Market review
The All Share Index (ALSI) closed 3.4% up over the quarter, losing some of its earlier gains as inflation fears gripped global markets. Substantial dispersion in performance across the sectors was evident as resources gained 13.4% over the quarter, while the Financial and Industrial Index lost 6.4%. General mining led resources higher, closing up 18.1% over the three months to the end of June. Banks and general retailers shed close to 15% over the quarter, while the defensive food retail and telecommunications sectors ended up 3.2% and 3.4%, respectively. The telecommunications sector was buoyed by corporate activity as MTN sought a potential merger with an Indian telecoms company.

Fund performance
The Investec Commodity Fund appreciated by 12.5% over the second quarter, against its benchmark, the JSE Resources Index, which rose by 13.4%. The fund's 12 month return was 48.8%, against the Resources Index return of 39.9%. The Investec Commodity Fund is ranked first in its sector over the three, five and ten year period to the end of June (annualised returns).

The overweight position in the platinum sector detracted from performance. Platinum shares rose by 2% representing a de-rating against the broader resources market. These shares underperformed as the platinum price looked vulnerable to slowing demand from both lower vehicle sales and tumbling jewellery demand. We remain upbeat about the metal's prospects. However, mines are having difficulties in meeting their output targets because of South Africa's power shortages.
The fund also suffered by being underweight the diversified mining houses, Anglo American and BHP Billiton. Despite mining a mix of commodities, both of these companies are most geared to the copper price, which rose during the quarter as stock levels reached historic lows.

The fund benefited from its overweight position in the oil sector, via its Sasol holding. Sasol outperformed and rose by 20% as the oil price continued to set record highs. Despite the share's gains, we remain happy holders as we believe that the share is a long way from pricing in the changed oil price environment. Should current oil prices hold, Sasol trades on 5.5 times forward earnings. Embedded in the current Sasol share price is a long-term oil price of US$79, versus our assumption of US$100 a barrel.

Despite continued favourable macroeconomic conditions for a stronger gold price (rising global inflation coupled with negative real interest rates), gold ended the quarter flat at US$931 an ounce. Signs that the dollar appeared to have bottomed, lead to some redemptions of gold exchange traded funds (ETFs), which kept the price subdued. We remain very bullish on the gold price, regardless of the dollar's performance against the euro. Gold has no fundamental reason to be correlated with the euro/US dollar exchange rate and there have been periods when the relationship didn't hold (2001, 2005). We still believe that the US dollar will continue to weaken against the emerging market currencies, which are important for the gold market. The US dollar/rupee and US dollar/renminbi exchange rates matter for gold demand, while the US dollar/Australian dollar, US dollar/Canadian dollar and US dollar/ rand exchange rates matter for gold supply. Gold shares have battled to translate higher gold prices into higher earnings due to increased costs and lower volumes mined. The fund therefore continues to prefer physical gold over gold equities.

The overweight bet on ArcelorMittal SA also added to performance. ArcelorMittal SA rose in anticipation of higher steel prices. The company remains totally integrated (it produces its own iron ore) and is attractively valued.

Market outlook and portfolio positioning
Although the cyclical environment is becoming more difficult for commodities, the structural backdrop remains positive, especially for the steel-making raw materials sector. The higher than expected iron ore contract settlements between Rio Tinto / BHP Billiton and Baosteel, is testament to this view. Steel-making raw materials, especially coking coal and manganese continue to benefit from very tight supply characteristics.

Amongst the diversified miners, BHP Billiton, is our preferred entry due to exposure to steel-making raw materials, oil and base metals. It remains in our view cheaper than Anglo American. We prefer African Rainbow Minerals above other mid caps due to its exposure to platinum and bulk commodities such as manganese and iron ore. In the medium term, growing volumes should also contribute to exceptional earnings growth.

Impala Platinum, our top pick in the platinum sector, has high-margin, strong organic growth and is outperforming its peers operationally. The rising cash pile points to the potential for yield enhancement and/or an increasing likelihood of share buy-backs. There is uncertainty regarding the company's Zimbabwean assets. However, we believe that in the past the market has ascribed little value to this exposure.

For exposure to the gold sector, we prefer AngloGold, the lowest cost producer of the majors. The company has potential to increase production from current operations and we have been impressed with the recent solid reserve and resource increases. Additional reduction of the hedge book is planned, which should benefit future earnings.

Our view is that while there has almost certainly been a speculative premium in the metals/energy space, it has been modest. The argument that the powerful early 2008 rally has been "all speculative, all investment-driven," is blunted by outperformance among non-exchange traded bulk materials (iron ore, coal), steel, and minor metals (e.g. molybdenum, cobalt), where speculation is difficult. Investment inflows have also been balanced by pervasive speculator short positions over the past six months.

We remain comfortable that commodity prices will stay higher for longer, and that longer-term, price trends will increase in real money terms (above inflation). The two main drivers are still very much in place; growing consumption, principally from emerging markets, and slower than expected delivery from decades of underinvestment in skills and equipment.

