Commodity Hedge Funds performance has been disastrous recently and assets under management continue to decline. The average fund lost 0.8% in Q1’13 and lost 3.7% in 2012 – the biggest decline in more than a decade. In 2011 they lost 1.4% (typical gains had been 20-40% per year in 2000 – 2008). What I find ironical is that for the first time Commodities are behaving like an “independent” asset class and providing diversification in a portfolio; the very same mantra used by funds of funds to convince investors and pension funds to pile into Commodities in early 2000 after looking at performance stats in the 1990′s. Only caveat was that during the boom in 2000-2008, correlation of all asset classes was close to 1 given growth was firing on all cylinders and physical commodity markets were extremely tight as well.
Welcome to the new paradigm! Commodity prices can keep going lower as the supply side plays catch up after a decade of investment. For years, many investors could not understand how copper continued to trade way above it marginal cost of production of $4500/t. The answer is simple. Commodity markets are all based on physical market balances. Either you have it (surplus) or you don’t (deficit). If it is the latter, then the price is irrelevant as it will continue going up exponentially until demand is killed off or supply catches up. To help bring about this equilibrium, the producers need to be incentivized with healthy IRR’s over the long term as well so that they are encouraged to invest.
It may be a bit premature to write off Commodities entirely as an asset class. Assets under management (AUM) keep seeing outflows week on week. As of 24th May, total assets under management for commodity exchange traded products decreased to $149.8 billion from $152.6 billion a week earlier. Money can still be made in Commodities, but the problem is that most people have gotten spoilt trading it only from the long side over the past decade.
