Global Investing

from Commodity Corner:

Why are commodities risky assets for investors?

Recently I received an email asking me to explain why commodities are risky assets. "I would think energy and raw
materials would still be in demand, even if Dubai defaults," the writer said.

 It's a good point. People need to eat, drink, drive and live. They can't do it without commodities.

 But for investors commodities are risky. That is because they mostly invest using commodity futures, which are subject to
wild price swings because they react strongly and immediately to demand and supply news and changing expectations for the future.    Since commodities became more popular with investors they have also become highly influenced by market sentiment and macro economic indicators and that's why they have been moving alongside equities.

More investors in commodity futures markets is also why the link between equities and commodities has become much stronger over the past year to 18 months.

 But that's an aside. Ultimately commodities are risky because they are volatile. Institutional investors don't like volatility whether its price volatility or return volatility.

When is a speculator not a speculator?

A lot of fuss is made about the dangers of speculators in commodity markets. But who is a speculator and who isn’t is based on a definition drawn up in the early part of the last century in the United States. The definition is no longer valid and anybody looking at those reports should be wary of drawing any firm conclusions.

For a start the word “speculator” with negative connotations is applied to pension funds, which invest over the long term to provide retirement income for many people around the world. Hedge funds are normally speculators but if they have hold the physical commodity then they can say they are commercial hedgers. Taking this theme a little further many natural resource companies run their Treasuries as profit making centres, which encourages them to trade the commodities they produce.

The London Metal Exchange has said it won’t go down the route the CFTC has and publish a weekly report detailing speculative long and short positions because there is no clear definition.

Investors break commodities link with equities

Investors smelling profits in commodities are using the sector as an early cycle play, alongside equities, because a lack of production capacity means higher prices sooner rather than later. 

Historically, prices of natural resources lag equities, which typically front run the economic cycle by between 18 to 24 months. The change is also partly due to the tumbling dollar, a major driver in recent weeks.

The natural resources sector is also one of the last to price in economic expansion. But not this time.

Start building the bunker

They keep telling us that the recession is over so maybe now’s the time to start worrying about inflation. That’s the view many wealthy investors are already taking, reasoning that a little bit of the yellow shiny stuff will provide some comfort as we start piling our cash into wheelbarrows to do the weekly groceries shop.

It is gold exchange traded commodities (ETCs) that have seen the biggest investor inflows this year so perhaps it’s not surprising that the gold price broke through $1,000 an ounce this week.

“Investors are concerned about sovereign risk, quantitative easing, government deficits and the outlook for the US dollar,” said Nicholas Brooks, head of research and investment strategy at ETF Securities, at a Dow Jones Indexes commodities briefing on Tuesday. “They are using gold as an insurance policy.”

The Big Five: themes for the week ahead

Five things to think about this week:

Q3 – CLUES AND CUES
- Global equity markets started the quarter positioned for economic stabilisation after a strong Q2 performance but, even so, EPFR data shows less than a third of the cash that flooded into money market funds in 2008 has exited in the year to date. The Q2 reporting season, which is about to kick off (Alcoa out this week), will show whether there are reasons for investors to draw down their cash holdings further. The U.S. data that came out before the long July 4 weekend held more negative surprises than positive ones, and macroeconomic confirmation of recovery will be needed to tempt more wary investors into equities.

BOND YIELDS
- Benchmark U.S. and euro zone bond yields broke lower after the U.S. non-farm payroll data but the VIX hit some of its lowest levels post-Lehman and a recent compression of intra-euro zone spreads has yet to go markedly into reverse. Which of these trends turns out to be sustainable will become more evident in the next few weeks, particularly as U.S. supply resumes this week with TIPS, 3, 10, and 30 year auctions.

L’AQUILA SUMMIT
- The slow-burning international reserve currency debate could pop up at the G8/G8+5 big emerging powers summit in Italy this week. China’s public stance is that it is not pushing the issue but Beijing also reckons a debate on this would be normal at such a forum. It is unclear if any final statement will mention it in a way that would rattle FX markets. But sideline comments on the debate will be closely watched and particular focus will be on which countries, if any, would be willing to join China, Brazil and Russia in their commitment to buying the IMF SDR notes — for which crucial groundwork was laid down this week.

The Big Five: themes for the week ahead

Five things to think about this week:

EYE ON CENTRAL BANKS
-  Investors will be on the lookout for any further signals on quantitative easing when the European Central Bank and the Bank of England announce their decisions on Thursday. Analysts see the ECB leaving rates on hold but pushing ahead with and possibly extending a plan to buy up to 60 billion euros in covered bonds. The focus will also be on growth forecasts for the next year and the message they send about the pace of any recovery.

