Commodity markets offer the chance to bet on the potential for war in Iran or how much copper Chinese plumbers will need to tide them over their New Year holiday. Investors pumped $6bn into US commodity- linked funds last year. This aids portfolio diversification. It also helps that commodity indices chalked up their fourth straight year of double-digit returns in 2005. The theory still holds, but financial gains could be squeezed this year.
Commodity returns have three sources: movements in the underlying spot price, interest earned on the margin held as collateral on futures contracts, and the “roll yield”. The latter derives from buying cheaper long-dated futures and waiting for the price to rise as the delivery date nears. This works when forward curves are downward sloping. Roll yield generated almost half the annual return from Deutsche Bank’s crude oil index between 1989 and 2004. Fears of supply shortages have pushed the near-end of the forward curve into contango – upward sloping. Roll yields turned sharply negative in 2005. Deutsche reckons oil indices might require a 2006 spot price of $77 a barrel, 21 per cent above the average so far, just to break even this year.
Volatility will increase. In base metals, speculative buying is pushing prices to new records, even as stocks increase. Unravelling esoteric fundamentals is one thing. But markets seemingly defying gravity exert a fascination all of their own.
