It seems those articles calling for the death of commodity funds didn’t resonate with investors looking to get in on a possible uptrend in the commodity markets. Thirty-Three Billion in new money flowed into Commodity Exchange Products in 2016, the most since 2009, and it doesn’t look like investors are slowing down in 2017. According to RBC Capital Markets, investors poured $3.3 Billion into global commodity funds in January, bringing total AUM to $172.3 Billion. It turns out investors did listen to op-ed’s like this one, calling on investors to “bulk up on commodities,” mainly on the idea that that we might see a resurgence in the commodity super-cycle in 2017.
A few things catching our eye here:
1. This is performance chasing writ large… The main interest for these flows is that the commodity indices were up last year. It’s usually shrouded in excuses like inflation hedges, but the interest would have been much more muted, if existent at all, had commodity markets posted another losing year in 2016. Will “commodities” push higher in 2017? Who knows, but it’s not a market known for its persistence of returns, and even if it does push higher – it is a market known for its volatility of returns… meaning even if right on direction, it will be a risky and dangerous path to get there.
2. This is an Oil bet in disguise. Most of the commodity indices are heavily skewed towards the energy complex and Crude oil in particular, with the rest of the exposure mostly in metals. So dream all you want of that field of Corn or Cotton and exposure to inflation in such markets in places like South America or Australia. You’re not going to get any return from those markets in a ‘commodity index’ product unless Oil and Metals play along. And if you’re basically just betting on Oil, there’s a lot better ways to do it than the inefficient access point of commodity index products.… and one very bad way to do it named $USO. See our breakdown here:
3. A recurring theme among investors we speak with is a renewed interest in so called “commodity strategies.” What do they mean by “commodity strategies?” Well, that’s where we scratch our head, too. You see, when you show up at a hedge fund conference looking to analyze and vet “commodity programs,” based on a renewed interest in commodities, based on the performance of the commodity indices last year – it is sort of like you’re going to a sushi restaurant in Chicago because you heard the city has the best steak restaurants. Put simply, many investors are looking at commodity based absolute return products based on directional long only commodity performance. Hey, we’ll take the interest, and they’ll likely be better served for being in the world of risk controls and the ability to go short. But more than a few are likely to be confused and/or upset when and if commodity prices go on a tear higher and their absolute return program doesn’t keep pace. Conversely, they should be happy as clams if commodity prices reverse course and their absolute return strategy has the opposite sign in front of their annual number.