A slowdown in Chinese and world GDP growth has seen commodities funds endure a difficult period. Industry favourites JPM Natural Resources, First State Global Resources and Smith & Williamson Global Gold & Resources are all down by at least 23 per cent over 12 months. While Dennehy accepts that China’s shift of focus away from infrastructure and towards consumption will have an adverse effect on the sector, he believes there are still many reasons to invest in these funds.
"The result of a fall in Chinese demand is an oversupply in commodities and consequently a fall in prices," he said.
"According to a recent report in the Financial Times, Chinese consumers of thermal coal and iron ore are already defaulting on agreed contracts."
"However, commodities are not a homogeneous group of assets – when some fall others can rise. Moreover, as demand evolves so will the commodity market."
"As China moves its economy from infrastructure spending to consumer demand, demand for iron ore will likely fall and demand for commodities such as potash, used for fertiliser, will increase."
"At the moment China counts for less than 20 per cent of the world’s potash demand."
Dennehy believes the next boom in the sector will be driven by other emerging economies that together dwarf China, and that more opportunities will present themselves.
"India for example, is some years behind China in its development," he explained. "The country contains 25 per cent of the world’s population under 25 and there are just 10 cars per 1,000 people."
"By comparison, China has 22 cars per 1,000 people, and by 2025 nearly 28 per cent of China’s inhabitants will be aged 55 or older."
"It’s also important not to forget the volume of people that aren’t in China and India; over one billion people live in the sweep of territory from Russia in the north, south through Turkey, the Arabian Peninsula and on through Africa to the Cape of Good Hope."
In the short-term, Dennehy thinks commodity prices and fund returns are likely to fall further, but he is poised to strike once prices get too low to ignore.
"Now is not the time to be bottom fishing, as we believe commodity prices will fall further before the next boom begins," he said.
"Our analysis suggests a downside of perhaps as much as 30 per cent from current levels, but we are building a shopping list now, preparing for an outstanding opportunity from those lower levels."
Dennehy points to M&G Global Basics, Artemis Global Energy, JPM Natural Resources and BlackRock Gold & General as his favoured picks in the sector.
"M&G Global Basics is run by Graham French, arguably the most successful fund manager of the last decade," he continued.
"He invests in first-world companies growing their profits in third-world countries through the supply of goods, services and basic materials."
Performance of funds over 10-yrs
Source: FE Analytics
According to FE data, the fund has returned 187.12 per cent in the last decade.
Both BlackRock Gold & General, which is headed up by FE Alpha Manager Evy Hambro, and Neil Gregson’s JPM Natural Resources have outperformed French’s portfolio over the period, but they have taken on significantly more risk.
"JPM Natural Resources is the longest standing diversified commodity fund which invests primarily in the shares of companies throughout the world engaged in the production and marketing of commodities," continued Dennehy.
"Rarely do we see value in gold, but it could be the case that prices drop to a point where ignoring it would be plain silly. If this occurs, we’d go for BlackRock Gold & General."
Launched in April 2011, Artemis Global Energy is the least established of those recommended by Dennehy. The fund looks to invest in companies that are likely to be re-rated when their mining prospects come to fruition.
As well as emerging markets driving demand, Dennehy believes re-development in the US could also prop up commodity prices.
"The US needs to upgrade and maintain its broken sewage systems, maritime infrastructure and railways," he explained.
"Back in 2009 a report by the American Society of Civil Engineers stated that the US needed to spend $2trn over a five-year period in order for its infrastructure to be upgraded to ‘good’. That’s up from the $0.6trn spent between 2003 and 2007."
Stephen Walker, head of equities research at Ashcourt Rowan, also believes the long-term case for investing in commodities is alive and well; however he thinks investors may have to wait for a significant period before they see a positive return.
"The long-term structural commodity story is likely to play out over a period far beyond most investors' horizons," he said. "In the near-term, whilst the energy and mining sectors, particularly the latter, could fare well in a market rebound, the outlook for the next few years is more clouded."
"The mining sector usually delivers exaggerated rises and falls relative to the broader market but both still tend to move in lockstep. We are concerned about the medium-term path of the US economy and the endgame for Europe is far from clear."
"Many investors will have exposure to the sector via their broader market funds and thus investments in funds within the Specialist sector are likely to mean ‘doubling up’. In the current market climate such a strategy is probably best only for those who can stomach similar or greater losses than those seen over the last year or so," he finished.