With many investors looking for ways to use market volatility to their advantage, Geoff Ho asks why the commodities and banking sectors have become so popular...

It is no secret that the past few years have been terrible for savers. Interest rates are at their lowest levels for 300 years and, according to economists, they are unlikely to rise until next year due to the stagnant state of the economy. Add in high inflation and the true value of bank savings is being eroded fast.

To make things worse, the value of many investors’ shares and funds are worth far, far less than they were before the global recession.

Throw in the debt crisis in Europe and the United States, not to mention ongoing conflict in key Middle Eastern states, and it is clear that markets will continue to be volatile in the short to medium term.

In this kind of environment, it is understandable if some investors choose to sit on their hands and not risk losing their hard-earned money. However. they could be wasting an opportunity. Provided people are comfortable with the risks involved, volatility can be used to generate superior returns.

One of the sectors that is proving to be popular with short-term traders is the banks, in particular the two semi-nationalised banks, Lloyds Banking Group and Royal Bank of Scotland.

Waiting for the upside
RBS and Lloyds needed over £40 billion of bailout cash between them in 2008 due to their heavy US sub-prime debt losses, bad property deals and the declining creditworthiness of their consumer and corporate clients. The share prices of RBS and Lloyds are respectively 95 per cent and 89 per cent below their 2007 peaks.

According to Manoj Ladwa, senior trader at ETX Capital, investors are attracted to the banks because they believe that, with the banks trading at such low levels, the potential downside is limited.

He says, ‘A lot of people are bottom-picking the banks now; there are a lot of buyers out there at these levels.’
IG Index chief market strategist David Jones concurs, noting the volatility of the banking sector, which has made it popular with traders, as it provides them with ample opportunity to go either short or long.

‘Banks are always popular because they are fairly volatile. That applies to the mining stocks too,’ he says.

Ladwa agrees, explaining that, rather than buying into sector giants such as Rio Tinto or Xstrata, short-term traders are choosing to move in and out of individual, small and mid-cap resources companies depending on their market view.

‘Mining stocks are always popular but the interest is not in the majors,’ he said. ‘It’s the smaller ones, as people think they will be taken over by the larger groups.’

Bid speculation
Like the banks, the mining and natural resources sector’s popularity lies in the fact that it is highly volatile. Aside from the constant bid speculation about them, shares in small to medium-sized companies also move wildly on rumours about potential oil, gas, metal and mineral discoveries and whether or not such discoveries will actually prove to be viable.

For those reasons, resources minnows Xcite Energy, Range Resources, Rockhopper Exploration, Gulf Keystone Petroleum and Desire Petroleum were heavily traded and among the top ten most popular buys and sells by retail equity investors in June, according to TD Waterhouse.

But the interest in natural resources and commodities firms is not just confined to traders and share dealers.
Fund investors, too, are trying to take advantage of the continued growth in the natural resources sector, which is driven by continued demand from emerging markets powerhouses such as China and India.

According to Des Byrne, managing director of Barclays Stockbrokers, funds such as BlackRock Gold & General
and JP Morgan Natural Resources are seeing inflows.

Byrne adds that investors are keen to buy into the likes of Aberdeen Asset Management’s Emerging Markets fund, as it enables them to benefit from the growth of places like India, which is very difficult for retail investors to put money into directly. Nearly 13 per cent of the Aberdeen Emerging Markets fund is invested in India.

Another trend, according to Barclays, is the theme of fund investors becoming bolder in their hunt for above-inflation returns, as demonstrated by the growing inflows into UK smaller companies funds.

‘People who put money into UK smaller companies know that they are taking a risk,’ says Byrne.

The rise of forex
One particular market that is becoming more popular with retail investors and day traders is foreign exchange, which is the biggest and most liquid market in the world.

According to the Bank for International Settlements, which acts as central bank to the world’s central banks, more than $4 trillion (£2.5 trillion) of currencies are traded every day. In comparison, the value of shares traded on the London Stock Exchange for the whole of June was a mere £107 billion.

But with the debt crisis haunting members of the European single currency, which has fallen in value against other currencies due to the ongoing woes of Greece, Ireland, Portugal, Spain and Italy, foreign exchange is becoming increasingly popular with the retail investing public. According to ETX’s Ladwa, trades such as the euro versus the US dollar are proving to be particularly popular.

‘We’re seeing a massive increase in currency trading,’ he says. A significant amount of that is down to the sovereign debt crisis and the sheer liquidity in the market. Unlike stocks, which can be illiquid, there’s always volatility and liquidity out there.’

Geoff Ho is deputy business editor at the Sunday Express