Market review
The third quarter was dominated by the subprime housing crisis in the United States, widespread credit concerns and the growth prospects of the US economy. Global events reflected in the SA market, causing bonds and the currency to weaken and equities to sell off as risk appetite waned and uncertainty with regard to the global outlook grew. However, the bears seemed to lose the battle yet again as US Federal Reserve governor, Ben Bernanke, provided some monetary relief.

Equities recovered strongly from their August lows, gaining 6.7% over the quarter. The local market was led higher by resources (up 13.5%) and industrials (up 3.3%). Financials, which were caught up in global credit concerns were down 1.6% over the quarter. Bond and property yields pushed lower and the currency gained strongly against a falling dollar. Over the quarter the All Bond Index was 3.4% higher, listed property rose by 9.5% and cash (as measured by the STeFI) earned a return of 2.3%.

Fund performance
The Investec Commodity Fund appreciated by a healthy 10.1% over the third quarter, underperforming its benchmark, the JSE Resources Index, which rose by 13.5%.

Within the portfolio, the overweight position in platinum shares detracted from performance. These shares rose by 4%. Anglo Platinum, in particular, was weak as a new emphasis on safety affected the outlook for volume targets. We have cut our holding in this counter, as we believe that the market is still not fully discounting the extent of these volume disappointments. However, supply disruptions from the world's largest platinum producer are beneficial for the platinum price. We estimate that as much as 500koz (including LonMin's shortfall) have been removed from a 7moz market, which we had previously seen as broadly balanced. We are therefore hopeful that a strong platinum price will result in good performances from the fund's holdings in Impala and Aquarius Platinum.

The fund's large underweight bet on the paper sector added alpha. The paper sector fell by a whopping 17%. These shares have underperformed in line with a dismal earnings performance due to a weak dollar putting pressure on exported paper prices.

The overweight bet on Mittal Steel also added to performance. Mittal SA rose in anticipation of higher steel prices, required by a more consolidated global steel sector able to pass on higher input costs of iron ore to clients with strong steel demand. Mittal SA remains totally integrated (it produced its own iron ore) and attractively valued, even after paying out a special dividend in excess of 10% of its market capitalization.

Market outlook and portfolio positioning
It is a tribute to the strength of materials demand in Asia and the difficulties being encountered by producers growing supply (given cost pressures, delays/interruptions and bottlenecks), that most commodity price forecasts are once again being upgraded. This comes despite growing concern regarding the health of the US economy.

In fact we believe that the investment environment for commodities as an asset class could be considered to be more favourable on the back of credit problems emanating from the US and rippling around the globe. The consequence of this problem has been a reversal of central bank bias (namely the US Federal Reserve) in terms of the focus on raising target rates and continuing a 'hawkish' stance on inflation.

With problems in credit markets needing support the US Federal Reserve has responded. We see this action as providing less support for the dollar and less of a bulwark against possible inflationary pressures. Those investors who see currency and inflation risks as important considerations over the next 12-24 months could look to commodities as a hedge against these risks. Furthermore, we note that the strong performance in commodities markets over the past quarter could begin to draw new capital into the asset class as the perception grows that the poor performance of commodity index investments over the past year has in fact reversed. We expect that the impact of the US slowdown will have a relatively low impact on the mining industry as commodity markets are largely driven by Asian economic factors. The bulk commodities particularly, iron ore and coal, are well insulated from the US.

To summarise, we see six compelling reasons to buy the miners longer term:

- Valuations are still very attractive.
- We expect substantial commodity price upgrades over the next two to three months, leading to earnings upgrades of perhaps as much as 15% -20%.
- Chinese and Indian growth in commodity demand, driven by ongoing strong infrastructure investment, continues to beat all expectations.
- The US is now almost irrelevant to the global growth story in commodities.
- Supply problems continue to get worse. In our view we are at least three to five years away from the possibility of production growth matching or exceeding demand growth on a sustainable basis.
- The federal funds rate cut further weakens the dollar and is potentially inflationary - the perfect combination for commodity prices; mining stocks tend to outperform after the first rate cut.

We still like the diversified miners, although we are acutely aware that earnings growth and share price performances are likely to moderate from here. Volume growth as an earnings driver could accelerate from here, but is unlikely to ever be a material driver of the earnings of the diversified miners. One possible exception to this in the short term is BHP Billiton - much of its approved organic volume growth is to kick in during the next 12 months. We believe that Anglo American's Platinum Group Metals (PGM) exposure and slightly lower base metals exposure could result in it holding onto its premium rating versus BHP Billiton for some time.

We retain a slight preference for BHP Billiton over Anglo. Given the market's greater concern over risk and volatility, we like BHP Billiton for its bulk commodity exposure (iron ore and coal are 36% of the portfolio). Prices for these commodities are contracted for the next twelve months and are therefore not subject to terminal market volatility. BHP Billiton is not expensive. The share is trading at 12 times financial year 2008 earnings, with very strong cash flow and more capital management expected.

