Large investors turn cold on commodities

December 5, 2013 9:00 am

Large investors turn cold on commodities

By Gregory Meyer in New York

After two years at the helm of the world’s worst-performing asset class, managers of commodities funds could be forgiven for feeling unloved. Wall Street analysts, big-picture strategists and powerful consultants have turned cold on oil, metals and grain futures as a decade-long rally peters out. And investors are listening, with many now reluctant to commit further funds. Some are heading for the exits.Their departure could affect not only the fortunes of fund managers. It couldinfluence futures markets, where “long-only” investors with a one-way bet on price rises account for a large share of open interest, or the number of outstanding contracts.

Commodities gained favour with a three-pronged sales pitch: they diversified portfolios, offered equity-like returns and protected against inflation shocks.

The global financial crisis and recovery undermined the diversification case, as commodity indices and stocks moved together in “risk-on, risk-off” swings.

In 2013, that correlation broke down – but in a way that did not flatter commodities. The Dow Jones-UBS commodity index is down 10 per cent this year, while the FTSE All World stock index has gained 16.4 per cent.

When central banks undertook “quantitative easing” to stimulate growth, commodity fund managers warned of inflationary consequences. Five years on, consumer prices in western countries are crawling up at an annualised rate of just 1.3 per cent, according to the OECD.

Indeed, the supply and demand balances that drive individual commodities have loosened their grip. Surging North American oil production has allowed western sanctions to bottle up Iran’s crude exports without triggering a price spike.

Last year’s record highs for corn and soyabeans, moreover, sent the world’s farmers on a planting spree, pulling grain prices lower. This year, 15 of the 24 commodities in the S&P GSCI commodity index have fallen, compared with five last year.

It’s not a great hedge against inflation. It’s also not so much of a safe haven

– Frances Hudson, Standard Life Investments

Wall Street banks, some of them inveterate commodities bulls, seem to have given up mustering enthusiasm. Barclays says returns are “likely to remain sluggish for some time to come”. Goldman Sachs forecasts “significant declines” of more than 15 per cent for gold, copper, iron ore and soyabeans; for energy, “downside risk is growing”.

Some asset managers are dismissive, too. “It’s not a great hedge against inflation. It’s also not so much of a safe haven,” says Frances Hudson, global thematic strategist at Standard Life Investments, which manages about $290bn.

Of 912 hedge funds, money managers and proprietary and corporate trading desks surveyed by Barclays, only 6 per cent said commodities will generate the best returns in the next three months, while a majority picked equities.

Advisers to large investors such as pension funds are also sceptical. “We have short-term concerns about commodity assets as a whole,” says Jeff Markarian, senior research consultant at NEPC.

Citigroup estimates a record $36bn has flowed out of passive commodities strategies so far this year, compared with net inflows of $27.5bn in 2012.

More active managers have not been spared. Schroders reopened its long-only commodities funds to new investors in June after some retail outflows and weaker commodity prices took assets below a $10bn capacity limit, says Christopher Wyke, commodity product manager. The funds’ size is now $7.6bn.

Fund managers say now is not the time to pull the plug on commodities. K Geert Rouwenhorst, a Yale professor who has conducted pioneering commodities researchand is also partner at SummerHaven, a commodity fund manager, says: “People have difficulty buying things for diversification purposes. But negative correlation is what it is. When one thing goes up the other thing goes down. You can’t have it both ways.”

Adam De Chiara, co-president of CoreCommodity Management, which oversees $5bn, says: “If it’s the case that equity markets are correct and we’re going to have a strong underlying real economic recovery, I think that commodities present an excellent relative and absolute value at these levels.”

Inflation may not have jumped, but it can still be guarded against. “If at the end of this year your house hasn’t burnt down, you don’t kick yourself for having bought fire insurance,” says Mr Wyke.

As bets on higher prices diminish, strategists recommend more nimble trades, such as on fluctuations in prices for commodities with different delivery dates. But investors concede these are more reliant on the skill of managers than the wider trends that were commodities’ original selling point.