Risk South Africa: investors have changed commodity markets

Speaking at Risk South Africa in Cape Town on March 6, Masters reviewed the causes of the massive fall in the price of commodities in 2008, emphasising the role that investor interest had played.

"Back when I first started in commodities, there wasn't a concept of commodities as an asset class. Each commodity was its own individual market," he said.

Using the example of oil, he asserted his view that market prices had become dislocated from fundamentals as a result of investor attention. "For 20 years, if you knew the fundamentals, you could predict the price. After 2004, that completely broke down."

Masters said the sizeable investor inflow meant that funds and commodity firms trading with fundamental views, such as drilling companies, had lost money. This even extended to Global Advisors' own oil fund, which went from a monthly average return of 0.75% to zero after December 2003. "The market had changed," he reflected.

In general, the sharp decline in commodity markets over 2008 represented a liquidation of leveraged positions of a kind that had never been seen before, he said.

And the heavy role played by investor interest was set to remain, he suggested, particularly via exchange-traded funds (ETFs). Despite last year's dive in underlying markets, investor interest in commodity ETFs had remained steady at a total of $55.4 billion in February 2009, compared with $49.3 billion in July 2008, according to figures from Clarium Capital Partners.

"The price of a commodity doesn't care whether the buying comes from the commodity or the futures market or the ETF market. So ETFs will have a huge effect on commodity prices," said Masters. This was especially true for markets such as silver, in which the total quantity of physical reserves remains slim compared with ETF interest in the metal.

Investor inflows such as these underlined the importance of considering financial demand, as well as the fundamentals of supply, when investing in commodities. "Looking at commodities is a supply-side analysis for most people," said Masters. But this obscured the fact that demand might now be a much more important driver of prices, he added.

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