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Commodities swing back into favour

Commodities stormed back into investors’ thoughts in 2022, delivering stellar returns. The conditions that supported the sector remain in play today, with further market volatility and stubborn inflation expected to continue supporting the appeal of the sector to hedge funds and others this year.

Combine harvester in ploughed field Source: Getty Images

Surging demand for agricultural knowledge

Hedge funds and proprietary trading firms are beefing up their agricultural markets expertise by hiring traders who specialise in this area, according to Bloomberg. 1 The news agency added that big swings in prices have made even relatively niche corners of commodities trading lucrative during the past year.

Commodities hedge funds were the standout performers in 2022, delivering a weighted-average return of 20.43% for Citco-administered funds and a 41.3% return for the HFRI 500 Macro: Commodity Index. The median return of 12.33% for commodities funds was the best of all major strategies. By contrast, the overall weighted-average return for hedge funds administered by Citco amounted to -7.02% in 2022, while the HFRI 500 Index delivered a return of -3.37%. 2

Many of the hedge funds with strong energy-trading operations, says Bloomberg, are now looking to diversify into agricultural and soft commodities to maximise returns across a broader asset class. The agency quoted a spokesperson for a commodities executive search firm as saying that demand from firms for agriculture, soft-commodities and metals traders was 65% higher than demand for energy specialists since the start of the year.

Prices for some key agricultural products, such as wheat, have experienced wild swings since the Russian invasion of Ukraine, creating investment opportunities. Continuing geopolitical instability is likely to keep volatility high. Bloomberg adds that rising capacity in the production of renewable diesel from vegetable oil and tallow has increased demand for traders in those areas, while "expectations of food inflation are also likely to create market distortions that could benefit specialist traders".

Sugar rush

Sugar provides an example of a commodity where demand for traders is high. Sugar prices have soared in 2023, reflecting both a slump in production in Asia, due to bad weather, and a surge in demand following the end of pandemic-related lockdowns. Transport bottlenecks in another key producer, Brazil, are also affecting global supplies. The outlook for prices is highly uncertain. While some analysts are anticipating a glut of sugar later in the year, others argue prices will continue to rise as demand continues to outpace production. That suggests sugar prices will remain volatile, creating further lucrative trading opportunities in this area alone.

Trends in the oil market are also likely to underpin prices for commodities. That’s because the price of oil is a key determinant in the price of just about every other commodity, given that it is a primary input for farmers, mining firms, and those that process or transport raw materials. Oil prices have been on an upward trend since 2020, and that could well continue. The International Monetary Fund (IMF), among others, has upgraded its economic forecasts, so demand for oil is likely to continue to rise, with China’s reopening providing a particular fillip to the market.

Moreover, the Organization of the Petroleum Exporting Countries (OPEC) has shown a surprising commitment to supporting prices, as demonstrated by the production cuts announced in April. Meanwhile, geopolitical instability poses a threat to oil supplies around the globe. Against this backdrop, perhaps unsurprisingly, the US Energy Information Administration revised its Brent crude-oil spot price upwards to an average $85 per barrel in its April 2023 short-term outlook – an increase of $2 per barrel from March’s forecast. 3

The commodities sector is also attracting hedge funds because of its ability to provide protection against inflation. Bonds, equities and real estate tend to be negatively correlated with inflation, according to Credit Suisse’s Global Investment Returns Yearbook 2023. Only commodities have a positive correlation with inflation, according to a Bloomberg report citing the yearbook, making them the only true hedge. 4 Moreover, the sector is diverse enough that it enables hedges against different types of inflation, such as cost-push or demand-pull, the news agency adds.

Figure 1: Commodities provide the best hedge against inflation

Commodities provide the best hedge against inflation chart Source: Bloomberg
Commodities provide the best hedge against inflation chart Source: Bloomberg

Inflation outlook suggests hedge-fund demand for commodities will remain robust

The IMF warned in April 2023 that global inflation will remain stubbornly high, easing slower than initially anticipated, from 8.7% in 2022 to 7% in 2023 and 4.9% in 2024. That outlook should ensure that commodities remain in strong demand as a hedge against rising prices. 5


Publication date: 2023-07-27T09:46:51+0100

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