LONDON (Reuters) - (The opinions expressed here are those of the author, a columnist for Reuters.) Do you remember JPMorgan’s Physical Copper Trust?
Registered in October 2010 with the Securities and Exchange Commission (SEC), it was probably one of the most controversial commodity investment vehicles ever conceived.
Although structured as a publicly-traded stock offering, it was to be backed by physical copper, 61,800 tonnes of it. Within days BlackRock had filed for an identical product almost twice the size with an implied holding of 121,000 tonnes.
Copper manufacturers were outraged at the concept of nebulous “investors” stepping into the physical supply chain and several of them fought a two-year rearguard action in the courts to block it.
That action was ultimately unsuccessful. But by the time the SEC approved both products in late 2012, the investment tide had already turned.
The initial boom in commodities investment had turned to bust, leaving a long trail of fund casualties in its wake.
A new boom is currently building momentum but it’s a boom of a completely different kind, a reminder that investment trends in metals such as copper follow their own cycle, one which can interact in price in unexpected ways.
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BOOM (PART 1)
With hindsight JPMorgan and BlackRock’s physical copper funds represented the high-water mark of the first boom in commodities investment.
Money was pouring into the sector, $71 billion of it in 2009 and $91 billion in 2010, according to estimates from Barclays Capital.
Heavy-weight pension funds such as The California Public Employees Retirement System (CalPERS) had been experimenting with the commodities sector since 2006, Commodities, the idea went, behaved differently from stocks and bonds and therefore acted both as stabilizers in a broader portfolio and as a built-in inflationary hedge.
The trickle of initial investment, however, turned into a deluge in the wake of the Global Financial Crisis.
Central banks changed the rules of the previous investment game, offering both stick and carrot for fund managers to invest in commodities.
In the developed world zero interest rates and quantitative easing wreaked havoc on returns on cash and bonds, both bedrock components of most big funds’ portfolios.
China, meanwhile, was so alarmed at the contraction in exports that it unleashed a massive infrastructure stimulus, stimulating prices across the commodities spectrum.
Nuanced academic arguments on portfolio diversification were swamped in the general stampede to move money out of non-performing assets into rising commodities.
Those two physical copper funds were conceived as a way of tapping into that surge in interest, aimed as they were at the most conservative of U.S. pension funds, those prohibited from investing in anything other than U.S. listed stocks.
However, by the time that the SEC gave its formal seal of approval to JPMorgan’s physical copper trust in December 2012, the rationale for investing in commodities was already unraveling.
The copper price peaked at $10,190 per ton in February 2011. By December 2012 it had fallen below $8,000 per ton, undermining the appeal of what was in essence a bull-market product.
It wasn’t just copper. As the tail winds of Chinese stimulus faded, the entire industrial commodities sector was topping out, bringing an end to what had been a one-way bet since the start of 2009.
At a deeper level early experimenters such as CalPERS were finding that commodities were not behaving as expected. The years 2009-2011 were characterized by the risk-on-risk-off trade with every part of the risk universe moving in lock-step.
And by the time that changed, it was to the detriment of commodities, which started falling even while stock indices were still rising.
Assets under management in the commodities space peaked at $451 billion in the fourth quarter of 2012, according to Barclays.
Under the double impact of collapsing prices and disinvestment the figure had fallen to just $160 billion at the end of last year, the lowest level since 2007.
Did the mass exit by fund managers exacerbate the collapse in prices? It depends on whether you believe the original investment boom was a driver of rising prices in 2009-2010.
Disentangling cause and correlation is nigh impossible and the whole topic is still a subject of heated debate.
But it is worth considering that the outflow of money from the base metals complex may have translated into the loss of over 600,000 tonnes of continuously rolling long positioning by funds invested in a commodity index such as Goldman Sachs’ GSCI.
BOOM (PART II)
Just as investment interest in commodities was dwindling in the developed world, it was about to flourish in a completely different form in a completely different place.
The London Metal Exchange copper price plunged over 11 percent over the course of just two days in January 2015.
It did so because of a wave of selling emanating from the Shanghai Futures Exchange, where market open interest hit an all-time high and volumes were the second highest on record.
Overnight the rest of the market woke up to the existence of little-known Chinese hedge funds such as the exotically named Shanghai Chaos.
Unlike their Western counterparts, who had been drawn into commodities on the long side via broad-based commodity indices, these new players showed they could aggressively play markets from the short side.
And they returned to attack the copper market in both July and November of last year.
Indeed, by November, it wasn’t just copper that was being hit. Both Shanghai aluminum and zinc contracts saw mass bear raids with volumes and open interest spiking to previously unseen levels. Aluminum was particularly interesting since the Shanghai contract had historically been relatively low in liquidity relative to copper.
In both cases the bear attacks lasted only a few days, suggesting a retail crowd surge that may have been looking for new ways to express a negative view on the Chinese growth story after Beijing clamped down on “malicious short-selling” on Chinese stock markets in July last year.
Five years after JPMorgan and BlackRock dreamt of bringing metals to the masses via their pension fund managers, the masses in China appear to have found their own path to commodity markets.
THE FUTURE IS UNCERTAIN
There’s still considerable uncertainty to what exactly is taking place on China’s commodity exchanges.
But the argument that retail players are getting involved was strengthened this year when trading volumes in Shanghai steel contracts and the Dalian iron ore contract went supernova.
The price of iron ore surged by 20 percent in a single-day, on March 8, and it did so amid an explosion of trading volume on the Dalian exchange.
One of the most physically-rooted commodities, it seems, was dragged sharply higher by speculative trading flows.
It’s a new phenomenon for commodity markets, where investment has in the past been largely confined to professional fund managers. High entry thresholds, particularly on the LME itself, have locked out all but the very wealthiest man in the street.
And it’s happening just as Western fund managers are starting to dip their toes in the commodity waters again.
Barclays estimates that more than $20 billion flowed into commodities in January and February this year, the strongest start to any year since 2011.
Most of that investment went into precious metals and the energy sector, but if it is the start of a larger (re-)investment trend, it will only be a matter of time before the trickle-down effect washes into the base metals sector.
And who knows? Maybe the dust will be blown off those filings for physical copper funds at some stage in the future.
After all, a long-only physically-backed copper investment to ultra-conservative pension fund managers may be a much easier sell now than it was back in December 2012.
Editing by Louise Heavens
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