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 $280.6 billion, or 43 per cent, 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 per cent 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 per cent, and corn, down 43 per cent.
“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 per cent 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 per cent for the year.
Price Outlook: A global slowdown may cause crude oil to plunge another 47 per cent to $50 a barrel next year, New York-based Merrill Lynch said in an October 2 report. Goldman Sachs Group Inc cut its forecast for copper next year by 12 per cent to $8,265 a metric ton and aluminum by 18 per cent to $2,920 a ton.
Corn may tumble as much as 15 per cent to $3.87 a bushel in the next six months, and soybeans by 11 per cent to $8.85 a bushel, said Don Roose, president of US Commodities Inc in West Des Moines, Iowa.
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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.
Copper fell by as much as 5.3 per cent today, soybeans by 5.8 per cent and palm oil by 10 per cent as the rout deepened.
Investors Exit: Outstanding contracts for 17 commodity futures traded in New York and Chicago fell 26 per cent since a peak on February 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 per cent of total open interest for futures on September 23 from 14 per cent on March 25, according to an October 2 report to clients by Barclays Capital in London.
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 $80 billion of assets as of September 1, up from $55 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.
Commodity Leverage: 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.
Futures, where a $12.50 deposit can control a $100 barrel of oil, allowed Dallas-based Pickens to earn $1.4 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 per cent from inception in 2005 through the end of last year. Chris Levett, who founded London-based Clive Capital LLP, returned 17.6 per cent in the first quarter on energy and metals bets.
Investments in commodity indexes reached a record $175 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.
Changing Outlook:Crude oil quintupled from July 2002 to a record $147.27 a barrel on July 11, corn more than tripled from June 2006 to the highest ever, $7.9925 a bushel, on June 27. Gold more than doubled in the three years to March 17, when it reached a record $1,033.90 an ounce.
Prices dropped since June as the US Dollar Index strengthened 9.6 per cent in the third quarter, the most since 1992, economic growth slowed and bank losses from the collapse of sub-prime mortgages swelled to $586.6 billion, according to data compiled by Bloomberg. While President George W Bush signed into law a $700 billion bank rescue plan October 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 per cent on October 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 $1.5 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.”
Lower Output: 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 $1 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.”
Economists say US growth will slow to 1.5 per cent next year from 1.7 per cent in 2008, according to surveys compiled by Bloomberg. China expanded 10.1 per cent in the second quarter, down from 12.6 per cent a year earlier, and India grew 7.9 per cent, compared with 9.2 per cent.
Institutional investors withdrew $5 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 per cent to about $120 billion, the bank said.
Closing Funds:Every commodity in the CRB Index fell in the third quarter, led by a 44 per cent drop in natural gas. The value of the 19 commodities fell to $374.8 billion on October 1 from $655.4 billion on July 3, according to data compiled by Bloomberg. The total value of those futures contracts on October 1, 2006, was $271.9 billion.
Ospraie Management LLC, once the world’s largest hedge fund dedicated to natural resources, told investors September 2 the New York-based firm would close its largest pool after slumping 38.6 per cent for the year. Pickens said September 30 that investors in BP Capital asked for the option to withdraw money after more than $1 billion of losses on energy trades this year.
RK Capital fell as much as 30 per cent in August as copper and aluminum fell to six-month lows, dropping 6.8 per cent and 8.9 per cent, respectively. Its Red Kite Metals fund lost about 40 per cent, according to an investor who asked not to be identified because the information is private.
Fund Redemptions: Funds of hedge funds in Europe may receive redemptions of up to 25 per cent 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 $1.9 trillion industry, according to Chicago-based Hedge Fund Research Inc. They account for about 42 per cent of hedge-fund assets, or about $826 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.”