Are investors spurning commodities? Net inflows to US commodity-linked mutual funds in the year to August were just $107m, compared with $3.8bn in the same period of 2005.
This could suggest that the bull market has peaked. Morgan Stanley, for example, suggests that slowdowns in China and in US housing will prompt mean reversion in commodity prices. A US recession and a sharp deceleration in China would certainly prick the bubble. It is not clear, however, that growth will slow by that much. Low stocks of several commodities and supply constraints will also lend support. Nonetheless, prices remain far above the cost of production. The International Monetary Fund estimates that aluminium, copper and nickel prices, are 1.5 to 2.75 times production costs.
Morgan Stanley also suggests that speculative investors deserting the ship like rats will reinforce any decline. A more subdued price outlook, combined with the negative carry costs of many commodity index investments, might reduce appetite for the asset class. Commodities in contango – with future prices higher than spot prices – account for two-thirds of the main commodity indices. Rolling forward a long position under this term structure costs money, as spot contracts are sold to buy later-dated, more expensive, ones. Investors, however, are becoming more sophisticated to try to mitigate these negative “roll yields”. Barclays Capital estimates that inflows to commodity-linked structured products so far this year have risen 80 per cent to $4.9bn, based on data from MTN-i, a compiler of league tables. Interest is also growing in alternative investment strategies, such as long-short, rather than buy and hold.
The slowdown in mutual fund flows into commodities does not necessarily mean investors have lost interest. Furthermore, speculators may not have undue influence over prices. A study this month by the IMF suggests that speculative positions follow commodity price movements, not the reverse. Even if speculators do turn bearish, their impact on prices may not be as dramatic as expected.