UBS offers advice on how to cash in on high oil prices

Given expectations of continued strong demand for natural resources, it's time to diversify your investment portfolio.
How much should you worry about the price of oil and precious metals?

UBS researchers forecast strong growth in demand for natural resources, and caution that supplies of natural resources will remain thinly stretched in the near term. That's because continued demand for natural resources from emerging market countries, a sharp slowing in new reserve discoveries, and low inventory levels will all likely extend the current bull market in commodities.

But this cycle of price increases isn't as bad as it could be: UBS researchers argue in a recent report entitled "Commodities: scarcity of abundance" that although the market price for energy products and base metals has risen sharply during the past few years, prices are lower than in past cyclical peaks after adjusting for inflation. And for investors, it represents an opportunity.

FinanceAsia talks to Yonghao Pu, head of wealth management research Asia-Pacific for UBS, and one of the authors of the bank's recent research report, about how to capitalise on this forecast.

For how long do you expect oil prices to remain high?

We expect oil prices to remain at about $72 per barrel this year but to ease to about $65 per barrel in 2007. Our forecast is based on the likely increase in supply over coming years prompted by the enhanced capacity being pursued by oil companies now.

Of course, demand, will keep prices relatively high. Barring a pandemic or war, and assuming a normal scenario, we expect oil prices to stay high but slightly lower than they are now.

So what's the key message you take away from this?

The key message for investors is the necessity to diversify their investments and pay more attention to the energy related-commodity sector going forward.

What type of investments would you suggest?

We are positive on the long-term outlook for commodities and on the diversification benefits of including them in investment portfolios. In light of the seemingly insatiable appetite for commodities on the part of India and China, long-term demand is likely to remain solid. We would also expect natural resources to play an increasingly significant role in most well-diversified portfolios.

We see a decent cycle for commodity prices going forward. You must remember that the cyclical trends for commodities, on average, last for around 18 to 20 years. The current upturn started in 2001 and in light of rising per capita incomes in highly-populated emerging-market countries, we would suggest the trend has only just begun.

Some analysts have suggested looking at derivative products, instead of direct investments in commodities, what are your thoughts?

Absolutely. It isn't like you're going to want to invest in buying a barrel of oil. Seriously, the logistics and maintenance of direct investments are virtually impossible for an individual investor, aside from gold. Futures, contracts, derivatives or commodity indices are now the primary investment vehicles.

How about funds or corporates that are investing in projects - such as building mines and plants? They are likely to be in emerging markets, which may represent riskier (but therefore higher-yielding) investments. Are you recommending such investments?

The OPEC countries, such as Iraq, or Iran may have higher geopolitical risks. But prices are so high that the appetite for investment relative high-risk locations is high. Indeed, China investigated investing in high-risk areas such as Africa because the price was right. At $20-$40 a barrel not too many people are willing to take the risk, but at $60 or $70 a barrel, risk appetite increases slightly.

China needs oil. Without oil, growth will suffer, and China relies on strong growth to create jobs and embark economic reform. As a result, it will seek supplies from a variety of places, not just OPEC countries. It needs to diversify its overseas investments around the globe.

But it also realises it must explore - and it is exploring - alternative energy investments, such as coal, nuclear, hydro and wind supplies on its own shores. All of which will diversify its options. Witness the continuing rise in the price of corn as a result of its use in generating alternative energy such as ethanol. China is certainly looking to explore alternatives available at home and these could be fruitful.

One could argue these high oil prices are good for OPEC, good for investors, but overall bad for Asia...

Non-oil producing countries are suffering û just look at the annual reports of airline and transportation companies or of those companies that are reliant on logistics. The high oil prices have clearly hurt them. However, many are capable of digesting, at least part of these higher prices, because their labour markets are flexible.

At the same time, OPEC countries have a lot of oil-money on hand that they want to spend, so imports have been increasing. Asian countries have been making up their losses from high oil costs with a higher number of exports to OPEC countries. So it's been bad but it's been good too.
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