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04 December 2023

Free-money inflated commodities bubble may burst

Gold bars at a plant of refiner and manufacturer Argor-Heraeus in Mendrisio, Switzerland. Asian banks are expected to increase their holdings of the precious metal. (REUTERS)

By Reuters

Disappointed by losses in stock markets and bonds during the recession, investors have turned to commodities in the hope of better returns, many borrowing at very low interest rates.

Current ultra-low interest rates are bringing a wave of speculation to commodities, inflating a bubble that will inevitably burst some markets, said the head of a London-based fund management company.

Jonathan Compton, Managing director of long-only equity investment group Bedlam Asset Management, which has about $620 million (Dh2.27 billion) assets under management, said oil, copper and some other commodities were vulnerable to sharp corrections.

"You will see a fantastic unwinding of the speculative longs the moment rates move up," said Compton. "Commodities most vulnerable will be the ones that are most widely held: copper and oil… and some very funny financials."

Pension funds and money managers have tripled their holdings in commodities markets since 2007, industry data show, with $250bn to $300bn now invested by passive long-only funds.

Hedge funds and other actively managed units also hold huge stakes in commodities and together buy-side investors control as much as half of the open interest in some commodity markets. This has made some commodities, inflated by speculative, short-term capital, vulnerable, analysts say.

Compton is particularly scathing of some exchange-traded products (ETPs), some of which he said were "structurally odd" or administered in several countries, preventing proper oversight.

ETPs and exchange-traded funds (ETFs) are listed vehicles allowing buyers to hold securities that move up and down with a commodity or other investment.

Most gold ETFs are backed by bullion and seen as almost risk free. But other ETPs are more exotic, based on futures or derivatives or are highly geared.

"The industry is probably 95 per cent clean, if not more. But you only need a couple to go off and you have a domino effect. Then you get real panic and commodities get dumped," he said.

Compton said copper and oil could both be vulnerable to downward corrections, and the fall in copper could be serious.

"Copper stands out because it is the absolute bellwether proxy industrial metal. My concern is the very long positions in ETFs… there is rampant speculation," he said. "World copper stockpiles are rising and more and more ETFs are being sold. If a commodity price is rising along with reserves, there is clearly a mismatch. ETFs are temporarily taking supply off the market – but it is very temporary."

He estimated the cost of mining at "well below $3,000 a tonne" compared with current futures of more than $6,500.

Bedlam holds no oil shares, having sold them in the run up to the record high near $150 per barrel seen in 2008. "With oil, stockpiles are high, while demand is basically flat and supplies are plentiful until there is a political upset somewhere and it very widely held," he said.

But Bedlam does like some commodities. It owns four gold miners, all of which are in its top-20 holdings: Goldcorp, Yamana Gold, Agnico-Eagle Mines and Lihir Gold Together, these make up nine to 11 per cent of the value of the funds that can hold them.

Compton says that although Western central banks have been cutting gold reserves, Asian banks will increase their holdings. He also likes grains, cocoa and the outlook for farmland.

"With grains you have quite clearly a structural bull market for many years to come," he said. "If you could store grains for 10 years, then you would buy them and put them away."


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