Commodity debate: Finding the diamonds in the dust

Commodities debate participants

FdW, PGGM We invest in commodities for diversification purposes, to bring down volatility without sacrificing return. Commodities have done very well in our portfolio since 2000, although the scope has changed, especially with the current contango and lack of backwardation. We keep an eye on the lack of backwardation, but we’re not unduly worried. The bigger picture is still diversification. We want commodities as a strategic position, to hedge against unexpected events, as well as for return. However, our allocation of 5% is not enough to hedge us against the risk of inflation. It would have to be much higher for that but there are better vehicles available to get inflation protection.

RB, Watson Wyatt Paul, who invests in your funds and what are they looking for?

PT, Touradji We encourage people to think of our active products as pure alpha vehicles, as opposed to an inflation hedge. Until three years ago, there had been either sideways or down markets in commodities. In the last three years there’s been heightened interest from the institutional community, primarily from a beta perspective but increasingly for alpha. Whether it’s a reflection of the maturation of the asset or of this disappointing contango in the market, it’s created a problem for investors, and a combination of the two is leading people to move away from traditional beta investment. There’s been a lot of angst, both in the press and the markets, about this negative roll yield turning away all the traditional commodity investors. That’s patently silly. The long-only investors came in primarily for the diversification benefit. Rather than a rush for the exits, we’ve seen a rush to figure out how to counter the weight of money that’s causing the nearby rolls to the negative roll. We’ve seen pick-up in work on how to do better than traditional investors.

RB, Watson Wyatt Has that proved beneficial?

PT, Touradji Our job is to make money through any environment. When that environment changes, so must our strategies. We have been investing more heavily in relative value rather than directional, adapting to the heightened volatility. If the volatility subsides, we’ll invest more directionally again. We’ve always seen opportunities in the commodity markets. It’s a challenge to capture those opportunities, but that’s our job.

BG, Pimco Investing in commodities is a good idea, primarily for diversification. We deal with institutional investors, as well as high-net-worth and family-office investors. Investor numbers are growing and those already in the markets are staying in. The exception is the retail investor who tends to chase returns. The negative returns of the GSCI, or the flat returns of the Dow Jones AIG commodity index in 2006, caused some retail investors to leave.

PD, Commerzbank Supply continues to play catch-up with demand, which suggests that the bull run still has some way to run. A key element in our client base are German corporates, which are particularly interested in oil prices, but which also have a keen interest in base metals prices. Our investor client base has a wider interest, but what is common to both is a particular interest in hedging strategies given the huge rise in uncertainty which has surrounded commodities over the last year or so. In our view, investing in commodities is still a good idea, because markets are tight, demand in Europe and the US remains solid, and Asia is the big swing factor which will continue to drive markets higher. Unless you think there’s going to be a sharp correction on fundamental grounds, you want to be long commodities.

SW, Diapason Commodities have been through a cyclical correction, and we have had under-average returns over the past 12 months for the asset class. Every investor wanted to a cyclical correction before investing, and now they’re getting it. It is an opportunity. We’ve seen a slowdown in US activity, and many of the cyclical commodities have been under pressure, especially oil. But on the bigger picture supply/demand/inventories imbalances remain, there’s a shift of power from west to east implying more infrastructure developments. There’s a shift of return from paper asset to tangible asset. There’s a shift in environment from disinflation to more inflation. All that is favourable for commodity prices.

BM, Morgan Stanley An issue is the persistence and steepening of contango; it has made the internal sales job for pension funds trickier. An environment whereby they could go in with a zero forecast for spot returns and still have a positive return due to the backwardation meant the argument was easier to make. In the contango environment you need a positive spot price forecast to justify investing, so some are finding it trickier. But on the flip side geopolitical risk continues to increase, making the event risk hedging case for commodities greater. So the total-return forecast is weighed down by this contango but the diversification aspect is strengthened by the fact that you need a geopolitical hedge to the tension in the Middle East. Regarding flows, the retail sector in Europe has woken up to commodities. A lot of jurisdictions in Europe didn’t have access to this asset class before, and now they do, through structured products or funds. A lot of them are grabbing this opportunity.