Oil looks cheap, but investors are wary

By Jane Merriman - Analysis

LONDON (Reuters) - A flight into cash during the credit crisis has helped drive oil and other commodity prices down so steeply that they are a potential "buy" for pension funds with a longer view.

But timing is everything.

"People are sitting on cash -- big lumps of it," said Mark Mathias, chief executive of commodity fund manager Quantum Asset Management. "Everyone is worried about when to go back in. Long-term, oil is cheap, but who knows where it goes in the short term."

Investors are searching for evidence that could signal whether the global downturn may be near to the bottom.

In these troubled times, the Baltic Freight Index has become a key leading indicator of economic vitality.

"The Baltic Freight Index is the electro-cardiogram for the world economy," said Hilary Till, principal, Premia Capital Management.

The Baltic Exchange's main sea freight index .BADI has risen over the last 10 days, but prices to ship commodities are still near their lowest in more than two decades.

"When you are in an extreme state, the things you follow are indicators for the overall health of the world trading system or the banking system," said Till, who is also research associate at the EDHEC Risk and Asset Management Research Center.

MORE DE-LEVERAGING

Investors have dumped commodities along with other financial assets after a crisis in the banking system seized up global markets and tipped the world economy into recession.

There is still more de-leveraging to come.

"Liquid assets are still in the firing line to be sold," said Mathias. "I think a lot of pension fund money left the (commodity) indexes in general, but quite a lot is actively planning to come back in."

If pension fund investors come back, they would be more likely to opt for more dynamic strategies rather than long-only investments in commodity indexes, which are used to gain access to the asset class.

"Some investors are looking at non-directional stuff, such as market-neutral hedge funds," said Mathias.

The California Public Employee Retirement System, for example, may consider investment strategies in commodities beyond commodity indexes such as the S&P GSCI .SPGSCITR.