Using commodities to hedge potential losses in stock markets has not worked lately, and the tighter link among assets these days means diversification benefits may not be as great as before.
Hedge funds, pension funds, mutual funds and wealthy individuals who invested in commodities on the theory that they move independently of other asset classes watched helplessly as the global economic nosedive turned commodities, once the top asset class, into the year’s worst performer after equities.
Those who have studied commodities and long-time investors in energy, metals and grains say that in ordinary times, these markets make good alternatives to stocks.
But these are not ordinary times.
“This is the worst I’ve seen in my 10 years in the business,” said Rian Akey, chief operating officer at Cole Partners, a Chicago fund manager that invests in commodity hedge funds.
“The theory of diversifying into commodities has relied on all things being different to stocks, that is, different fundamentals, different pricing issues, different asset classes. All that goes away when people are selling everything, no matter what, to raise cash. Then, you have high correlation instead of non-correlation.”
Until June, commodities were the best-performing asset class for four consecutive quarters, as easy credit, booming growth in giant developing economies such as India, China, Russia and Brazil and surging inflation sent prices of oil, gold, copper, corn and other resources to record highs.
Mr. Akey, who wrote a paper in 2005 that showcased commodities as an effective source of risk-adjusted return and portfolio hedge, said the credit crisis had shown that the asset class was not, as many had believed, the antithesis of stocks.
“In a negative equity environment, you have the potential to make money in commodities. But it can be damaging if people put too much reliance upon commodities as an equity hedge, because you can also lose money during down periods in equities as well,” he said.
“The current environment is characterised by deleveraging and, clearly, fundamentals are not the driver. I don’t think in the short term you’re going to see diversification being highly beneficial for anybody.”
Brian Hicks, co-manager of a resources fund at US Global Investors, commented recently on how commodities and equities had tacked on to each other on their way down: “There is nowhere to hide.”
The situation was different as recently as July, when crude oil hit record highs above US$147 a barrel while the S&P 500 stock index was down 15 per cent on the year. Even when commodities rallied broadly in July, some markets, such as cotton and sugar, fell on their own fundamentals.
Yale professors Geert Rouwenhorst and Gary Gorton popularised the theory in 2004 that commodities did not correlate with other asset classes. They published a study comparing annualised monthly returns from commodities with those of stocks, bonds and US treasury bills between July 1959 and March 2004.
The professors did not respond to e-mails from Reuters, requesting comment on that paper, entitled “Facts and Fantasies about Commodity Futures”, and its relevance to the credit crisis.
But in an interview during the brief turmoil in commodity markets in March, Professor Gorton defended the non-correlation theory, saying it had held up for most of the 45-year period covered in the study.
Mihir Worah, manager of the US$6.5 billion Pimco Commodity Real Return Strategy Fund, said the findings worked most of the time.
“Yes, it was valid [but] ... obviously did not hold and I don’t think you could’ve expected it to hold [given] what happened in the last three months,” Mr. Worah said.
He said even if the world economy recovered and markets went back to trading on fundamentals, the diversification benefits once seen in commodities may not be as great.
“The independence that we saw between commodities and equities 20 years ago, I don’t think we are going to see that level of independence because now a lot of the same people are trading both assets,” he said.
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Commodities No Longer a Safe Haven
Decline erodes diversification edge over stocks
Reuters in New York
27 November 2008
Using commodities to hedge potential losses in stock markets has not worked lately, and the tighter link among assets these days means diversification benefits may not be as great as before.
Hedge funds, pension funds, mutual funds and wealthy individuals who invested in commodities on the theory that they move independently of other asset classes watched helplessly as the global economic nosedive turned commodities, once the top asset class, into the year’s worst performer after equities.
Those who have studied commodities and long-time investors in energy, metals and grains say that in ordinary times, these markets make good alternatives to stocks.
But these are not ordinary times.
“This is the worst I’ve seen in my 10 years in the business,” said Rian Akey, chief operating officer at Cole Partners, a Chicago fund manager that invests in commodity hedge funds.
“The theory of diversifying into commodities has relied on all things being different to stocks, that is, different fundamentals, different pricing issues, different asset classes. All that goes away when people are selling everything, no matter what, to raise cash. Then, you have high correlation instead of non-correlation.”
Until June, commodities were the best-performing asset class for four consecutive quarters, as easy credit, booming growth in giant developing economies such as India, China, Russia and Brazil and surging inflation sent prices of oil, gold, copper, corn and other resources to record highs.
Mr. Akey, who wrote a paper in 2005 that showcased commodities as an effective source of risk-adjusted return and portfolio hedge, said the credit crisis had shown that the asset class was not, as many had believed, the antithesis of stocks.
“In a negative equity environment, you have the potential to make money in commodities. But it can be damaging if people put too much reliance upon commodities as an equity hedge, because you can also lose money during down periods in equities as well,” he said.
“The current environment is characterised by deleveraging and, clearly, fundamentals are not the driver. I don’t think in the short term you’re going to see diversification being highly beneficial for anybody.”
Brian Hicks, co-manager of a resources fund at US Global Investors, commented recently on how commodities and equities had tacked on to each other on their way down: “There is nowhere to hide.”
The situation was different as recently as July, when crude oil hit record highs above US$147 a barrel while the S&P 500 stock index was down 15 per cent on the year. Even when commodities rallied broadly in July, some markets, such as cotton and sugar, fell on their own fundamentals.
Yale professors Geert Rouwenhorst and Gary Gorton popularised the theory in 2004 that commodities did not correlate with other asset classes. They published a study comparing annualised monthly returns from commodities with those of stocks, bonds and US treasury bills between July 1959 and March 2004.
The professors did not respond to e-mails from Reuters, requesting comment on that paper, entitled “Facts and Fantasies about Commodity Futures”, and its relevance to the credit crisis.
But in an interview during the brief turmoil in commodity markets in March, Professor Gorton defended the non-correlation theory, saying it had held up for most of the 45-year period covered in the study.
Mihir Worah, manager of the US$6.5 billion Pimco Commodity Real Return Strategy Fund, said the findings worked most of the time.
“Yes, it was valid [but] ... obviously did not hold and I don’t think you could’ve expected it to hold [given] what happened in the last three months,” Mr. Worah said.
He said even if the world economy recovered and markets went back to trading on fundamentals, the diversification benefits once seen in commodities may not be as great.
“The independence that we saw between commodities and equities 20 years ago, I don’t think we are going to see that level of independence because now a lot of the same people are trading both assets,” he said.
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