Material underperformance

Commodities bear market is a shifty beast

As an investment, commodities underperformed equities in 2012. But the bear market in raw materials is a shifty beast. The most significant fall has been in commodity price volatility, and that’s not a bad thing for anyone.

The underperformance is real, but should be qualified in two important ways. First, oil and gas has been much stronger than other commodities. Since January 2012, the commodity underperformance, relative to the MSCI World Index of stocks, was 18 per cent for Thomson Reuters/Jeffries CRB index, and a more modest 13 percent for the S&P GSCI, in which oil has a heavier weight.

Second, the prices of the two most important commodities for the world economy are high by historic standards. At nearly $119 a barrel, Brent crude is comfortably above last year’s record average price of $112. Iron ore, which isn’t in either index because trading is still limited, has rallied sharply from its September lows, although at $155 a tonne, it remains about 20 percent short of its all time 2011 high.

Overall, few investors have lost faith. Aggregate funds parked in commodities, including mutual funds and exchange traded products, rose nine per cent to $247 billion in 2012, according to Thomson Reuters data. But some commodity investors have taken fright.

A few high-profile commodity hedge funds have closed and some commodity index funds are seeing modest outflows, but the quitters are mostly investors who had only recently started dabbling in the asset class, according to Barclays.

Meanwhile, commodity price volatility has fallen 80 percent from its 2012 high, and is now close to lows only seen a handful of times since the late 1990s. Unusually high positive correlations between commodities and equities have also shown signs of slipping.

That suggests commodities are starting to chart their own course again, after a period in which they struggled to distinguish themselves from other risk assets. It would be ironic, and typical, if the dilettantes who waded into the asset class at the height of the “super-cycle” hype gave up just when commodities became an effective portfolio diversification tool and inflation hedge.