A Cautionary Tale
For the last couple of quarters, commodity investments have captured
intense investor interest, with many of our own clients having inquired
as to our stance on inclusion given their latest rise in popularity.
Commodities have developed a reputation for providing a hedge against
inflation and an apparent negative correlation to equities. Further
research into this subject reveals that no such advantage proves
out. A compelling study by former USC finance professor, Truman Clarke
details the lack of substantiation for the bold claims made by commodities
proponents. IFA has detailed that study and you can read the article
by clicking here.
Deservedly so or not, commodities assumed their moment in the spotlight,
prompting a need for further explanation as to what commodities are
and the risks associated with them.
Quite simply, a commodity is a hard asset, an item that is purchased
on the hope that an increased demand or a decreased supply for the
item will cause its value to increase. Commodity investments differ
from stock investments in that companies, on average, make about
10% of profits per year. Under most conditions, their stock value
is expected to increase approximately 10% a year, on average, as
well. The expectation of price appreciation for commodities is not
based on profits, but rather on supply and demand. In short, commodities
do not engage in capitalism.
Recently, the rapid rise in oil prices, based on supply fears and
political tensions, caused rampant speculation in the futures markets. Oil
futures were driven from $100 to $140 a barrel in a few short months,
and investors loaded up on them, sending prices even higher.
The laws of supply and demand do ultimately prevail, however. Oil
prices have recently retreated, and investors who purchased futures
contracts have paid dearly for price speculation.
Even worse investment experiences have occurred for commodities
investors who elected to invest in the Ospraie Fund, a hedge fund
that was -- until just a couple of days ago -- one of the biggest
players in commodities. That is, until the fund manager announced
that it would unexpectedly fold its largest fund, the result of significant,
precipitous, and unrecoverable losses the fund suffered in a single
According to a Wall Street Journal article, dated September
3, 2008 titled “Ospraie Closes Largest Fund As Commodity Losses
Swell”, “The Ospraie Fund fell 27% in August alone
due to bets on oil, natural gas and structured products, and the
fund has been selling off its holdings over the past three weeks,
possibly contributing to a decline in commodity prices. The fund,
whose assets peaked at $3.8 billion late last year, is the biggest
run by Dwight Anderson, a veteran commodities investor.”
That statement quoted from the Journal is pretty incredible.
A decline in commodity prices was actually set in place by an overextended
hedge fund. Perhaps the most disconcerting aspect of the story is
that it details massive losses that were incurred by Anderson who
is described as “a veteran commodities investor.”