COMMODITIES SUPERCYCLE, CYCLICAL SURGE
- Oil prices are nearly double their four-year low set in December and the Baltic Dry Index, which tracks rates to ship dry commodities, has risen more than 300 percent since the start of the year. Coupled with a weakening dollar, investors might be bracing for the return of the supercycle in commodities. The resultant inflationary pressures could push investors away from government bonds and into the arms of equities.

EMERGING DISCONNECT
- High-yielding emerging market currencies remain weak, weighed down by poor domestic growth prospects even as emerging equities rise along with their developed market peers, buoyed by hopes of a global economic recovery. The disconnect is likely to persist with governments, particularly in emerging Europe, looking likely to lower interest rates further.

Big Five

Five things to think about this week:

VALUATIONS
- The MSCI world stocks index has rebounded 37 percent since March, the VIX fear gauge has hit its lowest level since September 2008, and positive earnings surprises in Europe are marginally outstripping negative ones. But there are serious questions over the equity market’s ability to sustain its rise.

MACRO SIGNALS
- Trade data from the U.S., Canada and the UK, all out in this week, will be combed for signs of any recovery in global commerce. Also due are flash GDP data from the euro zone, industry output for the U.S., France, Italy, the euro zone and the UK, and Japan machinery orders.  
  
QUANTITATIVE EASING
- The ECB has finally shown willingness to deploy unconventional easing measures but it’s hard to judge the success of such steps. Narrowing credit spreads, stock markets’ bounce and gains in emerging market assets all show efforts to restore confidence in the financial system are having an effect. But if getting and keeping bond yields down is the yardstick for success, it’s unfortunate that 10-year UK and U.S. government bond yields are back up to levels seen before the announcement of quantitative easing in those countries. And diminishing returns on further balance sheet expansion raise questions over how much more money central banks can print before inflation fears start to preoccupy policymakers and markets.
  
COMMODITIES
- Confusion over the reasons for the commodities rally has reduced the usefulness of commodities prices as indicators of the industrial outlook. An apparent economic recovery in China has helped to boost the CRB commodities index by 21 percent from February’s lows. But how much does the rise reflect a change in supply/demand for commodities, and how much is it simply due to idle money flooding back to unstable markets? Similarly, why has spot gold remained strong above $900 as jitters over the financial system decrease? Gold could be reflecting expectations that recovering economies will boost physical demand for the metal, but it may also be responding to fears of currency debasement after central banks’ radical monetary easing.

EMERGING MARKETS 
- Rising commodity prices and an easing dollar have offered a perfect environment to re-enter emerging markets. The coming week’s  EBRD meeting will focus attention on central and eastern Europe and how it is coping with a nasty period of refinancing (albeit less dire than the IMF initially estimated).

from Commodity Corner:

Correlation Between Oil and Equities Markets

oil-vs-stock-market

Oil prices have been trading in an unusually strong positive correlation with equities markets over the past few months on hopes that signs of an economic recovery could mean a boost for energy demand.

But with oil and product inventories swelling and little sign of demand improving in the United States and other big developed economies, analysts warn that the linkage may be hard to maintain, especially if U.S. motorists cut back on vacations this summer.

Greenland – new and poor country?

Greenland, an arctic island with a population of 57,000, voted for self-governance from Denmark in a referendum on Tuesday. The “Yes” camp won an overwhelming 75 percent of the vote.

Shrimp and halibut fishing and tourism form the backbone of the economy but the island is rich in minerals and its waters may hold vast hydrocarbon reserves.

The resources setting is very much like one of Iceland, although Greenland – made up mostly of Inuit people who live in small, isolated villages – does not have a huge banking sector. (Neither does Iceland these days, some might argue.)

Hedge funds and commodities find interest cooling

rtr1w493.jpgIt was not so long ago that hedge funds and commodities were the two red hot areas to invest in.

The credit crisis has shown that investor interest can quickly cool.

Many hedge funds betting on a so-called “super-cycle” have been caught out by a sharp pullback in commodities after a five-year bull market and are now facing the task of soothing anxious investors.

One of those to have suffered – hedge fund firm RAB Capital - is trying to strike a bargain with investors in its flagship Special Situations strategy, which has plunged 48 percent year-to-date after some bad bets on mining stocks plus a high-profile mistake at Northern Rock.