Commodity funds have reported record inflows this year. Inflows into commodities now total $51 billion year-to-date the strongest since 2009 (only by $1 billion) when commodity assets were at the start of a three-year boom.
However, while every month so far this year has seen inflows into commodity investments overall, flows slowed during July as it seems that investors are now looking to take profits. Norris makes the point that much of the investor demand for commodities this year has been tactical, and unless the asset class continues to generate strong returns in the second half, outflows could resume.
Commodity funds are in for a rough H2
Investors are forced to commodity funds this year in an attempt to shield their portfolio from macro uncertainty and diversify away from equities and low yielding bonds. These flows, combined with some substantial price appreciation have pushed total commodity assets under management to a 13-month high of $235 billion, a massive increase from the low of $161 billion for total commodity AUM at the end of 2015.
Nonetheless, Barclays analyst Norris believes that given the scale of inflows into commodity funds this year it will almost certainly turn out to be the case that July will represent the high-water mark for inflows. There are three reasons for this assumption:
“A large part of the interest of investors in commodities so far this year appears to be safe-haven related. Precious metals (mainly gold) have captured around 60% of all commodity inflows so far this year…”
“Second, much of the demand for commodities this year appears tactical rather than strategic. It is true that commodity indices have seen their largest net inflows since 2010…However, single commodity ETPs have proved much more popular than indices, especially in oil and precious metals and… investors have shown that they are willing to trade in and out of ETP positions very actively.”
“The third problem is one of returns. Benchmark commodity returns (with reference here to the Bloomberg Commodity Index – BCI) were flat in Q1 but up a stunning 14% in Q2 as oil, in particular, rallied hard. However, so far in Q3, things are not looking nearly so good and the BCI has shed 8.4% in Q3 to date. One worrying pattern for commodity investors that is relevant here is the tendency for commodity prices and investments to perform fairly well in H1 but then to collapse in H2. It happened in both 2014 and 2015 when the BCI fell 22% and 23%, respectively. Over the past five years, the average H2 loss for the BCI is 11% compared with just 3% in H1.” — Barclays
Simply put, based on H1 inflows and past trends, it looks as if commodity investors are going to have a tough time in the second half. It seems that the period of strongest returns for commodities is now behind us and flat to slightly lower looks like the most likely outcome for the second half.
According to Barclays’ Norris commodity index swaps, which tend to reflect longer term strategic allocations to commodities have seen a modest reversal in June and July. Commodity index swaps have seen outflows of just under $2 billion during the past two months after attracting inflows of $21 billion during the first half — possibly the first sign that investors are starting to lose confidence in the asset class.