Market review
After a strong first quarter, domestic equity market returns moderated slightly over the past three months. The FTSE/JSE Index gained 4.3% since the end of March. The market was driven higher by general mining (up 12.5%), oil and gas (up 9.9%), construction (up 9.9%) and life insurance (up 6.9%). The Resources Index rose by 6.8% over the quarter. Interest rate sensitive counters, in particular banks were down 6.9% and retailers lost 6.7%. This reminded investors of a similar occurrence last year, when diminishing global risk appetite coupled with higher domestic borrowing costs, caused a massive sell-off in domestic oriented sectors.

Fund performance
The Investec Commodity Fund appreciated by a healthy 9.8% this quarter, outperforming the benchmark. Within the portfolio, the overweight position in platinum shares detracted from performance. These shares fell by 1% (after good gains in the first quarter) even as the platinum price rose by a further 2%. Platinum shares weakened as some of their by-product metals (particularly nickel) declined. The downward move was also in anticipation of some volume losses should a strike ensue.

However, we remain very bullish on the platinum sector and we believe that there are three catalysts that could cause the platinum price to rise much higher in the near term. We see the platinum price rising as high as US$1500/oz due to the high probability of supply disruptions as a result of strikes; the recent launch of the platinum ETF; and a recovery of the bridal jewellery market in China. (2007 is believed to be the most fortunate year to be married in the past 50 years). Platinum shares are not reflecting this rosy outlook and trade on cheap multiples.

The fund's large underweight bet on the gold sector added alpha. The gold sector fell by a whopping 14.4%. These shares have underperformed in line with a dismal earnings performance due to lower volumes of gold mined, rising costs and increased shares in issue. Unlike platinum shares, gold companies have failed to translate a higher commodity price into higher earnings.

The underweight bet on Sasol also detracted from performance. Sasol's share price recovery reflected an improving oil price, a weaker rand and recognition of attractive valuation multiples. Towards the end of the quarter we began eliminating our underweight position in Sasol. We bought the shares to a neutral position in the belief that the share's valuation now discounts much of the bad news and in anticipation of continued strength in oil prices. We financed the Sasol buys by taking profits on some of our Mittal position. Mittal outperformed the sector during the quarter and its valuation is hence less attractive now. Lastly, our overweight holding in Sappi added to positive alpha. Sappi rallied by 17% as capacity closures internationally, and US antidumping duties on coated paper imports from Asia, made it easier for paper price increases to be put through. Sappi's earnings are massively geared to such increases.

Market outlook and portfolio positioning
Despite cyclical headwinds in the US, global physical demand for commodities continues to be robust. This, combined with continued tight supply conditions across a broad range of commodities as well as an increasing trend by governments towards the protection of national resources, leads us to remain generally positive on the commodities complex.

The reasons for our positive stance are as follows:
o US housing stats are not the indicators they once were: With the rise of China, North-America now only consumes 15% of global copper, for example.
o Inventories are still historically low and the markets remain finely balanced: In terms of weeks of consumption, London Metal Exchange stocks still represent about two weeks of demand (this compares with the historic average of around four to six weeks of demand). This should provide a floor on prices, as physical buyers will step back into the market strongly if prices dip too low.
o The supply side is still pushing hard: In 2005 the market lost 1 mt of copper due to unforeseen supply disruptions (i.e. strikes, weather, and maintenance issues), in 2006 it was 700 kt. As companies push their assets harder, we expect this to continue. While most forecasters expect a modest surplus in 2007, significant supply disruptions could change this.
o Market consensus is below current prices. Consensus for the copper price in 2007 is in the region of US$2.90/lb. The current price is over US$3.50/lb. Accordingly; market wide earnings changes should not be revised up if current prices are maintained.

Given the market's greater concern over risk and volatility, we like BHP Billiton for its bulk commodity exposure (iron-ore and coal are 36% of the portfolio). Prices for these commodities are contracted for the next twelve months and are therefore not subject to terminal market volatility. BHP Billiton is not expensive, trading at 11.9 times CY07 earnings, with very strong cash flow and likely more capital management to come.

In contrast, Anglo is trading on a more expensive forward multiple of 13.8 times, even allowing for stronger precious metals prices. The market is probably already stripping out a soon to be sold Tarmac and Anglogold from Anglo's valuation but, even so, Anglo then trades on a multiple of 13 times. We fail to see why Anglo attracts a 10% premium to BHP Billiton when both businesses are equally exposed to the jitter inducing copper price and have overlapping portfolios in terms of metallurgical coal, steam coal and iron-ore. It is also hard to believe that Anglo is a target for a buy-out given its rich valuation and too high market capitalisation. We conclude that Anglo's share price resilience is due to the company's share buy-back programme, using borrowed money and the proceeds of future once-off asset disposals. This buy-back is not justified by free cash flows and is unsustainable in the longer term.

