The reason for this, Heartwood investment manager, Jade Fu, says is the ever-increasing dominance of financial considerations over fundamentals in many of these markets.
While acknowledging that each commodity market has different cycles and drivers, Fu said the one thing that unites them is their growing ‘financialisation’.
“This in turn leads to greater price volatility, and greater correlation with other financial assets, therefore reducing the diversifying characteristics of the asset class,” he said.
In a paper published in November 2013 for the United Nations Conference on Trade and development, titled, Quantification of the high level of endogeneity and of structural regime shifts in commodity markets, which examined the impact of the increasing role of financial markets on commodity price discovery, the authors found that: “the financialisation of commodity markets has not been accompanied with an increase of market efficiency compared with the period preceding the rise of electronic trading.”
It added, “Despite significantly increasing trading and market participation, we have observed signatures that suggest that the price discovery process has become in fact less efficient, in stark contrast to the usual postulated hypothesis.”
That is not to say that there are no longer any opportunities for investment within the commodity space, but rather that at a broad level, their use as a diversification tool has been weakened.
As Fu says, “We seek to take advantage of specific opportunities as we see them.” But a blanket commodity-index exposure we believe has less value for these reasons, as well as for the simple fact that the broad commodity indices are overwhelmingly dominated by energy components.”
And, at present, Fu adds, at current levels, there “remains a geopolitical premium in the oil price (not to say that this cannot spike higher), and we do not see any meaningful supply constraints.”
“In an environment of potentially rising real interest rates, there are headwinds for the asset class that have not been present for a while. We continue to see potential in specific commodities, but a targeted and nimble approach is key to adding value from this diverse group.”
