Equities set to keep edge over commodities-analysts

Tue Sep 24, 2013 8:55am EDT

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By Eric Onstad

LONDON, Sept 24 (Reuters) - Investment flows into commodities are improving, but broad sector indexes are unlikely to consistently outperform equities for at least another year, until global growth gathers more momentum, analysts and fund managers say.

Strong commodity gains in August together with a breakdown in correlations between commodities and other asset classes like equities is helping to spark interest from investors.

"The view on commodities was pessimistic at best a few months ago. That seems to have changed, especially after August," David Hemming, portfolio manager in commodities at Hermes, told a recent conference.

The rise in commodities in August was driven by metals and oil, as economic data improved in China, the world's biggest consumer of raw materials, the euro zone ended a 1-1/2 year recession and tensions in Syria sparked worries about oil supplies and boosted gold as a safe-haven asset.

Net inflows of $5.5 billion have been seen so far this quarter in commodity index swaps, Citi said in a note on Monday. Liquidations earlier in the year, however, mean that there is still a net outflow so far in 2013 of $3.4 billion.

In recent years, many investors have favoured bonds while others wanting more risk have ploughed money into equities, leading to a sharp underperformance for commodities.

The 19-commodity Thomson Reuters-CRB index has lagged the S&P 500 equity index by 40 percent over the past two years, but in August the tables turned and the CRB came out on top by 6 percent.

That performance shows that commodities are probably in a transition phase but consistently stronger performance will have to wait until later in the global economic cycle, said commodities analyst Kevin Norrish at Barclays in London.

"Long-only indexes have given some positive returns, but they'll still going to underperform substantially other assets," he told the S&P Dow Jones commodities seminar last week.

"It's not really until you get to the latter stage of the cycle, that's probably the end of 2014 or maybe even 2015, that we might expect commodities to start generating impressive returns again."

Tactical investors are targeting asset classes showing the strongest returns, said Arun Assumall, head of commodity investor products at Macquarie Bank.

"What really hurt this year was just how compelling a story equities were last year and how it panned out," he told the seminar. "And so it's very difficult to compete and frankly, rightly so, a tactical guy should have bought equities."

CORRELATIONS BREAK DOWN

Some longer-term investors, however, have been encouraged that commodities are breaking away from tracking other assets.

Following the financial crisis, equities and commodities moved largely in tandem in response to waves of risk-on and risk-off trading.

But the 30-day correlation between the CRB and the S&P 500 equities index has flipped to a negative 0.19 from positive 0.74 in mid April, showing the least correlation since 2008.

"People are becoming more comfortable with the asset class and adding commodities as a diversifier," said Edmund Carroll, global head of commodities at UBS.

Other correlations are breaking down as well, including between individual commodities within the sector and the link between the sector and the dollar.

But the lack of strong direction and volatility in most commodity markets mean that investors must look at strategies that often rely on physical flows of commodities to generate healthy returns.

"You really need to be in the nitty-gritty to realise those trading opportunities and a lot of the sell side just doesn't do it," said Michael Jansen, head of research at fund manager and metals merchant Red Kite Group.

Other investors are buying physical assets linked to commodities, such as master limited partnerships (MLPs), which own energy pipelines, said Michael-John Lytle, chief development officer at Source, a provider of exchange traded funds.

"You can start to see how that's a good long term investment vehicle as opposed to something that's going to chop and change on a weekly or monthly basis." (Editing by Keiron Henderson)

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