The commodity Jiseki

Last Updated: Tue, Mar 27, 2012 19:40 hrs

We at Orpheus are commodity bulls. A commodity is a generic term used for a group of metals, energy and agro assets. Among the commodity complex itself, it's important to understand how various components will outperform or underperform. A generic broad positive forecast, though useful, does little to mitigate the overall risk that comes with large return divergence between assets.

To explain the divergence risk and differentiate it from a large commodity-bullish forecast, we analysed nine commodity London ETFs viz, wheat, cotton, corn, gold, platinum, silver, crude oil, natural gas, gasoline and all commodity Index (AIGC.L). Three from this group were agro- commodities, three were energy-based, three were from metals complex and the tenth asset was a broad commodity index. We compared them from January 2009.

Natural gas was the worst at negative 90 per cent, wheat followed at negative 42 per cent. On the top tier was silver (at positive 196 per cent) with gasoline at second best, delivering 154 per cent for the period under study. Strangely crude oil, corn and commodities delivered six per cent, 14 per cent and 22 per cent respectively over a similar period.

Assets Returns (%)
Natural gas -88.99
Wheat -42.22
Crude 6.13
Corn 14.59
All commodity index 22.27
Platinum 75.67
Cotton 86.27
Gold 92.68
Gasoline 154.30
Silver 196.96
Return is based on performance during 
January 4-March 4, 2012

Even if we ignore the outliers i.e. Natural Gas and Silver, the commodity complex witnessed an inter commodity market divergence of 112 per cent (long gasoline, short wheat). This was an annualised return of 37 per cent.

Now that we have clarified how the commodity complex is behaving and we have an idea about the worst and best, it would be interesting to look at which of the outliers are prone to reversion. Simply put, this means which of the best outperforming assets investor should under allocate and vice versa.

There are of course outliers like natural gas that have been exception to this rule, but sooner or later the outlier will catch up with reversion. The worst wheat and natural gas look attractive for investment allocation, while gold, silver and gasoline seem ready for further stagnation and underperformance. To confirm this view we looked at the long wheat, short-silver pair. The pair has already turned in favour of wheat. This means wheat should outperform silver. Now this may sound ridiculous but we need to believe in the performance cycle. We need to give the cycle signal sometime. Either it will negate itself or deliver.

Last but not the least, it's important to identify an asset class with a secular trend because an asset with a positive bias is bound to give an absolute return. Even according to the Benner cycle, commodities have turned up in 2011 and the cycle should remain positive till 2019. Benner Samuel was a farmer from Ohio who wrote his prophecies in a book about price fluctuations in 1875.

Benner lived in an era of Axe Houghton Indices, the time when Chicago Board of Trade was established and agricultural commodity trading was active business. Society was busy with agriculture and expanding railroads. This is why his workings were based on pig iron, corn, cotton and hogs. Agricultural statistics was compiled and used to establish demand and supply patterns. It was then 135 years back Benner wrote the future cannot be calculated based on agricultural statistics. Statistics compilation according to him would remain always poor, irregular, manipulable, undependable and non-predictive.

He said, “There is a time in the price of certain products and commodities, which if taken by men in advance leads on to fortune; and if taken at the decline leads to bankruptcy and ruin”.

The author is CMT, and Co-Founder, Orpheus CAPITALS, a global alternative research firm

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