Investors warm to commodities in search for return

As developed equity and bonds see volatility, advisers re-examine a disfavored asset class

Aug 6, 2014 @ 2:18 pm

By Trevor Hunnicutt

Global uncertainty, coupled with the strength of the Chinese markets, is leading U.S. investors back into commodities.

Investors put more money into commodities ETFs and ETNs in July than they have in any single month over the past two years, according to ETF.com., which provides research on exchange-traded funds and exchange-traded notes.

The lift came as Chinese markets — and, in many cases, the funds tracking them — notched their best gains since late 2012, raising hopes that the world's second-largest economy will support demand for the industrial metals used to manufacture cars, buildings and consumer electronics bought by the country's growing middle class.

The flows also come against a backdrop of volatility in the equity and bond markets of developed countries. For example, data released Wednesday showed that Italy fell into recession for the third time in six years while a conflict continues between Western countries and Russia over the war in Ukraine.

“A lot of people released capital from the fixed income space as well as the equity space, so the money has to go somewhere — it might be a hedge,” said Eduardo Ramos, founder of Freedom Advisory, based in Guaynabo, Puerto Rico.

Commodities-based funds have been in a slump over much of the past year as advisers and other investors braced for the end of a more-than-decade run-up in prices, a boom known as the “commodities supercycle.”

For investors who made the plunge, the results weren't pretty. The S&P GSCI, which tracks commodity futures, lost 5.3% in July, its worst return in 26 months.

SCANT GAINS

While some trading-oriented strategies like leveraged funds and single-metal-tracking notes did well, more conventional funds tracking commodities broadly dropped more than 4% in July. Over the past five years, they're up a scant 1.24%, according to Lipper, the Denver-based research firm.

(Related: How alternatives are changing the landscape of investing)

The investor deposits came as fund promoters wrote with enthusiasm about the market.

“What a difference six months can make,” said Frank E. Holmes, chief executive of U.S. Global Investors, a San Antonio, Tex.-based commodity fund house, in a report on July 14. “Even though the commodities market has so far exceeded everyone's expectations this year, especially following a lackluster 2013, a correction could occur with little warning. ... For now, however, it appears as if resources could continue their strong performance for at least the near-term and hopefully much longer.”

Adviser David Edwards said investors were chasing strong returns.

“Individual investors were buying high in the hopes it will go higher, and they've probably been disappointed,” said Mr. Edwards, president of New York-based Heron Financial Group.

Long-term demographic trends are still likely to propel commodity prices in the long-run, he said, who places 5% of client portfolios in the Pimco CommodityRealReturn Strategy Fund (PCSRX), an inflation-hedged broad basket of commodities.

“The long-term trend is that commodity prices have to go higher — we live in a planet of 7 billion people, it will be 8 billion by the end of the century, and about two billion of those people moved from subsistence to middle class in the last three decades,” said Mr. Edwards.

What remains to be seen is how much of their money China's 1.3 billion people will spend — and in what ways. For 30 years, the country's economy grew at an average annual pace of 10% growth, but over the last two that's slowed to below 8%.

Funds tracking China nonetheless were the best performing category last month, climbing 4.24% as the Shanghai Stock Exchange Composite Index posted a 7.48% return, its largest monthly gain since Dec. 2012. The Hang Seng Index, in Hong Kong, posted its best gain since Sept. 2012, 6.75%.

The top funds last month included both gold funds and index trackers. The SPDR Gold Trust (GLD) won nearly $243 million in assets last month, while three broad-basket indices (USCI, DBC and GSG) took in about half a billion dollars, according to Morningstar Inc., the Chicago-based research firm.

In all, the category saw nearly $1.2 billion in new money last month, the most since Nov. 2012, San Francisco-based ETF.com said.

Geopolitical crises can benefit gold, seen as a safe-haven investment. On Wednesday morning in New York, December-dated gold futures rose 1.66% to $1306.70 an ounce.

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