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LONDON: Oil has traded a narrow range since the start of this year, stabilising after a sharp recovery from the crash that followed a more than six-year bull run, ended with the record highs of mid-2008. The historic bull run coincided with the arrival of new types of investors and traders that made oil more like other financial markets. The market’s traditional participants include oil companies and airlines, who use futures contracts and derivatives mainly for hedging exposure to physical oil.
All participants have grown increasingly sophisticated, moving from passive to active and to various types of structured products that can generate returns unrelated to price direction and market structure. The following are outline details of the main buyers and sellers of oil, as well as of other commodities, and some of the ways they gain exposure.
PENSION FUNDS STILL ARRIVING
As raw materials gained popularity as portfolio diversifiers, some of the pension funds, the most naturally cautious investors, devoted up to five percent of their portfolios to the asset class. Equities still form the bulk of investment portfolios, but the balance has shifted as fund managers have increased their exposure to emerging markets, fixed income and alternatives, which notably include real estate as well as commodities.
Big pensions who have bought raw materials include the $200bn California Public Employees’ Retirement System (Calpers), the biggest U.S. public pension fund, which started investing in 2007. As the trend continued, in June this year, the California State Teachers Retirement System (Calstrs), the No. 2 US pensions fund, approved a plan to invest in commodities. Fund managers say investment is still flowing into commodities, but so far this year, many say inflows have been relatively modest.
INDEXES AND INSTITUTIONAL
For institutional investors, including pension funds, the traditional way to gain exposure to commodities has been through equity stakes in resource-holding companies, such as oil major BP and miner Rio Tinto. Once they have decided to move into commodity markets, typically they have taken exposure through long-only commodity indexes.
These baskets of commodities tend to be heavily weighted towards energy and to rely on a backwardated market structure (meaning prompt prices are more expensive than those for later delivery) to generate returns. At the end of the first quarter, Standard & Poor’s estimated the total amount tracking the S&P GSCI was about $75bn to $80bn and the total amount tracking the S&P GSCI and similar commodity indexes was about $130bn to $140bn.
That compared with only about $5bn to $6bn at the end of 1999, but is dwarfed by the more than $4 trillion tracking the S&P 500, the world’s most widely-tracked equities index. Barclays Capital estimated global commodity assets under management stood at $291bn in May, down from $294bn in April after steep price falls in risky assets.
SECOND HALF 2008 ONWARDS
Deep recession, weakened energy demand and rising inventory levels have created the opposite market structure to backwardation — contango — in the oil market, undermining passive, long-only index investment, and making some investors favour different styles of index and commodity product. Another consequence of recession has been that asset classes have tended to move in tandem — again weakening the value of commodities for institutions because they have lost their appeal as portfolio diversifiers. The unusual positive correlation was marked last year when a wave of cheap money generated by economic stimulus measures led to a wave of cross-asset buying. It has continued this year as risk appetite and risk aversion have alternately swept across nearly all sectors.
Hedge funds have injected liquidity into oil and other commodity markets. They include London-based Clive Capital LLP and New York-based Touradji Capital Management LP, which invest in a range of commodities. Traders have said many oil-focused passive funds have been underperforming so far this year, compared with last year, but some active funds should have made good returns from taking short positions and precious metals funds have also done well.
The two main long-only indexes are part of the family of Dow Jones-UBS and S&P GSCI indexes. The S&P GSCI Commodity Index invests in 24 commodities. Its website shows the index weightings as of June 28 were: 71.15 percent in energy; 12.58 percent in agriculture; 7.88 percent in industrial metals; 4.85 percent in livestock and 3.54 percent in precious metals. Dow Jones-UBS Commodities Index invests in 19 commodities, such as gold, crude oil, coffee, aluminium and zinc. No related group of commodities, or energy, precious metals, livestock or grains, may constitute more than 33 percent of the index or less than 2 percent of the index, according to the index website. reuters