fund won't be wound up for another three years, so plenty of time for the commodities to come off again.
And if our eight commodities come off the boil, then the potential payout willtoo.
The other major fly in the ointment is the £1 guaranteed pay out. It's backed up by five bonds which are all investment grade (at the moment at least), but any one of them could fail to pay out. If so, each disappearing bond provider could take 20p off the value of the fund.
But overall, I'm very impressed with the odds here. August's valuation on the commodities basket was 3% higher than inception (equating to a payout of £1.06 - all other things being equal). And at the end of September it was 18% higher (equating to £1.36 payout). Today, with commodities continuing their upward tear, it'll be worth even more. And with a management fee of just 0.35% pa, you are not paying too much for the trouble either.
With the fund promising double the rise in commodities and a pound back whatever happens (providing the bond providers stay in business), at £1.07, I've not seen a better play on the weakening dollar and rising commodities.
But I'm not shouting it from the rooftops over here. I wouldn't want to be mistaken for a profiteering Parisian after all.
This article was first published on 16 October in the free investment email The Right side.Sign up to TheRightSide here.
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.
He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.
Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.
