Monday, October 01, 2007

Caution on commodities

I read an interesting piece by John Authers over the weekend, in which the Financial Times columnist urged investors to familiarize themselves with the basics of the commodity markets before jumping in.

Since the start of this decade, performance in a wide range of individual commodities has been hot, prompting many new investors and funds to jump on the resource bull market bandwagon.

Authers reminds prospective investors that there are factors which distinguish the commodities market from other investments long familiar to most professional investors (equities, bonds), and that each individual commodity bears its own unique fundamentals and behavioral patterns.

Take it, John:

The first rule of journalism, some say, is: "Never be afraid to admit ignorance."

In that spirit, I will admit that I took over this column without the faintest idea why aluminium prices might behave differently from nickel, or why corn prices diverge from wheat. I am not embarrassed by this. The world of commodities is huge and complex, governed by the peculiarities of demand and supply in particular markets across the world. Little or nothing you learn covering mainstream financial markets, such as equities and bonds, much helps you when you are looking at a report on copper supply.

What I do know is that the past few years have seen an explosion of interest in commodities, not only from hedge funds but also from mainstream big institutions. That was prompted by the prolonged rally in basic commodity prices that started earlier this decade. The entry of new investors helped push the market still further. But my fear, confirmed at least by anecdotal evidence, is that many of these new investors share my ignorance of commodities.

You can read the entire piece here, "Go back to basics before you buy commodities".

For more info on two very important themes stressed in John's article, the increased correlation of stock and commodity returns and the "non homogeneity" of individual commodities, see, "Double down on commodities?" and, "Stocks and commodities positively correlated".