Ending the year on a dismal note

Solid price increases that drove strong returns in the past decade are over[SINGAPORE] The resurgence of fundamental supply and demand as a driver of commodity prices was supposed to be a life buoy for the struggling asset class this year.mini storage But as the global economy turned on its head, it dragged the asset class down further.After five years of commodity prices being driven mainly by macroeconomic factors such as quantitative easing (QE), industry observers noticed that correlations between commodities and equities started falling this year.According to research by Societe Generale, supply and demand fundamentals accounted for about 80 per cent of commodity price movements on average before the collapse of Lehman Brothers in 2008. In the aftermath of the financial crisis, however, macroeconomic factors gained an upper hand, accounting for about 60 per cent of price movements, and fundamentals only 30-40 per cent."Financial markets as a whole were very driven by the eurozone crisis - all markets really started to behave similarly," said Mark Keenan, head of commodities research at the bank. This year, fundamentals started to reassert themselves, and now explain 83 per cent of commodity price movements, he said.But this comes at a time when supply and demand fundamentals have become dismal."Excessive capacity investments in previous years have started to translate into more comfortable supplies across most commodity markets," noted commodity strategist Stefan Graber at Credit Suisse Private Banking & Wealth Management. "At the same time, current interest rate and growth dynamics prevented a stronger pick-up in commodities demand."Growth in emerging markets - typically more resource-intensive - is still lagging, while rising yields in the US economy increase opportunity costs of investing in non-yielding assets, he added. "This contrasts with the dynamics seen during the commodity boom years when US rates were falling, and Chinese economic activity accelerating."As a result, the Dow Jones UBS Commodities Index has fallen 8.3 per cent this year as at last Friday. The Standard & Poor's GSCI Index, weighted more heavily towards energy, has fared better in dipping only 1.36 per cent, albeit its first drop since 2008.Citigroup said in a Dec 9 report that passive commodity strategies have seen more than US$38 billion in total net outflows this year, compared with a net inflow of US$25 billion in the same period last year. Most of the outflows have occurred in precious metals.The stampede out of precious metals is due to dynamics unique to the gold market, and not the broader commodities complex, said Kevin Norrish, managing director of commodities research at Barclays Capital. "People were buying gold for all sorself storages of different reasons to do with inflation protection, short-term concerns over political stability . . . that's a bit different from the larger reasons why institutional investors have been investing in commodities as an asset class."The gold spot price has fallen 27 per cent so far this year to trade at about US$1,210 a troy ounce - the first time since 2000 that it has failed to end the year higher than where it started. A surge in speculative selling in bullion- backed exchange traded funds in April caused gold to fall to a low of US$1,180 a troy ounce, down 34 per cent from the most recent peak of US$1,790 in October last year.The US$1,180 price is now seen by traders as a critical support level, which if breached would trigger another quick descent in gold prices. Banks such as UBS and Societe Generale and Goldman Sachs are now forecasting a gold price of US$1,050 at the end of next year.Goldman Sachs has downgraded its 12-month rating for commodities from neutral to underweight, as it expects falls of 15 per cent or more for gold, copper, iron ore and soybean.Still, there are some like Threadneedle Investments commodity fund manager Nicolas Robin who believes that the improving global economy offers hope for the broader commodities asset class.Said Mr Robin: "Growth expectations for 2014 have recently been revised upwards, and this improvement will underpin demand for commodities. The OECD economies - and in particular the US - will drive global growth, which supports our view that oil-based energy will be the strongest sector next year."Emerging economies, aligned to a recovery in American and global growth, "will also gain strength through 2014, thus boosting demand for base metals later in the year", he added.In the view of Barclays' Mr Norrish, there is at least one positive offsetting the slightly negative returns seen in commodity indices this year: the decline in correlation with other assets means commodities can now fulfil their role as an asset class for diversification.But the solid price increases that drove strong returns in the past decade are over. Even as industry observers continue to debate whether the commodity super-cycle is truly past, and views are mixed over whether investor interest will return to commodities next year, many agree that long-only strategies which bet on one-way price rises will no longer work as well as before.There are still investing opportunities in commodities, but these involve trading the spreads, or relative values, between commodities or adding a shorting element to trading strategies, said those whom BT spoke to.As Mr Norrish puts it: "What that means is that investors are going to have to work quite a bit harder in order to generate their returns."迷你倉