Institutional Investor's Alpha Magazine - February 2009 - (Page 47)

Vermillion, believing that commodities must be meticulously hedged. By New Year’s day, however, the allure of commodities was unmistakable again. “I have not seen an environment where investing in commodities and underlying sectors has looked so promising,” says Donald Lindsey, chief investment ofﬁcer of Washington-based George Washington University and overseer of its $1.1 billion endowment, 2 percent of which is invested in commodities. “The supply constraints — the long-term view that there isn’t enough oil and gas and farmland and fuel — never went away, and now stocks of some commodities-focused companies are trading at less than the cash on their balance sheets. It is absurd.” Lindsey, who declines to say which companies he likes, intends to increase the endowment’s broad commodities allotment in 2009 — mainly because he expects the world to be more supply-constrained once it emerges from recession. “We will be looking across a wide range of hard assets, including traded and nontraded commodities, as well as global infrastructure,” he says. Although the outlook is still far from clear on oil, gas, metals and food commodities, investors are considering alternative commodities like power generation, nontraded commodities such as water and even construction commodities related to infrastructure build-out, which most say will be the force behind any rebound in global growth over the next few years. Of course, some hedge funds and certainly many CTAs are still basking in their commodities-investing success last year. The Barclay CTA index was up 13.23 percent in 2008, its best year since 2002. The most diversiﬁed CTAs showed the best returns; a Barclay CTA subindex called the diversiﬁed traders index was up 25.5 percent. This year the key for commodities investors may be ﬁguring out where in the cycle various commodities lie, and what the supply-and-demand curve will look like when credit markets return to normal and the global economy rights itself, and if global deﬂation is averted. Many are looking to the end of 2009, when government spending and near-zero-percent interest rates may ﬁnally create a turnabout. “There is a tremendous amount of extreme pessimism priced into the market right now that is signaling not just a recession but a potential depression,” says David Abramson, a senior commodities and energy analyst at Montreal-based BCA Research. One clear example is in the so-called petroleum crack spread — the difference between productions costs and market prices. By the end of 2008, the crack spread of gasoline rested at about negative $5, “meaning producers are losing money hand over ﬁst on every barrel of gasoline they produce,” says Abramson. “The only way you could bet that kind of contagion scenario is sustainable is if you expect the world to stop driving.” Similar theories apply to other commodities. The key to smart buying or selling will be in determining how much time it will take to get through excess capacity, as well as how long producers — particularly of oil, gas and Photograph by Peter Wynne Thompson metals — will continue to limit production. If vast government stimulus plans in China, Europe and the U.S. do what they are supposed to do, most expectations are that the global economy will recover in the next 12 to 18 months, and demand for commodities will rebound. Indeed, longer term, the biggest issue will be whether supply can keep up with demand, Ennis Knupp’s Black argues. David Morton, a consultant and commodities expert at Norwalk, Connecticut–based Rocaton Investment Advisors, also expects the case for commodities to improve this year, especially given their historical tendency to offer returns that don’t mirror the equity and bond markets and in view of current prices. “The lesson, if any, is that commodities are part of a different, complex market with different factors and mechanisms that bear little resemblance to price-earnings ratios or ratings, coupons and yield curves,” he says. Nygaard points to another important lesson to be learned from recent events. “Many hedge funds became something other than hedge funds over the past few years — they became one-way, levered long-beta bets,” he says. “That is great when times are going well and the directional tide keeps rising, but not when there is extremely high volatility and the markets inevitably go down.” Brad Cole of Chicago-based Cole Asset Management says the commodities market was ﬂooded by inexpert investors. FEBRUARY 2009 • INSTITUTIONAL INVESTOR’S ALPHA • 47

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - February 2009

Institutional Investor's Alpha Magazine - February 2009 Contents Letter From the Editor Longs & Shorts Digging Out A Call to Mentor Dicey Detroit The Constant Skeptic Cover Story: The Undaunted What Were They Thinking? Dark Days in Greenwich True Stories from the Commodities Files Return of the Native The Quest for Cover Moving On from Madoff

Institutional Investor's Alpha Magazine - February 2009

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