For longer term investors, equity markets have generally remained the risk asset class of choice. However, with equities around the world now finding it hard to continue the bullish momentum of the last few years, investors are now looking to alternative markets to diversify risk, and for potentially better returns. One such is commodities, which has performed well since the start of the year, with the Dow Jones Commodity index currently up 10%, compared with to just 2% for the S&P 500. In addition,, and perhaps more significantly, many of the traditional correlations between equities, bonds, commodities and currencies, and in particular the risk on, risk off, relationships, have all broken down as the financial markets continue to be distorted by quantitative easing.
This has helped to re-establish the fundamentals of supply and demand in the commodities market, and one only has to look at coffee which has risen dramatically this year following the severe drought in Brazil, with Nickel another example. The rise in Nickel followed the decision by Indonesia to ban exports in January, leading to strong gains for the metal as a result. Finally, backwardation is also playing its part in many commodity markets with spot prices leading the futures, and as such offering investors opportunities for better returns when rolling over contracts.
However, whilst the above are all positive reasons for considering commodities for longer term investments, China remains the dominant force in the market, both as a consumer, stockpiler and supplier, and any signs of an economic slowdown could seriously influence the supply demand relationship. Whilst some commodities have performed well, others have struggled gain any momentum, with gold and silver both consolidating following steep declines, along with copper. Oil continues to remain range bound with the WTI contract currently struggling to breach the $105 per barrel area, which remains firmly resistance. Soybeans on the other hand are offering excellent returns due to the bakwardation now in place.
As with all markets, picking the winners is hard, but with the fundamentals of supply and demand now starting to take centre stage once again, and with a helping hand from backwardation, perhaps now is the time to dip a toe back in this risky market. And of course, there is always volume price analysis to help to confirm the supply and demand picture on the price chart!
By Anna Coulling