For the year ahead, we are more bullish on precious metals than base metals. We believe that a weakening dollar, strong supply versus demand fundamentals, and diversification benefits should support precious metals prices. Within precious metals equities we still prefer platinum to gold. The current forward P/E ratio for the platinum sector is in the order of 14 times. This indicates that this sector still offers markedly less risk than the gold sector, priced at over 30 times. Given increased PGM prices and an expected increase in output, dividend yields for the platinum stocks exceed 5%, representing good absolute value. While we favour the sector in general, we believe Angloplats's relatively higher gearing to the metal prices will drive its outperformance.

Performance quarter-to-date: The Investec Commodity Fund appreciated by 10.8% this quarter, handsomely out-performing its benchmark, the JSE Resources Index, which rose by 4.5%. The quarter saw a weakness in most commodity prices. The bellweather copper price, in particular, fell 17%, as demand side concerns (slowdown in US housing starts, a decrease in Chinese imports, and substitution in some applications) and increased supply from scrap, led to a rise in inventory levels and the resulting sell-off. Energy prices were also weak: The oil price fell by 2% on the back of a warmer than expected Northern Hemisphere winter and the easing of political risks. Precious metals fared better: The gold price rose 6% due to dollar weakness and seasonal buying ahead of US holiday- and Indian wedding seasons. The Platinum price was largely unchanged, as was steel.

Strategy
The market is focussing on demand side concerns (particularly for copper), and the possibility of a large surplus of copper during 2007. Copper sentiment is also influencing the other metals markets. Re-weighting of large commodity indices is also providing a source for volatility - GSCI and AIG commodity indices are tracked by over $100bn of funds. We are still, however, positive on metal prices on a medium to long term view. After short term weakness and volatility, we expect markets to strengthen into the year.
The reasons for our positive stance are as follows:
o US housing starts are not the indicators they once were: With the rise of China, North-America now only consumes 15% of global copper.
o Inventories are still historically low and the markets remains finely balanced: In terms of weeks of consumption, LME exchange stocks still represent about 2 weeks of demand (this compares with historic average of closer to 4-6 weeks of demand). This should provide a floor on prices as physical buyers will step back into the market strongly if prices dip too low. o The supply side is still pushing hard: In 2005 the market lost 1mt of copper due to unforeseen supply disruptions (i.e. strikes, weather, maintenance issues), in 2006 it was 700kt. As companies push their assets harder, we expect this to continue. While most forecasters expect a modest surplus in 2007, significant supply disruption could change this. o Market consensus is not too different from current prices. Market consensus for copper price in 2007 is in the region of US$2.50-2.80/lb
- around current price levels. Accordingly, market wide earnings changes should not be materially down following the recent correction if current prices are maintained

Given the market's greater concern over risk and volatility, we like BHPBilliton for its bulk commodity exposure (iron-ore and coal are 36% of the portfolio), since prices for these commodities are contracted for the next twelve months and are therefore not subject to terminal market volatility. BHPBilliton is not expensive, trading at 7.5x FY07 earnings, with very strong cashflow and likely more capital management to come. In contrast, Anglo is trading on a more expensive forward multiple of 11.6x, even allowing for stronger precious metals prices. The market is probably already stripping out a soon to be sold Mondi and Anglogold from Anglo's valuation but, even so, Anglo then trades on a 9.7x multiple. We fail to see why Anglo attracts a 30% premium to BHPBilliton when both businesses are equally exposed to the jitter inducing copper price and have overlapping portfolios in terms of met coal, steam coal and iron-ore. We also fail to believe that Anglo is a target for a buy-out given its rich valuation too high market capitalisation. We conclude that Anglo's share price resilience is due to the company's share buy-back programme, using borrowed money and the proceeds of future once-off asset disposals. This buy-back is not justified by free cash flows and is unsustainable in the longer term. The fund also holds Kumba Iron Ore, principally for its exposure to the 9.5% higher iron-ore price settlements, gearing to a weakening rand and the potential for a take-out offer from Anglo, its parent company.
Outlook
For the year ahead, we are more bullish on precious metals than base. We believe that a weakening dollar, strong supply versus demand fundamentals, and diversification benefits should support precious metals prices. Within precious metals equities we currently prefer platinum to gold. The current forward P/E ratio for the platinum sector is in the order of 15x. This indicates that this sector still offers markedly less risk than the gold sector, priced at over 20x. Furthermore, given increased PGM prices and an expected increase in output, dividend yields for the Platinum stocks exceed 5%, representing good absolute value. While we favour the sector in general, we believe Angloplats's relatively higher gearing to the metal prices will drive its outperformance.