Have commodities come out of a 20-year bear market?

Everyone knows that oil and gold have been rising in price this year. But what seems to have largely gone unnoticed is that practically every type of physical commodity is showing a healthy improvement in price.

Indeed, annual returns for commodities read like a bull year for equities. Nickel is up 30% on a year ago, copper and platinum are strongly up. Soft commodities like cocoa, coffee, soya beans, palm oil and wheat are up by 13-60%.

The Commodities Research Bureau index, a basket of global commodity prices, is up by 30% since the end of 2001. That is why hedge funds linked to commodities were all star performers last year. This compares with falls almost as big in equity markets.

So what has happened? Why is the commodities market booming while equity prices are crashing? You probably need to be a Nobel prize winning economist to even begin to venture an answer, and this is not the place to try.

Yet for investors the inverse correlation between commodity prices and equities is worth noting and appreciating what it might mean in the future.

If we have come out of a 20-year slump in commodity prices - and most prices hardly moved in this period - then this means at least two things.

First, oil stocks and oil service company stocks, and anything associated with commodities (even the Australian dollar!) are all undervalued on fundamentals. Second, inflation is out of the bag. For increasing raw material costs are inflation at its source and will be reflected in consumer prices before long.

Trading in commodities is a specialist activity and for direct investment in commodities a specialist broker or fund manager is essential. In fact most trading is not done in physical commodities but futures and options contracts.

However, it may be far more sensible to plunge into commodities than to invest in equities in the hope that the three-year bear market will suddenly end. At least the new trend in commodities is clearly established and this is not a question of hoping for an upturn. The upturn has already happened.

Will a quick war in the Gulf bring this hiatus in commodity prices to an end? That is one view. But the surge in commodity prices may have more to do with excess liquidity created to deal with the equity crash, and thus be linked to a more fundamental realignment of capital values, or even the bottomless demand from China for raw materials.

But this is not a matter of speculation. Commodities are the new big thing for investors, having proven their worth in the past year by a wide margin.