Funds embrace commodities after Q2 exodus

LONDON Fri Jul 22, 2011 2:44pm BST

LONDON (Reuters) - Investors have started switching into commodities from equities and bonds this month, reversing flows in the second quarter, in a trend that is likely to continue as long as worries over inflation and debt crises dominate financial markets.

The switch breaks months of strong positive correlation between stocks and commodities indexes as funds, boosted by liquidity from the second round of U.S. economic stimulus, flooded into all markets.

While the MSCI world stock index .MIWD00000PUS has dropped 1.2 percent since the start of the third quarter, the Reuters-Jefferies commodity index .CRB has risen by 2.5 percent.

Fund managers and analysts say commodities may continue to outperform equities, because investors see them as the least-worst option at a time of rising inflation and weak paper currencies as Europe and the United States are beset by debt crises.

Graphic of the correlation between the MSCI All Country World Index and Reuters-Jefferies index of 19 commodities:

link.reuters.com/seb72s

"We are entering a new paradigm," said Christiaen van Lanschot, a partner at commodities-focused fund manager VOC Capital Management in London. "It appears that recently the strong positive correlation between the two has broken down."

PUSH INTO COMMODITIES

According to fund flows research company EPFR Global, commodity sector funds that invest in physical products, futures or the equities of commodity companies such as miners, attracted $1.465 billion (900 million pounds) in net inflows globally in the first two weeks of July.

The bulk of that money came in the week to July 13, when the euro zone debt crisis escalated. It was the largest cumulative flow as a percentage of fund group assets of all the sectors -- beating bonds, equities and money market funds.

"The 3 percent-plus portfolio gain posted by this fund group stood out in a week when all the other 17 major equity and sector fund groups tracked by EPFR Global lost ground," it said.

The push into commodities in July reverses a trend in the second quarter, when investors pulled a net $3.9 billion out of commodities, according to Barclays Capital data.

The move explains a divergence of stocks and commodities, with correlation dropping from more than 80 percent positive to around 40 percent negative over the past two weeks.

Thomas Becket, chief investment officer of PSigma Investment Management with $2.4 billion under management, attributes the breakdown partly to investor concerns about corporate profits due to higher raw material prices.

"You also have to remember that commodities started falling first. Equities had a minor correction back in May, but commodities corrected quite aggressively," Becket said.

Data from the big futures exchanges also provide evidence of a shift towards net long positions in oil this month.

After cutting exposure to oil futures and options in June, figures from the U.S. Commodity Futures Trading Commission on NYMEX trading and from the IntercontinentalExchange ICE.L show a significant reversal of positions in July. Speculators betting on oil raised their net long futures and options positions in U.S. crude futures in the week to July 12.

"LEAST-WORST OPTION"

At the same time hedge funds and other money managers investing on ICE increased their net long positions on Brent by over 20 percent and on gasoil by more than 50 percent.

"Commodities could be seen in some ways as the least-worst option, given what is happening with other markets," said Amrita Sen, an oil analyst at Barclays Capital who looks closely at fund allocations into commodities. "Some investors have not liquidated positions in commodities, while they have exited some other asset classes such as equities."

Willem Sels, UK head of investment strategy at HSBC Private Bank, which manages around $500 billion, said he had cut his exposure to high-yield bonds and equities to neutral from a small overweight in June. But he is now overweight gold and precious metals, seeing these as a good hedge against inflation, a weak dollar and the uncertain outlook.

"There are fewer and fewer safe havens in the world, so there is more of a concentration of flows into the few safe havens that we still have, like gold," Sels said.

Angus Murray, chief executive of Castlestone Management, which runs some $317.51 million in commodities, said investors had taken risk off their books as they came into the summer, and gold had benefited particularly.

"There are some very real concerns around whether Greece is going to default, and what impact that would have on European banks," he said. "Added to that is a concern about what would happen if the U.S. got downgraded, so the only asset that investors feel comfortable owning is gold by default."

(Editing by Jane Baird)