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Funds Retain Faith With Commodities

Date: Tuesday, January 16, 2007
Author: David Elliott, Dow Jones Newswire

LONDON (Dow Jones)--Fund managers, having spent a number of years wooing the commodity sector, appear to have removed their rose-tinted spectacles at the start of 2007.


Having been widely cited as the main factor behind the bull run in commodities at the turn of the century, they are now being blamed for hefty losses that have stretched beyond the boundaries of a routine co rrection.


Of the metals, copper has seen around 10% wiped off its value since Jan. 2, aluminum 6% and gold 5%. Soft commodities haven’t escaped either, with both corn and wheat futures falling over 9%, sugar 5% and coffee 6%.


But bearing the brunt of the selling pressure is the crude oil market, where Nymex West Texas Intermediate has lost more than 11% since Jan. 2 and is currently holding precariously on to the key $55 a barrel level.


Warmer-than-normal weather in the U.S. northeast, a region that accounts for a significant percentage of heating oil usage, has been cited by some as the cause of the selloff but the depth of the price slide now makes that factor look like a scapegoat.


The funds “had balanced their books at the end of the year, came back to a market looking weak and decided to sell into it,“ said a broker at a London-based trade house. “It’s a general new-year commodities sell-off.“  


Antoine Halff, an analyst at Fimat in New York, said the slide has been prompted more by technical selling and the “vagaries of fund portfolio management“ than with supply and demand fundamentals. Some funds use technical analysis as a key part of their trading strategy.


“While unseasonably warm temperatures have undermined demand for heating fuels, the relatively small scale of heating demand as a share of total consumption means the weather can only account for part of the price drop,“ he said.


It seems the Christmas and New Year holidays prompted a change of heart by fund managers but others feel the summer was the turning point when the peak for crude, of $78.40/bbl for Nymex WTI, was hit.


The reasons for the exodus are undoubtedly linked to a worsening fundamental picture for a market that has suffered from waning demand for heating oil following an unseasonably warm winter in the northern hemisphere and an easing demand picture.


But wider macro economic factors may also be having an effect.


Eoin O’Callaghan, an analyst at BNP Paribas in London, said the falloff in speculative investment in commodities  reflects a slowing U.S. and global



“The recent oil and base metal price selloff is perfectly consistent with liquidity fundamentals,“ he said. “Just as excess liquidity inevitably finds its way into speculative investments including commodities, so its withdrawal by tighter monetary policy has led to correlating selloffs across commodity classes.“


As a result, fund intererst in commodities could be said to be dependent on the temperament of the global economy.


But the structure of the commodity markets has also deterred renewed interest in the sector from investors.


One of the attractions of commodities for funds at the turn of the century was a steep backwardation, where the nearby contract months are more expensive than the deferred.


This meant that at a contract’s expiry investors could roll their long positions forward and actually pick up the differential, or carry.


But the backwardation in most markets has disappeared to be replaced by a contango structure, where the nearby contracts are at a discount to the deferred.


This means investors have to pay the discount to the forward contract if they want to roll positions forward.


“These guys have had to swallow losses on the outright price and have then been hit by a big bill to pay the carry and they don’t like it,“ said a senior soft commodity analyst at a Swiss trade house.


Again, this situation has been nowhere more pronounced than in the crude oil market, where a steep contango has been in place.


“The total return has been negative,“ said Steven Miller, hedge fund manager at Baker Steel Capital Managers in London. “It makes oil a lot less attractive.“


He said funds may have reduced the amount of oil in their portfolios but felt there was still room for it as an investment.


“It’s just hard to increase oil’s application (in a portfolio) given the steep contango,“ he said.


Olivier Jakob of Swiss-based adviser Petromatrix thinks funds have taken a negative view of the oil market rather than abandon it altogether.


He points to the latest Commitment of Traders report from the Commodity Futures Trading Commission which shows non-commercials, or speculative investors, have reduced their long positions but have retained interest in the Nymex WTI crude market by increasing their short positions.


“I’ve read a lot about funds fleeing from commodity markets but have seen very little evidence of it,“ he said.


Indeed, he points out, speculators have actually increased their interest in commodities through exchange traded funds and indexes that track the movement of commodity prices.


Neil Heywood, director of marketing at Armajaro Asset Management. which runs the $440 million Armajaro Commodity Fund, felt commodities are not being brushed aside by funds.


John Tilney, the manager of Armajaro’s fund, claims not to have had a losing year in the commodities market since 1980, a feat which Heywood said is a tribute to being able to cherry pick different commodities rather than treating the sector as a whole entity.


The Armajaro Commodity Fund’s return of 18.6% in 2006 speaks volumes, Heywood said, especially when you consider it contains no foreign exchange, fixed income or equity investments.


So, while it may appear funds are abandoning commodities altogether, they are actually just changing their positions to match the prevailing conditions in the market, both fundamental and technical.


“Whether we like it or not commodities are here to stay as an asset class,“ Heywood said.


Source: David Elliott Dow Jones Newswires (4420) 7842 9411 david.elliott@dowjones.com