Commodities popularity at highest in four years

With gold prices setting new records on almost a daily basis, it comes as little surprise that BofA Merrill Lynch’s latest fund manager survey revealed commodities are at their most popular in four years with a net 25% of the panel overweight on these assets.

Monetary policy
“Investors see inflation as a greater risk than deflation and are hedging that risk with overweight positions in emerging markets and commodities, and an underweight position in the US dollar,” said Michael Hartnett, chief global equity strategist at BofA Merrill Lynch Global Research.

In the week to November 12, 218 fund managers, managing a total of $534 billion, participated in the survey. Over 75% of those surveyed said they expect the Federal Reserve to hold off from raising interest rates until the second half of 2010 and one in six believes it will be 2011 before the Fed acts. The respondents also gave US policy-makers the thumbs up, with two thirds claiming they believe current monetary policy is “about right.”

Within Europe, 40% of respondents expect the European Central Bank to raise rates in the third quarter of 2010 and just over a quarter expect a hike to come as soon as the second quarter, but 16% don’t forecast any change until 2011.

Commodities in favour
Though BofA Merrill Lynch’s risk appetite index has remained unchanged at +44, the threat of rising inflation has meant that while global fund managers have maintained cash balances at 3.7% and remain overweight equities to roughly the same degree as last month (37% versus 36% in October), there has been a significant shift out of bonds and into commodities.

The proportion of respondents who are overweight commodities such as gold and oil has more than doubled over the past month, while a net 53% are now overweight emerging market equities. Those assets that protect against deflation, such as fixed income and utilities, are now less popular this time round.

Positioning could shift, however, if the US dollar were to rally as energy and technology are currently the most favoured global sectors and both are beneficiaries of a weaker dollar, as are emerging markets and ‘safe haven’ investments in gold.

Regional conviction
Regionally, a net 22% of fund managers see the European Union as the most undervalued region but a positive dollar view versus the euro has left participants undecided on whether to overweight Europe of the US over the following year.

Having last month gone overweight the Eurozone the first time in nearly two years, global asset allocators added to their position this month—a net 13% are now overweight the region, up from 11%--but Europe was also the only region to see a defensive shift in November. With investors likely taking off risk into the year-end, this month’s BofA Merrill Lynch Europe fund manager survey (which questioned 177 managers, managing $361 billion in assets) recorded sector allocations swinging back towards defensives, away from cyclicals and financials. Banks and technology stocks were the main losers, both sinking to underweight, while healthcare and oil & gas were the biggest gainers.

“Investors are now narrowly focusing their bets in three defensive sectors seen as very undervalued,” a BofA Merrill Lynch research report commented. “This may leave them vulnerable to another bout of cyclical outperformance into year-end.”

In line with this cautious sector stance, investors continue to hold cash, with a net 18% of respondent overweight on the asset—the most cautious stance of any region despite European fund managers’ positive view of valuations. A net 13% of European respondents see local equities as undervalued amid an improving profit outlook.

This vote of confidence in the Eurozone economy is in stark contrast to the entrenched and increasing pessimism on Japan, though asset allocators also remain skeptical of the UK. In November, a net 10% of global fund managers are underweight the UK, down from 18% the month before, though BofA Merrill Lynch analysts believe it is debatable whether this discrepancy in views on Europe and the UK can be sustained for long, given the UK equity markets’ high international exposure.

Economic outlook
Putting UK pessimism to one side so as to end on an encouraging note, less than 10% of the total number of fund managers surveyed fear a double-dip recession and though this latest survey revealed consensus now predicts a small global economic recovery rather than a big one, the level of conviction in investors outlook appears to be steady: The proportion of asset allocators who see a strengthening economy over the next 12 months has changed very little since August, while the vast majority (69%) expect improving profits for the next year—the same figure as revealed in last month’s survey.