Commodity markets are near a top and set to move sideways in 2011 even if the U.S. economy improves, as last year's best-performing asset class has mostly priced in the recovery, according to a top Pimco fund manager.
Mihir Worah, who manages Pimco's $21 billion CommodityRealReturn Strategy Fund — the largest commodity mutual fund in the world — said he is neutral on base metals as China moves to slow growth, sees oil topping $100 a barrel and warned that wheat prices, which have surged to near-record highs, could be set for a hard landing.
"Certainly I don't think commodity prices can go down from here," Worah told Reuters in an interview. "I (just) don't see too much upside for commodities in 2011."
He said that while the U.S. economic outlook is "significantly better" for 2011 compared with 2010, commodity markets have largely priced in a recovery.
Pimco expects the U.S. economy to expand by about 3.0 to 3.5 percent in 2011, partly led by the Federal Reserve's $600 billion bond-buying program, or QE2, which aims to keep interest rates low. It had raised its growth estimate last month by 1 percentage point following the White House tax compromise.
"What's new is the stimulus that is coming from fiscal policies, the tax cuts," Worah said. "An extension of the Bush tax cuts, but more importantly, the (one-year) payroll tax cuts."
Worah, a former physicist at the University of California, Berkeley, joined Pimco in 2001. He also heads its Real Return portfolio management team.
With $1.236 trillion under management as of Sept. 30, 2010, Pimco tops the list of large U.S. institutional investors that include commodities in its asset allocation strategies.
Its CommodityRealReturn Strategy Fund, which uses active management and Treasury inflation-protected securities (TIPS) to enhance returns based on the Dow Jones-UBS Commodity Index, has rapidly expanded since its 2002 launch, with total net assets rising by nearly half over the past year.
Worah said the fund — which buys commodity derivatives linked to the index, then collateralizes that investment with a TIPS portfolio — had a return of about 25 percent for the year, beating the 16.7 percent rise in the DJ-UBS index
OIL SEEN PEAKING AT $100; WHEAT GAINS FRAGILE
Worah anticipates continued investor interest in inflation hedges, whether it is in commodities or real estate, over the next few years. But he has very different outlooks for metals, energy and grains in 2011.
"Probably there is some room for energy prices to go higher, especially natural gas, which is at extremely depressed price levels," compared with crude oil and coal, Worah said.
Natural gas fell 21 percent last year, the worst performance among major commodities. Spot crude oil rose 15 percent last year and touched a more-than-two-year high above $92 a barrel on the first trading day of this year.
"Crude oil also could have upside potential" if the economy recovers as we expect, he said. "(It) could touch $100 a barrel ... but is unlikely to go much higher than that."
But he is neutral on base metals, the commodities that are most highly exposed to China. That country uses about 30 percent of world's supply of copper and represents about 80 percent of copper's demand growth, he said.
"China has resolved to keep a lid on its own economic growth ... and copper prices are at all-time highs."
On grains, he said inventory levels were high for wheat.
"Unless we get another year of floods and droughts," grain prices — particularly wheat prices — are likely to correct significantly in 2011, he said.
Excessive rains have downgraded the quality of Australia's wheat crop, while a drought decimated Russian grain production last year and helped to rally global wheat prices.
Worah expects U.S. inflation to increase modestly — to an annual rate of about 1.5 to 2.0 percent, from about 1 percent in 2010 — as the price of housing stabilizes and the lagging effect of commodity-price increases seep through in 2011.
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