Market review
Equity markets ended the first quarter sharply lower driven by fears of a US recession, general risk aversion and a massive downward revision to earnings. The MSCI World Index declined by 8.9% over the quarter, outperforming the MSCI Emerging Markets Index, which closed down 10.9% (in US dollar terms).

The FTSE/JSE All Share Index retraced the losses sustained towards the end of 2007, closing the first quarter up 2.9%. Resources were the clear winners, returning 17.6% as commodity prices reached new highs and earnings were aggressively revised upward. The domestic focused FTSE/JSE Financial and Industrial Index lost 8.5% over the quarter, depressed by tougher trading conditions and poor sentiment towards rate sensitive sectors. Banks, tainted by global credit market woes and local policy uncertainty, closed the quarter down 10.7%, while general retailers lost 14.3%. The construction and telecommunications sectors were less affected by the slowing domestic consumer environment, losing 7.6% and 4% respectively.

Fund performance
The Investec Commodity Fund appreciated by 17.8% this quarter, in line with its benchmark, the FTSE/JSE Resources Index, which rose by 17.6%. The fund's 12-month return was 45.3%, against the Resources Index return of 31.8%. The Investec Commodity Fund is ranked second over the year in its sector and first over the three and ten year period to the end of March (annualised returns).

Within the portfolio, the overweight position in the platinum sector added to performance. Platinum shares rose by 29% during the quarter but were dwarfed by the massive 55% rise in the platinum price (in rand terms). The metal was squeezed due to the supply shock of production cuts caused by SA's power crisis. Platinum shares, although benefiting from higher prices will have their earnings offset by lower volumes. Thankfully the fund, mindful of last year's similar experience with gold shares and the gold price, holds a large position in the platinum exchange traded fund (ETF).

Sasol rose by 15% in line with a sharply higher oil price. We remain upbeat on Sasol's longer-term outlook given higher for longer crude prices and the company's attractive technology. However, 2008 multiples and earnings limit near term upside for the Sasol share price and we have reduced our holding.

The fund suffered by being underweight the diversified mining houses, Anglo American and BHP Billiton. Despite mining a mix of commodities, both of these shares are most geared to the copper price, which increased sharply during the quarter as stock levels reached historic lows.

The gold price rose due to the 'perfect storm' of global inflation (record high oil prices and rising food prices) coupled with declining global interest rates in reaction to the liquidity crisis. Gold, like other real assets, is a hedge against inflation since 'you can't print more gold'. Mining companies have battled to translate higher gold prices into higher earnings due to higher costs and lower volumes mined. Therefore, the fund continues to prefer physical gold over gold equities.

The overweight bet on Arcelor Mittal SA also added to performance. Arcelor 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. The company remains totally integrated (it produces its own iron-ore) and is attractively valued.

Market outlook and portfolio positioning
Commodity prices have recently been driven higher by robust demand from emerging markets, supply disruptions, infrastructure constraints and a weakening US dollar. Among the supply disruptions, South Africa, Chile and China are suffering power interruptions, which have dented the production of gold, platinum, copper and aluminium. Floods in Queensland, Australia and snowstorms in China hampered metallurgical coal production, causing a severe shortage. Infrastructure bottlenecks include iron ore and coal port constraints, which limit supply growth. As a result, we remain bullish on near term commodity prices.

Mining companies' earnings continue to be weighed down by above inflation cash cost increases and US dollar weakness. For example, Anglo American reported US dollar cash cost increases (over and above inflation and exchange rate variances) of 11.2% and 7.5% for 2006 and 2007 respectively. Mining inflation is mainly driven by high raw material costs and critical skills and equipment shortages. Higher unit cash costs and capital expenditure in the mining sector prompt us to believe that long-term commodity prices will also remain elevated.

The most important recent development in the precious metals market is the power crisis in South Africa, which has interrupted mining operations. Based on our estimates, this development will visibly alter the supply/demand balance for gold and (especially) platinum this year.

South Africa is by far the world's most important supplier of platinum, producing about 80% of annual volumes mined, and owning nearly all the known reserves. Demand for platinum from auto manufacturers (for use in catalytic converters) is relatively price inelastic. Given that there are minimal above ground stocks, the removal of 500 thousand ounces due to reduced power, will severely impact the seven million ounces per annum platinum market. We expect this tighter market to drive the platinum price much higher.

South Africa is the world's second largest gold producer behind China and sits on a third of the world's reserves. South African gold producers have warned that the forecast power rationing will result in a 20% reduction in gold mined. This is a further supporting factor in a gold market we already see as extremely tight due primarily to huge demand from investors.

