The Government's finances are stretched to breaking point. The next administration may be tempted to start the money printing presses again to clear debt.
Politicians know that they can't keep upping tax, and they've been making promises to that effect. They've also been making promises about not slashing spending. So where's the money going to come from?
Rather handily, Mervyn King's latest wheeze, quantitative easing (QE), seems to have worked pretty well. Inflation didn't take-off as many pundits had predicted. The temptation to do it all again, and on a larger scale, may be too difficult to resist. The risks to our currency could be considerable.
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If QE goes wrong, then you can expect inflation. Inflation attacks the 'real' value of cash. We need protection, and that protection can be found in commodities.
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There's a fund that offers the security of cash, with the potential to make serious profits if inflation causes a commodities boom.
Unlike paper currency, commodities can't just be 'created' by a central bank. If the Bank gets back to the printing press, then commodity prices should go up.
Close Brothers Enhanced Commodities II
This investment trust trades in London (LSE: CED2) and [at the time of writing] costs 96p to buy. The fund was launched in 2007 at £1.00 and will be redeemed in June 2013.
At redemption, investors will get their £1.00 back, along with twice the growth in the value of a basket of commodities. This is interesting
The commodities in the basket are oil, copper, aluminium, zinc, nickel, sugar, corn and wheat. The fund doesn't physically hold them, but has contracts with third parties who'll pay double any percentage increase in the commodities values.
The percentage gain is relative to the value of the commodities on the 'base date', which was 31/05/2007.
At the end of December 2009, the commodities were up 12%. If the fund ends up the same in June 2013, then shareholders will get £1.24 back. That's the initial £1, plus double the 12% increase in commodities, i.e. 24p.
The fund provides monthly updates on the commodities values, and the latest one shows that the commodities are down 3% from the 'base date'. If this persists, and the value of the commodities ends up less than when the fund launched, then investors just get their £1 back.
This looks a pretty good deal to me. You get twice any upside, and you don't suffer the downside risk. This is my kinda bet.
Buy at any price up to £1.00
When the fund launched three years ago you could get 6 or 7% return on your savings in the bank. And yet, investors were happy to give up this yield in return for the gamble on commodities.
Today you'll barely get anything for cash in the bank and the recklessness of central banks means commodity prices could suddenly spiral upwards. Yet the fund trades at less than its launch value. It looks cheap and one US hedge fund certainly agrees.
The risks
The commodities in the fund are priced in dollars, the currency of global trade. So to make serious money, it's really dollar inflation we're betting on.
The US is in the same predicament as the UK and there's good reason to think that their authorities are mulling over the same dangerous policy actions as our guys.
During the financial crisis, central bankers and politicians across the globe schemed and manipulated the financial system to save the banks.
Now they might have to scheme to save governments. And governments could prove even more costly than banks to keep afloat! We could be looking at a situation where paper currencies weaken relative to hard assets like commodities.
When the fund launched three years ago, it raised £45 million which they invested into five bonds that mature in June 2013 i.e. the redemption. The bonds are 'investment grade', but again, we're exposed to the risk that the bond providers go bust. It's happened before
This is the second commodities fund launched by Close Brothers. The first fund has recently been redeemed, but one of the five bond providers had gone bust. The bond was from Icelandic bank Glitnir.
In the first fund, shareholders were lucky that the commodities bet had done extremely well, so the payout was still £1.85. If they hadn't held that bond, the fund would have returned over £2.00. That's a pretty impressive return given the markets performance in the five years since the fund was launched.
This article was written by Bengt Saelensminde and was first published in the free daily investment email The Right Side on 7 April 2010.
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