COMMODITY prices are heading back to record highs after the spring’s sell-off and the City is once again talking of a 20-year bull run in the sector.

Brent crude oil has surged by 14% over the past month to $57.51 a barrel, not far off its high of $57.83 in early April. Copper hit a record high on Thursday after China, the world’s biggest importer of many commodities, reported that industrial output had leapt by 16.6% in the year to May.

Commodity funds have been the stars of the investment world in recent years. The RAB Special Situations fund, which focuses on commodity stocks and is aimed only at wealthy investors, has posted a staggering return of 2,200% since January 2003, although analysts believe that such a rate is unsustainable.

Of the funds that are available to all investors, Merrill Lynch World Mining, an investment trust, tops the tables over five years with a gain of 222%; JP Morgan Fleming Natural Resources is not far behind with a return of 217%.

The commodity market is not for the faint-hearted, however. Mining shares can be extremely volatile: they slumped by nearly 10% in April, one of their biggest one-month falls for 20 years, before staging their recent comeback.

Even analysts who believe that commodities are in the midst of a long-term bull cycle accept that there are signs of a bubble in some parts of the market, especially among small oil and mining stocks quoted on the Alternative Investment Market.

Shares in Regal Petroleum, an AIM-quoted oil firm, have lost nearly 90% of their value in the past two months after the company was forced to admit that a much-hyped oil discovery off the coast of Greece was not commercially viable.

Philip Richards, manager of RAB Special Situations, said: “The AIM market is like the Wild West at the moment. There are some great opportunities, but also big potential pitfalls.”

Despite the risks, he believes that the commodity market is in the midst of a “supercycle” — a 20-year bull market fuelled by the industrialisation of China and India.

Richards said: “If you look at history, there have always been supercycles in demand for commodities. There was a super- cycle during the British industrial revolution, during America’s huge period of growth before and after the second world war and during Japan’s industrialisation in the 1970s.”

Now it is the turn of China. Its economy has expanded by 9.5% over the past 12 months and has grown by an average of 9.4% a year since economic reforms began in the 1970s, according to Capital Economics, a consultancy.

As China’s economy expands, it is sucking in raw materials to build up its infrastructure, including roads, power stations and factories.

Analysts believe there is insufficient supply of commodities to cope with this new source of demand, which has driven up prices. Evy Hambro, manager of the Merrill Lynch International World Mining fund, said: “The mining industry has simply not invested enough in production capacity to meet this new demand.”

The oil price has been driven higher by similar factors: markets fear there is insufficient supply to meet the robust demand from China and America, which are growing by over 9% and nearly 4% a year respectively.

The Organisation of Petroleum Exporting Countries (Opec) said last week that it would increase production by 500,000 barrels a day, but that statement did little to arrest the rise in the oil price.

Richards said: “Demand for oil is about 85m barrels a day at the moment and most people forecast that it will hit 125m barrels a day in the next 15 to 20 years. I see no way in which this will be met, so oil prices will stay high.”

Goldman Sachs, the investment bank, has even forecast that the oil price could hit $100 a barrel in the event of a “supply shock” — a disruption to the supply of oil as a result of natural disaster, sabotage, war or political upheaval.

However, even the bulls would admit that there are clouds on the horizon. Money has poured into the commodities sector and pushed some share prices to precarious heights — so much so that a number of analysts have drawn parallels with the tech bubble.

David Bowers, chief strategist at Merrill Lynch, the investment bank, said: “We have become increasingly aware of the parallels between perceptions of the resources sector today and the tech bubble of 1999-2000. Investors believe that the Chinese economy, and therefore the resources sector, can grow at 9% a year forever.

“But China’s growth is itself built around the US consumer, to whom it exports goods. If the US consumer slows down due to higher interest rates and oil prices, investors in commodities could be caught unawares. Talk of a supercycle could therefore be premature.”

Some fund managers have taken profits in the more highly priced commodity stocks. For example, Graham French of M&G Global Basics has recently cut back his holding in Cameco, a Canadian uranium miner trading at 40 times earnings — a valuation reminiscent of the tech bubble.

French said: “Whenever there is a bull market in commodities, a bubble always develops among the smaller stocks. It happened in the early and mid-1990s with gold shares.

“Some people will make a lot of money from the bubble, but when you are running a fund for the average saver, you have to stick with good long-term bets such as Rio Tinto and BHP Billiton, the Footsie mining groups. I believe in the theory of the supercycle fuelled by China, but I think investors need to be careful where they invest.”