Asset managers are advocating a re-appraisal of commodity funds, given the asset class has historically provided a natural hedge against the inflation many believe is returning to the global economy.
And global investors appear to agree. Since last January, when commodity funds' assets under management (AUM) hit their lowest level since the 2009 commodity crash, flows have climbed steadily, particularly during the second half of the year.
In January, inflows were especially strong. AUM rose 7% month-on-month and 53% year-on-year to $391 billion, of which $91.5 billion is actively managed.
So far, commodity experts believe hedge funds have accounted for most of the flows into actively managed funds. Retail and traditional asset allocators, by contrast, have been ploughing money into exchange-traded funds.
But active fund managers believe asset allocators need to change tack, citing last year's paltry returns from oil-based ETFs.
For example, the spot price of Brent crude rose 52.4% over the course of 2016. By contrast, NYSE-listed ETF, United States Oil Fund, returned 6.5% during the year compared to 22% for oil-focused hedge fund Andurand Capital.
Christopher Wyke, Schroders' product director for emerging-market debt and commodities, told AsianInvestor: "Investors made the right asset allocation decision when they chose oil, but the wrong vehilce when they chose ETFs.
"The market is in contango [meaning the spot price is lower than the forward price]," he continued, "so they're getting a negative roll yield when each monthly futures contract rolls over. It's killing returns."
Wyke also believes Asian investors have lagged the rest of the world when it comes to re-investing in commodities, although he says high-net-worth investors had been an exception.
Mike Coleman, who founded RCMA Asset Management's long/short $220 million Merchant Commodity Fund in Singapore, agrees. He believes Asean-based investors have typically been loath to invest in commodity funds because many are physical producers and want diversification.
For Northeast Asian allocators, the main reason is cultural. He said, "They're conservatively run institutions and they don't allocate much to alternatives, let alone commodities, which are a subset of global macro funds."
Inflation, deflation or stagflation?
Wyke believes this attitude needs to change fast in a world where inflation is re-appearing, given that commodity prices remain low by historical standards, but may not stay that way for long.
He cited Merrill Lynch’s monthly survey of global asset managers. In February, managers went overweight commodities for only the second time since 2012. A month earlier, they were 3% underweight and at their most bearish in 2015, were 30% underweight.
Overall, commodities have been in a secular bear market since 2011, although a bounce-back began in the middle of last year.
The question is how long this can last, and this is where Wyke and Coleman part ways. Wyke argued that commodities are in the early stage of a new bull market, whereas many believe bonds are overpriced and equities only have a few pockets of value left.
Many economists, for example, believe the current economic cycle is in its advanced stages and commodities are normally a late-cycle mover. As demand picks up, commodity prices rise and lift inflation, which can, in turn, choke off global growth.
Coleman pointed out that commodities do not perform well in the face of stagflation. By contrast, Wyke highlighted that the move from monetary to fiscal policy at a time of full employment should act as a growth and inflation stimulant.
Coleman also believes commodity prices may consolidate at current levels unless there is a positive surprise, such as an uptick in global growth to the 4% to 4.5% level.
“Commodities were oversold in the first half of 2016,” he said. “But it’s not clear whether this is a correction of that oversold market, or the beginning of a new cycle. Some industrial commodities such as iron ore and rubber have been pulling back in the past month.”
When it comes to individual sub-sectors, Wyke and Coleman also have contrasting favourites.
Coleman still likes coffee and sugar, which both performed well in 2016. The former rose 35.2% before peaking in early November, while the latter climbed 28% over the course of the whole year.
“Coffee was our favourite last year, and we still think there’s another leg to the bull market,” he remarked. “Sugar has been disappointingly soft recently, but the supply/demand dynamics still work in its favour.”
Coleman is not so keen on grains. “We won’t get structurally bullish until there’s some kind of weather-related problem to spur the market,” he noted.
However, Wyke said Schroders did well from coffee and sugar in 2016, but now favours grains and materials, flagging lumber’s 11% rise over the past month.
Wyke also said his firm likes natural gas. Prices collapsed a decade ago and Schroders believes they are poised to make significant gains as the supply/demand dynamics have shifted. He also highlighted precious metals and particularly silver, whose fastest-growing industrial use is for solar panels.
And he concluded that Chinese investors could be a strong factor pushing gold prices up. Capital controls make it hard to move money offshore, so mainland investors have been buying the precious metal to protect themselves against further renminbi devaluation.