AFTER years of disappointing returns, commodities have now entered into a bull market and become the best-performing asset class this year. Prices are expected to stay high in the second half of the year with tightening physical and supply fundamentals across the complex, said analysts.
Yet, many investors remain wary of investing in the asset class and are still underweight on commodities, said a fund manager.
The strong performance of commodities, fuelled by higher crude oil and gold prices, has outpaced those of equities and bonds.
The Bloomberg Commodity Index is now 20.5 per cent higher than its January low, meeting the common definition of a bull market. It has delivered total returns of 12.1 per cent this year.
"Commodities, which have for the last few years held title as the worst-performing global asset class, appear to finally be entering their renaissance," said Citi Research in a note.
The asset class has seen inflows of US$34.2 billion so far this year in exchange-traded funds and passive indices, it said.
Compared to last year, when commodities prices were bolstered by inflows of US$16 billion of passive investment money in the first half of the year before collapsing in the second half, Citi deems the current recovery in prices a sustainable one. Other analysts concur.
"In our view, solid commodity returns this year have been largely a function of micro fundamentals: Low prices are boosting consumption but are also acting to curb supply, leading to higher equilibrium prices," said Bank of America Merrill Lynch (BoAML) analysts.
In crude oil, a structural decline in production and disruptions in a few producing countries have led to a tighter market.
Meanwhile, expectations of the La Nina weather phenomenon later this year and supply disruptions in Latin America are supporting grain prices. Gold prices, which after a rousing start to the year turned southward in May, are also starting to pick up again after US non-farm jobs figures disappointed last week.
Still, most investors have chosen to stay on the sidelines than to invest in the asset class, Christopher Wyke, Schroders product manager for emerging market debt and commodities, told The Business Times.
"People have been hesitant to invest in commodities this year," he said. "Most investors are very wary because they see oil has been falling for 18 months."
Overall, there is still a net outflow from commodities, though this has been reduced this year. Gold and crude oil have been the main beneficiaries of inflows, albeit from very low bases, he added.
According to a BoAML survey in May, institutional investors' current allocation to commodities is still one standard deviation below its long-term average. But slightly fewer fund managers are staying underweight on the asset class, with 19 per cent doing so last month, down from 22 per cent in April.
The biggest price gains usually occur at the beginning of a bull market, and the best time to buy is when consensus expectation is turning, as seen in commodities now, according to Schroders.
While the asset management firm had called a bottom on the gold price and also placed an "overweight" rating on oil in January, its commodity fund has seen "very little" inflows, said Mr Wyke.
"Retail investors will invest after something has gone up. Obviously our aim is to make money for our clients, so we were very frustrated," he said. The best way to invest in commodities is through an actively managed, long-only, fund rather than an exchange-traded fund, he added, as individual commodities have varying supply and demand fundamentals.
In the crude oil market, there is now concern over a rebound in production in the US, after data showed that drillers there last week returned nine rigs to operation, the biggest gain since December.
Still, the international Brent crude benchmark remained above US$50 a barrel on Tuesday.
Mr Wyke is very bullish on further recovery of the oil price. Because of the high decline rates of shale oil fields, minimally 700 rigs are needed to maintain production at current levels, he said.
Only 325 rigs were in operation in the week to June 3, according to energy services company Baker Hughes. US rig count has been falling since hitting a high of 1,609 in October 2014, though the pace has slowed.
The current oil price is below the average cost of production globally, and therefore not sustainable, said Mr Wyke. "Over the last 20 years the price has often been below the marginal cost, but it's never until now been below the average cost."
"Nobody's making money, and if you're not making money, you're not going to drill for oil," he said. "So the world may not have run out of oil but it's run out of cheap oil."
In an earlier version, we wrote that Christopher Wyke, Schroders product manager for emerging market debt and commodities, recommended investing in commodities through an actively managed hedge fund rather than an exchange-traded fund. This has been corrected to show that he was referring to an actively managed, long-only fund.