The commodity supercycle: myth or reality? Part 8

Other cautious market commentators are concerned about the influence of investment demand on commodity prices. They include Gene Epstein, writing for Barron’s; Caroline Baum, writing for Bloomberg; Jeffrey Korzenik, who is chief investment officer at Vitale, Caturano and Company in Boston, and who wrote about the subject in Marketwatch; and Mack Frankfurter, who is chief investment strategist at Managed Account Research in Santa Barbara, Calif.

Although each of them has his, or her, own point of view, the picture that they paint is that of a substantial investment demand in the commodity market, which may be an important factor in high commodity prices, to the extent that it may even cause price distortions. A number of them say that investment in commodities has become vastly more accessible to mainstream investors, with the introduction of commodity-linked exchange-traded funds (ETF), mutual funds and structured notes. Examples of these are the Barclays iShares Silver Trust (SLV-X) and Street Tracks Gold Shares ETF (GLD-N). This accessibility attracts investment dollars that would not otherwise have found their way into this market.

Even big institutional money is flowing into commodities. Clark McKinley, spokesman for pension giant Calpers (the California Public Employees Retirement System), says that the fund has so far invested US$1 billion in commodities, partly in a commodity index and partly in commodities themselves. Their current guideline is to invest 1.5% of their assets, or US$3.6 billion, in commodities, so it can be expected that more of their money will flow into this asset class. (Portfolio managers do have leeway around the 1.5% guideline, so they are not compelled to invest more in commodities).

In his Barron’s article in late March, Epstein quotes analyst Steve Briese as estimating that index funds were holding US$211 billion worth of bets on the buy side in U.S. commodity markets, while analyst Greg Blaha estimates the figure at a lower US$194 billion, out of total bullish positions of US$568 billion in March. Clearly index funds exert a strong influence on this market.

With this kind of speculative money chasing commodities, these commentators may have a point. Commodity prices are affected by investment demand. However, this also makes prices vulnerable to a correction. If prices were to turn south, it could trigger a stampede for the exits, which could seriously hurt prices. In the Barron’s article Epstein quotes analyst Briese as saying that a price collapse of 30% is possible, and prices could fall even further. He also believes that the smart money is betting on price declines in commodities.