Commodities back from the brink, ready to bounce

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Commodities back from the brink, ready to bounce

Business Times
March 20, 2013
By: Andrea Soh

[SINGAPORE] Reports pointing to the death of commodities as an investment class appear wildly exaggerated.

In fact, despite the doom-and-gloom headlines, the sector seems set to provide investors the benefit of diversification, industry observers say.

The Financial Times and Wall Street Journal reported last month that institutional investors such as pension funds, insurers and hedge funds have pulled large sums of money from commodities following the sector's worst annual performance in more than a decade. Barclays data showed nearly US$10 billion in outflows from commodity indexes.

In the week up to Feb 26, hedge funds and other speculators also reduced net-long positions - which bet on the rise in prices of commodities - by 16 per cent to 447,106 contracts, the lowest since March 2009, according to data by the US Commodity Futures Trading Commission.

But analysts warn against writing off the sector.

"I take issue with the idea that there's been a big shift in attitudes amongst investors that is underpinning this fairly modest outflow (of US$10 billion that WSJ quoted)," Barclays commodities strategies Kevin Norrish told The Business Times.

In fact, news of investors fleeing commodities is "out of date" in his view.

The largest outflows from commodities occurred in 2011, when US$24 billion was taken out from commodity index-linked investments over three consecutive quarters, he said in a report written with three other analysts. Overall assets under management for commodities has been stable at above US$400 billion for several consecutive months, and the recent outflow was from a sub-sector of commodity index swaps.

Those that have reduced their holdings in commodity indexes recently are investors who bought in the last four years and suffered the brunt of the poor performance by commodities assets, said Mr Norrish.

"The recent investors have not got the portfolio diversification that they expected to get. But there are very few asset classes that provided portfolio diversification since the financial crisis," he said. "Those that have experienced commodity assets over a few cycles are much less likely to be getting out of the asset class."

According to Newedge's index of commodity hedge fund returns, the sector lost 3.7 per cent last year as the prices of most commodities fell.

Returns from the sector appear to be on a downward trend, averaging 27.1 per cent from 2002 to 2005; 11.8 per cent from 2006 to 2009; and 1.1 per cent from 2010 to 2012.

Last year was particularly harsh as commodity prices followed macropolitical events more than the underlying supply and demand fundamentals.

Even for hedge funds owned by commodity giants - said to have an advantage in their understanding of commodities markets - the going has been tough.

A spokesman for Galena Asset Management, a subsidiary of trading house Trafigura which manages US$2.5 billion in assets, said: "2012 was definitely a more challenging year. Unconventional central bank action and loose monetary policy proved difficult to navigate."

But things should pick up for commodities in 2013, market observers say. This is because correlations between commodities and equities have fallen, said Asia chief investment officer Pranay Gupta at Lombard Odier, a private bank and asset manager. Commodities' monthly return correlations with global equities (based on the MSCI All Country World Index) from 2008 till now is 73 per cent, but in the last six months this stood at 48 per cent, he said.

Similarly, Deutsche Bank's head of commodities research Soozhana Choi sees this linkage weakening further as the US and global economic growth move towards "a more sustained footing".

"As a result, the drivers of commodity prices may be able to switch their focus back towards physical fundamentals such as demand, supply and inventory trends, and less on the US equity market, credit spreads and US dollar," she said.

The improving macroeconomic situation in fact strengthens the argument for commodities, said Mr Gupta. The determination of central banks to reflate their economies will make commodities more appealing as an inflation hedge, he added.

The way Mr Norrish sees it, "commodities are starting to behave more like commodities again".

"If that's the case, commodity assets will become more attractive and investment flows may start to recover," he said.

Meanwhile, the way institutional investors approach the asset class looks set to change.

"We see investors increasingly seeking out more sophisticated, actively managed commodities products," said Nicolas Robin, co-manager of the Threadneedle (Lux) Enhanced Commodities Fund.

Similarly, the Galena spokesman said that simple directional exposure may not deliver the same historical results as before. To seek superior returns, investors would have to turn towards more actively managed products in the "discretionary and alpha space".

Commodities stocks in Singapore may also be ready to put their woes behind them after being among the worst performers on the benchmark Straits Times Index last year. Companies exposed to hard commodities are expected to benefit from firmer macroeconomic conditions in the second half of this year.

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