June 30, 2008, 6:00 am

Are commodities an asset class?

by: The Financial Blogger    Category: Investment, Market and Risk
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In the past 1-2 years, commodities have changed a lot in the eyes of investors, both institutional and individuals. In the past, asset classes were generally either equity, fixed income (bonds), or fx. Commodities have been traded for a long time but it was generally a hedging market where buyers and sellers would go to insure the future price they would receive would not affect their operations too much. If a farmer wanted to be sure he wouldn’t be too affected by a fall in corn prices, he would go in the futures market and simply sell futures, so any loss on the price (on the sell of his crops) would be offset by his future. The other side of the trade was generally the company that was going to buy the product in a given period and wanted to insure price stability.

 


But recently, a lot of investors, mainly hedge funds at the start started investing in commodities taking bets on their rise, fall or even volatility. This has caused much debate in the governments and the US government is currently looking at legislation that would limit such “speculation” in the commodities markets.

Good thing or bad thing? Well, it’s a very heated debate and I could only give my opinion. Obviously the argument for those supporting such legislation is that current speculation is causing huge trouble around the world as prices of food and energy has risen far above the supply and demand. And it’s easy understanding their point. When you look at poor countries that spend 30-40% of their income on food, it’s easy to see how a 100% rise in the prices can be tragic. The solution is not easy and some countries (China for example) have tried to subsidize prices to help their populations afford the increasingly expensive oil. But long term, there’s no doubt that it cannot be maintained.

I still think that in the end, markets are efficient and if the rise is not warranted, prices will go back down sooner than later… The problem with this bubble compared to many others is the extent to which it impacts regular citizens whereas usually bubbles were investment bubbles and would mostly impact investors (i.e. not the poorest members of the society). And we also have to look at how it could be done practically. There’s already talk that if such legislation is put in place in the US, hedge funds and big pension funds will simply do their trading elsewhere such as in London, so is it really going to make a difference?

It will be a big debate, and one that we will watch with interest as the past few months have shown without any doubt that the fluctuations in the commodities markets have great impact in the everyday lives of each of us. In my next column, I’ll take a look at the different ways to play the commodities market.

 

 

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[…] Financial Blogger presents Are commodities an asset class? posted at The Financial Blogger, saying, “In the past 1-2 years, commodities have changed a […]