Commodity Trade Mantra

Investors’ Bullish Commodity Bets Hit Record on Signs of Growth

Investors' Bullish Commodity Bets Hit Record on Signs of Growth

Investors’ Bullish Commodity Bets Hit Record on Signs of Growth

Commodity prices are enjoying their best run in years, fresh evidence that investors are betting on a pickup in the global economy after years of sluggish growth and scant inflation.

The S&P GSCI Index, which tracks commodity futures, rose 28% last year in its biggest gain since 2009. Many commodities have continued to rally this year. Oil and natural-gas prices have soared more than 50% over the past 12 months. Precious metals like silver and materials like lumber have scored big gains in recent weeks.

Rising interest in commodities reflects a sharp turnaround from a year ago, when these markets fell to historic lows that wiped away all gains from the 2000s. Booming commodity prices had attracted new producers, flooding markets for everything from oil and gas to aluminum and wheat.

Now, as signs of inflation and improving global demand have returned, investors are beginning to pile back into commodities.

Commodity assets under management globally rose 7% in January from the previous month to $391 billion, up more than 50% compared with the previous year, according to Citigroup. Long positions at actively managed funds rose to the highest level since 2014, the bank said.

Darwei Kung, portfolio manager of the $2.1 billion Deutsche Enhanced Commodity Strategy Fund, thinks the rally is just getting started after an epic collapse that only ended last year.

“We have a long ways to go on prices,” he said.

A sustained rally in commodities would likely signal healthy consumer and business demand. It could also be a boon to the many emerging-market countries that rely on commodity exports, such as Russia, South Africa and Malaysia. A Brazil exchange-traded fund doubled in price over the past year, in part boosted by the powerful gains in commodities, analysts say.

But extended commodity rallies also tend to stoke inflation, which could bring higher U.S. interest rates that can choke off economic growth. Rising interest rates could also boost the dollar, another threat to the commodities and emerging-markets rally.

Bullish bets on oil, copper and cotton futures all hit record levels in January, according to data from the Commodity Futures Trading Commission that goes back to 2006. That was the first time in nearly a decade that this cross section of materials and resources established new highs simultaneously.

The Materials Price Index, which tracks oil, metals, lumber and other commodities, closed higher for a record 17 straight weeks before finally falling in the last week of February.

“There’s a lot of optimism coming back into the market,” said John Caruso, senior trader at RJ O’Brien & Associates LLC.

Commodities aren’t the only investment rising on optimistic growth expectations. Bets on Treasury inflation-protected securities, or TIPS, which offer protection against higher consumer prices, have been increasing. Major U.S. stock indexes are also at all-time highs, with the Dow Jones Industrial Average closing above 21000 on Wednesday for the first time.

Inflation has been nearly nonexistent in much of the developed world, though it is showing signs of stirring.

The U.S. consumer-price index increased in January by 0.6%, the biggest monthly gain in almost four years. Europe’s inflation measure rose to the highest in four years last month. Recent Chinese data also shows expansion in manufacturing and increasing consumer confidence, easing investor concerns that China’s growth would continue to slow.

Investors hope that President Donald Trump’s fiscal stimulus and financial deregulation proposals can boost growth and consumer prices further. Mr. Trump reiterated plans to push for tax reform and infrastructure spending in his first address to Congress on Tuesday.

“There has been euphoria post election,” said Jeffrey Sherman, portfolio manager of the DoubleLine Strategic Commodity Fund. The fund started increasing exposure to commodities about a year ago, and has gone from holding its base minimum of 75% long positions in September 2015 to being 90% long at the end of January.

Some analysts believe the euphoria may be misplaced. They say that these early signs of growth could still fizzle out. In a February report, Goldman Sachs analysts wrote that even if economic indicators look promising, “‘show me the activity'; real demand, real stock draws and empty warehouses.”

A rising dollar could also pose a problem. While the currency declined for most of the first two months of this year, it has rallied in recent days on stronger indications that the Federal Reserve could raise rates at its mid-March meeting. That could put pressure on commodities. Most are priced in dollars, and when the dollar appreciates that makes it more expensive for foreigners to buy these goods.

Not all markets are sending bullish signals for growth. Yields on 10-year U.S. Treasury debt recently fell to their lowest level since November, a warning that riskier assets may be overvalued. Gold has also staged a comeback this year, as buyers have sought insurance against economic and political risk.

Investors have other reasons to be cautious. Oil prices rallied after the Organization of the Petroleum Exporting Countries and other big oil producers agreed to cut output in November. But a significant expansion of U.S. production, or if OPEC fails to extend its production cuts beyond June, could undermine the gains in oil.

A retreat in commodity prices, combined with a strengthening dollar, would be a double blow to emerging markets, which would find it much more expensive to pay back their dollar-denominated debt.

Some institutional investors that got slammed during the commodities collapse may be reluctant to jump into this rally.

“You haven’t seen this wholesale buying from the investment community, and I think a lot of it is they’ve gotten burned for owning commodities for many years,” said Mr. Sherman.

Even the extreme bullish positions in commodities stoke concern that any bad news could spark a reversal if investors unwind their bets. The last time oil, copper and cotton set all-time highs together was in 2008, months before an economic downturn sent commodity prices tumbling.

“There is so much uncertainty that we just haven’t felt comfortable taking positions in commodities right now,” said Bill O’Grady, chief market strategist at Confluence Investment Management, a St. Louis-based money manager.

Still, prices may continue to rise as investors come back to the commodity market, he said. “[It’s] really starting to capture the imagination of some investors. We could see it get even more extreme.” —Katherine Dunn

 

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