While supply/demand fundamentals are positive, we believe a tidal wave of investment flows into commodity markets has further boosted prices in the first quarter of 2008. The total value of non-commercial positions on the US commodity exchanges has increased to US$275 billion, from US$150 billion in August. A number of new macro developments have further accelerated the flow of funds into commodity markets, namely inflation (or inflation prospects), falling interest rates, and the combination of the two - declining real interest rates. The weakening US dollar has been the main macro force attracting funds to commodity markets. A soft US dollar lowers prices in local currencies, encourages inventory building by consumers and increases costs at producers. A depreciating greenback attracts investors to commodity markets as well. However, it is encouraging that the pattern of a strong dollar price and weakness in other currencies is evident in non-exchange-traded commodities, where there is little speculative interest.

We remain comfortable that commodity prices will stay higher for longer, and that longer term, price trends will increase in real money terms. The two main drivers are still very much in place; growing consumption, principally from emerging markets, and slower than expected delivery from decades of underinvestment in skills and equipment.

Market review
Against a backdrop of substantial volatility and heightened uncertainty, global equity markets fared poorly over the final quarter of 2007. The Global MSCI composite lost 2.3% over the fourth quarter (in US dollars). Emerging markets held up admirably on the back of domestic currency strength and somewhat different local growth dynamics. The MSCI Emerging Markets Index gained 3.7% over the quarter (in US dollars).

Domestic equities came under pressure during the quarter, with the All Share Index closing down 3%, but achieving respectable returns of 19.2% for the year as a whole. The losses were concentrated towards the end of the period, as both resources and financials became victims of the uncertain global growth outlook and continued negative sentiment associated with the global banking sector. Gold miners ended the year as the market's worst performer, losing 14.1% over the quarter and 20.6% over the year. The construction sector continued its strong run, to end the year 77.3% higher as the best performing sector.

Fund performance
The Investec Commodity Fund appreciated by 2% over the final quarter of 2007, handsomely outperforming its benchmark, the JSE Resources Index, which fell by 7.5%. The 12-month return was 43.3%, against the Resources Index return of 29.1%. The monthly return was -1.2% while the Resources Index delivered -6.2%. The Investec Commodity Fund is ranked second over the year in its sector and first over the quarter, two, three, seven and ten year period to December (annualised returns).

Within the portfolio, the overweight position in Sasol shares, added to performance over the quarter. Sasol rose by 15% in line with a sharply higher oil price. Higher for longer crude prices and Sasol's attractive technology suggest a favourable longer-term outlook for the company. However, while we remain upbeat on Sasol's longer term outlook, 2008 multiples and earnings limit near term upside for the share price. We have therefore reduced our holding in Sasol.

The fund also benefited from being underweight the diversified mining houses; Anglo and BHP Billiton. Despite mining a mix of commodities, both of these shares are most geared to the copper price, which fell sharply during the quarter in anticipation of a slowdown in demand.

The fund holds a position in the gold exchange traded fund (ETF). This also assisted in adding alpha. The gold price rose due to the 'perfect storm' of global inflation (record high oil prices and rising food prices) coupled with declining global interest rates in reaction to the liquidity crisis. Gold, like other real assets, is a hedge against inflation since 'you can't print more gold'. The yellow metal also enjoys lower real interest rates as they reduce the holding cost of this non-interest bearing asset, and further weaken the dollar, to which gold shows an inverse correlation. Gold shares have battled to translate higher gold prices into higher earnings due to higher costs and lower volumes mined. The fund therefore continues to prefer physical gold over gold equities.

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. The company remains totally integrated (it produces its own iron-ore) and is attractively valued.

Market outlook and portfolio positioning
We remain comfortable that commodity prices will stay higher for longer and that longer term, price trends will increase in real money terms. The two main drivers are still very much in place; growing consumption, principally from emerging markets, and slower than expected delivery from decades of under-investment in skills and equipment.

However, fears of a slowing US economy and in some cases growing stockpiles are creating anxieties. This may encourage "paper" commodity investors to continue looking for alternatives, which will almost certainly create higher levels of volatility and some short-term price weakness. Although the cyclical environment is getting more difficult for commodities, the structural backdrop remains encouraging.

The large diversified miners still form the bulk of the fund's exposure. Given their magnificent recent performance, we were of the view that these shares were looking fully valued over the medium term. On balance, that remains our view but potential merger activity between BHP Billiton and Rio Tinto and the volatility that this proposed transaction has induced has led us to a far more bullish outlook for BHP Billiton in particular. This in part is due to the outlook for the sector assuming the merger is successful. Anglo looks relatively expensive compared to BHP Billiton but we recognise that it may benefit from corporate activity, however unlikely in our view. When stripping out the substantial value of Angloplat (which has outperformed its parent materially since December) from Anglo American, the balance of the group looks particularly cheap.

For the sector, good earnings growth is expected this year, although earnings momentum is beginning to wane. Share buy-backs remain added attractions but are unlikely to significantly boost share prices. Corporate action and high levels of liquidity within the sector should mitigate a sharp de-rating of the sector.

The mid-cap sector has also performed remarkably well and offers some interesting options. Our preferred stocks remain Kumba Iron Ore and Exxaro for their exposure to the bulk commodities, coal and iron-ore.