* Commodities see inflows after liquidations last year
* Metals in favour, some investors wary rally overdone
* 2014 asset performance: link.reuters.com/gap87v
* 2014 commodities performance: link.reuters.com/reb25t
By Eric Onstad
LONDON, July 21 (Reuters) - Investors are slowly being drawn back into commodities, attracted by stronger global economic growth and more volatility within sub-sectors, typified by current investment flows out of grains into industrial metals.
The sector has been shunned in recent years, knocked by poor returns during the financial crisis which saw commodities move in step with other assets.
Commodities has benefited this year after China unleashed stimulus measures to prop up growth and recovery took hold in the United States.
"There was a pretty large unwinding of money tracking commodities towards the end of last year, but it's reversed this year and you've seen investors coming back," said David Hemming, a commodities portfolio manager for Hermes Fund Managers, which manages 27 billion pounds ($46 billion) of assets.
Earlier in the year, commodities was the best performing asset class, but declines in agriculturals and oil have weighed in recent weeks. The 19-commodity Thomson Reuters/Core Commodity CRB Index is up about 6 percent this year, but has shed 5 percent since hitting a two-year high on June 23.
This compares with a gain of 4.5 percent this year in global equities.
Koen Straetmans, senior strategist at ING Investment Management in the Netherlands, upgraded commodities to overweight from neutral about a month ago on the bet that others would follow. The group manages $232 billion of assets.
"After the dismal performance last year, investors had been underweight the complex, so in terms of positioning we thought that you might see a catch up and reversal," he said.
"That, together with stabilisation in emerging markets and China, made us upgrade the sector."
So far this year there has been a net inflow of $9.1 billion into commodity investment products, comprising index swaps and exchange traded products, according to Citi.
But that is still a fraction of the outflow of $28.7 billion in the same period last year.
"There's been interest out of the U.S. and we've also seen a pick-up of activity in Asia," said Hemming. "We've seen institutional investors continue to take a look at commodities, generally though ... they can take a bit longer to finally put an allocation in."
Investors are again seeing commodities as a way to diversify their portfolios, a theme that died away during the financial crisis as all asset classes largely moved in tandem.
The 30-day correlation between the CRB index and the MSCI world equities index has dropped to 20 percent from 66 percent a year ago.
Performance within the commodities complex has also diverged. Industrial metals have recently outperformed grains and energy, opening up trading opportunities.
The London Metal Exchange index of six base metals has rallied 12 percent since last March while the grains component of the Dow Jones Commodity index has shed 22 percent in the same period.
Commodity trading advisors (CTAs), or managed future funds, have been leading the move to swap grains for metals, Hemming said.
"This is actually the time to buy," said Wiktor Bielski, head of commodities research at VTB Capital in London.
"If you look back at the cycles in the 70s, 80s and 90s, the right time to buy and the biggest gains in base metals are always at the start of the cycle. Even better than bull markets at the end."
Some investors are worried, however, that while base metals have potential for further price gains, they have rallied too fast based on forecasts of shortages while hefty inventories still have to be eroded.
"From here on, I'm not really inclined to play it further. The short-covering has broadly unwound in copper and you also see very recently that copper inventories in China are rising again," said Straetmans. On Friday, weekly data showed that copper in warehouses monitored by the Shanghai Futures Exchange surged by nearly 30 percent.
Hemming agrees that metals may be the next sub-sector that could see a pull-back in coming weeks. "As we've seen some length coming out of grains, some of that has been redeployed in the metals ... but our analysts believe that we're starting to get to the point where prices have run beyond fundamentals." ($1 = 0.5859 British Pounds) (Editing by David Clarke)