Two recent pieces by Adam White at Seeking Alpha, a financial website, show the problems caused by investing in commodity indexes, both for individual investors and for the functioning of commodity markets.
In “Imagine Investing in Commodities from 2004-2008, and Losing Money,” White shows that, contrary to the famous Yale research paper that convinced many institutional investors to include commodities in their portfolios, investing in commodity index funds is not nearly as beneficial as the authors suggest.
“The diversification benefits of commodities have become increasingly tenuous as prices in the years following the report’s publication moved in tandem with other major asset classes, including shares and bonds,” writes White.
“As stock markets plummeted worldwide in 2008, commodities fared just as badly. And last year both bottomed in March, challenging the notion that they respond to different phases of the cycle.”
White goes further in explaining that the authors of the 2004 study were paid by AIG for their work. As White writes, “so let’s get this straight. AIG (AIG) paid these two professors to do this research which basically found that commodities were good investments – shocker! (AIG also reportedly paid Gorton $1 million to develop the risk models for CDS – how well did that work out?) This allowed Goldman Sachs (GS) and AIG to go out and hook a large number of pension funds and other dumb money investors into commodity indices promising ‘equity-like returns’ and ‘low correlation with stocks.’”
The problem is that when investors, heeding the report’s recommendations, poured money into the commodity markets it resulted in two things. First “the correlation between the S&P 500 and the S&P-GSCI index has risen to as high as 80% so that they provide no diversification benefit whatsoever… Anybody that invested in the S&P-GSCI TR Index from 2004-2008 is losing money as of today.”
The second problem caused by the influx of investment money into commodity markets is that they threw off those markets with their massive, one-sided investments.
White explores this problem more specifically by looking at the aluminum market in “A Slow Motion Cornering of Global Commodities Markets.” He writes, “between 75 and 90 per cent of the world’s physical aluminium stocks are tied up in financial arbitrage deals exploiting the difference between the spot and forward price, according to several industry insiders.”
“In aluminium, physical stock levels on the London Metal Exchange have quadruped in the past 18 months to about 4.5m tonnes. That amount, enough to build approximately 68,000 Boeing 747s, implies gross oversupply, especially as the pick-up in manufacturing remains slow in developed economies. Yet prices keep rising.”
“By this process synthetic hoarding in the futures markets becomes real-world hoarding of essential commodities. We have a slow-motion cornering of the markets occurring in most commodities.”
For these reasons and others, there is a growing campaign for investors to divest from the commodity markets. Those investments are not nearly as beneficial as initial studies suggested and they are very detrimental to the functioning of our commodity markets.
Pension funds and endowments have literally millions of investment options for their portfolios. There is no reason that we should allow them to destroy the commodity markets for producers and consumers, increasing price volatility and hampering possibilities for an economic recovery.
Please make sure that your investment portfolio does not include any commodities or commodity indexes. Divest now.