Commodities R.I.P. as speculators exit, growth stalls
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Commodities markets are heading for the biggest annual decline since 2001 as investors exit leveraged bets and slowing economic growth erodes demand for raw materials.
The value of the 19 commodities in the Reuters-Jefferies CRB Index fell $US280.6 billion, or 43%, from its July 3 peak, a loss larger than their total worth two years ago, data compiled by Bloomberg show. UBS AG, the Zurich-based bank that bought Enron Corp.'s energy unit in 2002, plans to exit most commodity trading. About 15% of investors in Boone Pickens's BP Capital LLC hedge fund may want their money back.
The same credit-market seizure that led to last month's bankruptcy of New York-based Lehman Brothers Holdings Inc. and the forced sale of Merrill Lynch & Co. is squeezing speculators who drove commodities to record highs. Slower expansion in the US, China and India is also undermining prices of crude oil, which fell 36%, and corn, down 43%.
``The day of steadily rising commodity prices is over,'' said Chris Rupkey, the New York-based chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. ``A lot of the demand for commodities has been speculation, and now that demand is falling away because of fear taking hold in the market.''
The CRB, which doubled from 2001 to a record 473.97 on July 3, may drop 15% this year, said William O'Neill, a partner at Logic Advisors in Upper Saddle River, New Jersey. The last time the index lost that much was 2001, when the US sank into a recession. It's down 9% for the year.
Price outlook
A global slowdown may cause crude oil to plunge another 47% to $US50 a barrel next year, New York-based Merrill Lynch said in an Oct. 2 report. Goldman Sachs Group Inc. cut its forecast for copper next year by 12% to $US8,265 a metric ton and aluminum by 18% to $US2,920 a ton.
Corn may tumble as much as 15% to $US3.87 a bushel in the next six months, and soybeans by 11% to $US8.85 a bushel, said Don Roose, president of US Commodities Inc. in West Des Moines, Iowa.
Investors who embraced commodities as an investment class like stocks and bonds, while demand from China and India eroded supplies faster than they were replaced, are now in retreat.
Outstanding contracts for 17 commodity futures traded in New York and Chicago fell 26% since a peak on Feb. 29 to the fewest in two years, data compiled by Bloomberg show.
Net-long positions, or bets prices will rise, held by hedge funds and other large speculators fell to 7% of total open interest for futures on Sept. 23 from 14% on March 25, according to an Oct. 2 report to clients by Barclays Capital in London.
Unprecedented rally
The decline follows an unprecedented rally as the UBS- Bloomberg Constant Maturity Commodity Index of 26 raw-materials rose every year since 2001.
About 450 commodity hedge funds held $US80 billion of assets as of Sept. 1, up from $US55 billion last year, said Brad Cole, president of Cole Partners Asset Management in Chicago. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices, and participate substantially in profits from money invested. They typically use borrowed money, or leverage, to amplify investments.
Frankfurt-based Deutsche Bank AG, Newport Beach, California-based Pacific Investment Management Co. and Jersey- based ETF Securities Ltd. led Wall Street in creating funds linked to commodities indexes such as the Dow Jones-AIG Commodity Index or so-called exchange-traded funds that trade like stocks and buy raw materials such as gold, oil or cotton.
Commodity leverage
Futures, where a $US12.50 deposit can control a $US100 barrel of oil, allowed Dallas-based Pickens to earn $US1.4 billion in 2005, Institutional Investor's Alpha magazine estimated. Michael Farmer and David Lilley at RK Capital Management LLP saw their Red Kite Metals fund in London gain 145% from inception in 2005 through the end of last year. Chris Levett, who founded London-based Clive Capital LLP, returned 17.6% in the first quarter on energy and metals bets.
Investments in commodity indexes reached a record $US175 billion at the end of June, Barclays Capital said. Saudi Arabian Oil Minister Ali al-Naimi and Michael Masters of Atlanta-based hedge fund Masters Capital Management said speculation, not supply and demand, was responsible for increasing prices.
