Crazy or brave? That might be the most logical thought if anybody told you now was a good time to invest in commodities, given the sharp declines in the main indexes in the past few months.
But that’s exactly what the overwhelming majority of fund managers and bankers were advocating at last week’s World Commodities Week conference in London.
Their optimism was in contrast to the clutch of analysts who presented at the meeting, who generally reinforced the current bearish theme by pointing to softness in demand in top importer China, as well as plentiful supply for many commodities.
The fund managers and bankers do have more than just blind optimism (and a desire for fresh funds to manage), and can point to a raft of reasons why they believe prices are near a bottom.
But the question remains as to who has the most compelling argument, and whether institutional and other major investors are prepared to buy into an asset class that most would view as having a disappointing recent track record.
While commodities had a good start to the year, outperforming equities, they have since struggled, with the Bloomberg Commodity Index down 13.2% from its 2014 peak in late April, and the S&P GSCI 14.9% weaker from its June high.
Much of the weakness has been because oil prices fell after gaining on geopolitical fears related to Iraq and Ukraine, while metals and bulks suffered as China’s economic growth outlook wobbled and certain agricultural commodities weakened in the light of higher expected production.
The problem for any bullish outlook is that the above reasons are pretty much still in force.
So what are the reasons to expect improved performance is around the corner?
Other than a gut feel that prices have fallen enough, the most cited argument at the conference was that the so-called commodity supercycle remains in place, and the long-term growth case remains compelling even if the market is currently in a bear phase.
Even if these are valid arguments, the main problem is that for many commodities producers have acted to bring on so much new supply that even bullish demand outcomes will be swamped by the increased output.
This is the case in coal, iron ore, refined oil products, and copper, with liquefied natural gas among commodities with the potential for oversupply.
Even if there are strong gains in volumes, there may not be matching gains in prices, which is an undesirable outcome for commodity investors.
While a broader, long-term bullish demand trend may still be intact for commodities as China, India and other major developing nations such as Indonesia, experience urbanisation and a growing middle class, the actions of resource companies has significantly undermined the potential for higher prices.
The trick is to find commodities with supply constraints, coupled with a still compelling demand profile, and then find ways to tap into the potential for higher prices.
For portfolio investors, commodities were touted as still offering diversification and insurance against inflation.
However, there was recognition that unless absolute returns can be boosted, commodities as an asset class will struggle to attract new investors and may lose more of the existing pool.
What was increasingly clear at the conference was that some of the traditional ways of investing in commodities were unlikely to deliver acceptable returns.
Strategies that involve playing contango and backwardation on futures curves, or trades that followed momentum were described by one fund manager as “naive.”
More complex strategies, active management, trading both long and short and focusing on individual commodities rather than a basket in an index are possible solutions.
But for parts of the investment community, such as major pension funds with strict mandates, these strategies may not be suitable and won’t help boost interest in the asset class.
But what is clear is that commodity investment, if it is going to be successful, is going to become increasingly specialised and active.
Passive strategies and traditional index-based products are unlikely to be able to deliver returns high enough to make them compelling when viewed against alternative assets classes.