* Inflation likely to support oil, weaken stock markets
* Lack of new project investment to tighten oil supplies
By Joe Brock
LONDON, Aug 4 (Reuters) - Global economic recovery and the return of sustained inflation should bring to an end oil's positive correlation with equities, but probably not for at least a year, a manager at PIMCO said on Tuesday.
From an investor's point of view, one of the prime benefits of exposure to commodities is that it balances a portfolio because raw materials tend to behave differently from other asset classes.
That can change in times of recession.
"In a sudden recession, if most or all assets including equities lose value, then a drop in demand for commodities can see most or all commodity prices go down together," Antoinette Eltz, responsible for inflationary strategies at the leading fund manager, told Reuters.
Oil and other commodities have tracked equities faithfully as stock markets have climbed to their highest levels this year in anticipation of economic recovery, which for commodity markets implies a return of consumer demand.
Oil, which hit a low of $32.40 in December, its weakest in nearly five years, has risen to highs around $70 a barrel.
Over the longer term, Eltz was confident commodities would return to their traditional role as a portfolio diversifier and an inflation hedge.
"If you look at commodity indices over the past 40 years, this coordinated price movement is rare. It is not the norm," she said.
"Commodities are a diversifier for portfolios because they tend to be negatively correlated to stocks and bonds and positively correlated to inflation. Diversification and inflation hedging are priorities for many of our clients over the long term."
Eltz said she believed there would be no significant inflation in the next 12 months but there was a risk of inflation in a 3-5 year time frame, which should reverse oil's relationship with equities.
INFLATION CORRELATION
The recovery of commodity prices in the longer term could be part of the inflationary problem, which would probably depress equities prices.
A lack of investment in bringing on new energy supplies, because of poor economics while prices were lower and credit was lacking, could add to the problem and increase the arguments for buying commodities as a hedge.
"Last year in 2008 when we had higher commodity prices and inventories were dwindling, a lot of projects were initiated to help increase supply. However, many of these projects are being aborted or put on hold. So once demand comes back supply shortages could be a problem," Eltz said.
Even before then, any sudden supply shock could jolt commodities back into following fundamentals, rather than equities.
Eltz works at PIMCO's London operation.
The U.S.-based fund has hundreds of billions of dollars in assets under management in the United States.
In Europe, it has two different commodity funds worth a total of 100 million pounds ($169 million).
One is a passive fund, based on investment in a commodity index, while the other has an active element. (Editing by Anthony Barker)