Crude oil quintupled from July 2002 to a record $US147.27 a barrel on July 11, corn more than tripled from June 2006 to the highest ever, $US7.9925 a bushel, on June 27. Gold more than doubled in the three years to March 17, when it reached a record $US1,033.90 an ounce.
Changing outlook
Prices dropped since June as the US Dollar Index strengthened 9.6% in the third quarter, the most since 1992, economic growth slowed and bank losses from the collapse of subprime mortgages swelled to $US586.6 billion, according to data compiled by Bloomberg. While President George W. Bush signed into law a $US700 billion bank rescue plan Oct. 3, the leverage that pumped up commodities is unlikely to return.
``Easy credit is done, it's finished,'' said Robbert Van Batenburg, head of research at Louis Capital Markets LP in New York, a broker to institutional investors and hedge funds. ``I don't think there's going to be a quick end to this situation.''
The three-month London interbank offered rate, or Libor, that banks charge each other for 90-day loans in dollars, increased to 4.33% on Oct. 3, the most since January, the British Bankers' Association said.
Bailout, volatility benefits
Some investors and analysts expect commodities to rebound after the worst quarter for the CRB Index since at least 1956. The US bailout may revive speculation as the government buys troubled assets, and record swings in prices may lure investors. The 10-week volatility in the CRB Index last month was the highest since 1973.
While economic growth is slowing, demand for food and fuel will continue to increase even if producers cut back supplies.
``I'm not bearish on softs,'' said Christoph Kampitsch, who helps oversee $US1.5 billion in hedge funds at Erste Group Bank AG in Vienna. ``In nine to 12 months, soybeans, cocoa, sugar and wheat will recover. For agricultural products, there could be supply disruptions very easily. People also need to eat.''
The drop in prices may lead to lower production and create shortages as soon as next year.
``It's a wholesale liquidation of all assets as people became concerned about the economic outlook,'' said Angus Murray, founder and joint chief executive officer of New York- based Castlestone Management Ltd., with about $US1 billion in assets. ``If this liquidation continues, commodities producers will stop producing. We'd end up with a severe shortage of commodities that would eventually boost prices back up again.''
Slower growth
Economists say US growth will slow to 1.5% next year from 1.7% in 2008, according to surveys compiled by Bloomberg. China expanded 10.1% in the second quarter, down from 12.6% a year earlier, and India grew 7.9%, compared with 9.2%.
Institutional investors withdrew $US5 billion from commodity indexes during the third quarter, according to Barclays Capital. The combination of outflows and dropping prices pushed assets under management in indexes down 31% to about $US120 billion, the bank said.
Every commodity in the CRB Index fell in the third quarter, led by a 44% drop in natural gas. The value of the 19 commodities fell to $US374.8 billion on Oct. 1 from $US655.4 billion on July 3, according to data compiled by Bloomberg. The total value of those futures contracts on Oct. 1, 2006, was the $US271.9 billion.
Closing funds
Ospraie Management LLC, once the world's largest hedge fund dedicated to natural resources, told investors Sept. 2 the New York-based firm would close its largest pool after slumping 38.6% for the year. Pickens said Sept. 30 that investors in BP Capital asked for the option to withdraw money after more than $US1 billion of losses on energy trades this year.
RK Capital fell as much as 30% in August as copper and aluminum fell to six-month lows, dropping 6.8% and 8.9%, respectively. Its Red Kite Metals fund lost about 40%, according to an investor who asked not to be identified because the information is private.
Funds of hedge funds in Europe may receive redemptions of up to 25% of assets by the end of the fourth quarter, said Aoifinn Devitt, founder of Clontarf Capital, a London-based investment consulting firm that tracks performance of about 20 commodity hedge funds. Funds of hedge funds are the largest investor group in the $US1.9 trillion industry, according to Chicago-based Hedge Fund Research Inc. They account for about 42% of hedge-fund assets, or about $US826 billion, according to HFR estimates through the end of June.
``It's difficult to be bullish on commodities,'' said Peter Rup, chief investment officer at New York-based Orion Capital Management LLC, which invests in hedge funds. ``I don't think you'll return to the highs of June or July. When the money is put back into the markets, it will find its way into equities not commodities.''
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