Commodity Online
After eight months of consecutive decline are the commodity markets on a real revival path?  Analysis of returns of major indices does prove that commodities yielded positive returns in March after eight months of continous decline, but it looks uncertain whether the trend can continue or be sustainable especially the rally in base metals.

Driven by double-digit gains in base metals coupled with returns in energy and grains, the (Merrill Lynch) MLCX TR index increased by 5.43% in March, the S&P GSCI TR by 4.51% and the DJ-AIG by 3.60%. Equity and bond indices also appreciated, with the S&P 500 TR increasing by 8.76% and the ML US Broad Bond Market index increasing by 1.50%.



Although the energy contango persisted, the rally in spot prices of crude oil and products over the second half of the month brought the sector into positive territory. Despite US natural gas going against the trend in the energy complex, the
ML Energy TR index returned 5.07%.

The ML Grains TR index yielded 6.87% as the grains and oilseeds also increased over the month. On the other hand, lean hogs and live cattle saw negative returns and the ML Livestock TR index ended the month down at -1.83%. In soft commodities, gains in cotton and coffee were offset by an opposite movement in sugar, resulting in a 0.75% return in the ML Softs TR index.

Base metals such as copper and zinc posted positive returns and brought the ML Industrial Metals index to 10.86% for the month. Meanwhile, gold and silver fell and the ML Precious Metals index ended the month at -1.88%.

Inflation and commodities
At times of inflation, it looks like investors are better off betting on commodities. Commodities are a natural instrument for investors concerned about inflation risk, due to their role as the very basic raw materials used to produce the goods we consume in our everyday lives. Urban consumers spend a significant portion of their budget in food, fuel and electricity which are directly linked to energy and agriculture. Hence, we should expect a direct relationship between commodity prices and inflation, according to a Merrill Lynch report.

For a more even returns, investors looking for safety can go for an investment basket consisting of commodity investments, real estate, equity sectors correlated to inflation and inflation-linked debt/inflation swaps.

While inflation-linked bonds offer fixed real returns, the price of the bond embeds the market’s expectation of future inflation rates. Thus, IL bond returns are more linked to unexpected inflation the market did not foresee. On the other hand,
commodities and real estate are asset classes with returns closer to realized inflation and therefore more likely to protect an investor against expected inflation.

Merrill Lynch has constructed a portfolio using 84.60% TIPS (the ML Inflation-linked US Treasuries index),6.50% equities (equally weighted MSCI indices of the healthcare, food & beverages, transportation, utilities and materials sub-sectors), 3.55% REITS (the DJ REITS index) and 5.35% commodities (the MLCX index). Despite the recent sell-off in equities and commodities, the proposed portfolio was able to outperform TIPS over the last decade with the same level of volatility.

Stability is now visible in commodity prices, aggregate demand and supply. In order to weigh in the impact of a modest demand recovery in commodity prices, capacity utilization remains a key variable.

Capacity utilization rates across a broad range of industries in the economy were running relatively high at the peak of the last business cycle . Now, while utilization rates have collapsed for a broad range of industries such as motor vehicles, semiconductors or chemicals, but commodity utilization rates are still high , suggesting that a rebound in economic activity will likely impact commodity prices before it hits other sectors.

Since January 2004, commodities have broadly outperformed traditional equity indices, but there has been diverse performance among commodity indices.

Specifically, the MLCX TR index outperformed the Standard & Poor’s US 500 TR index by 8.61% on average during the last five years. However, the same comparison for the S&P GSCI TR index yields -0.08% and for the DJ-AIG TR index the relative performance is 3.22%. In the time period, EM equities and the ML US Broad Market Bond index fared better than commodity indices, primarily due to the recent correction to commodity prices.

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