Commodity Online
Commodities closed a negative quarter in September, with benchmarks down an average of 11%. Losses were lead by base metals (S&PGSCI down 22.5%) and energy (S&PGSCI down 13%), which were the sectors most exposed to the economic cycle, while precious metals and livestock were up 4.3% and 5.5%, respectively.
Volatility was the main theme in a quarter in which most of the losses were towards the end. In fact, Q3 was on track to be a positive quarter up to the end of August, driven by double-digit gains in precious metals and agriculture and moderate gains in soft commodities. But, things started to turn in early September when the worsening European debt situation weighted heavily on sentiment and markets had a fresh sell-off on risk assets.
However, put in perspective of the current macroeconomic environment, there was still some room for good news for direct commodity investors. First, direct commodity exposures held far better than broad-based equities and their commodity-equity counterpart.
The EuroStoxx industrial metals index fell 43.3% in Q3, while the S&PGSCI industrial metals index was down 22.5%. Within precious metals, the S&PGSCI precious metal index was up 4.3%, while the gold bugs index just managed being positive at 0.9%.
Pure commodities also outperformed emerging market assets, which underperformed meaningfully in September due to anxieties about a hard landing in China. The MSCI emerging markets was down 15.7% in Q3, and the DJ-UBS fell 11.3%. In the year-to-date, the MSCI EM is down 16.3%, while the DJ-UBS is down by almost half that.
Second, even within pure commodity exposures, all was not a red sea. Some active strategies managed a positive return. As we have highlighted in the past, the dynamic spread trade strategy (ie, short the front end and long the back end for a basket of commodities, with the long position rolling each month along the curve) has outperformed meaningfully this year, up 4.2% year-to-date.
The September outperformance was driven by natural gas’ contango curve strengthening and a sharper fall at the front end than at the back end, and nearby wheat prices falling. Overall, our view remains that spread strategies are likely to outperform as long as there is no clear solution to the European debt crisis and volatility remains.
In such an environment, directional trades offer less upside potential and are more prone to sharp sell-off episodes such as those seen over the past few weeks. As a result, spread trades offer more “protection” to sell-off episodes.
That said, commodities – particularly base metals and energy, which have fallen the most – may react positively to news of any resolution of the euro debt crisis. Copper, corn and crude oil remain our favourite trades due to their tight supply outlook and supportive demand picture.
In addition, roll yields continue to provide positive contribution to returns. In September, the roll yield on the S&PGSCI contributed 0.2% to total returns; so far in October, it has contributed 0.1%. This stands in sharp contrast to few years ago when negative roll yields constituted a drag on overall returns that sometimes amounted to up to 6%.
So far in October, commodities have bounced back. The S&PGSCI is up 5.8% on the month, driven by energy (7.8%) and agriculture (4.7%). As highlighted above, these are sectors that should benefit from an improving macroeconomic situation.(Barclays)
