Commodities Top Returns Even in Worst Meltdown of a Generation

  • Top-returning oil fund earned 241% while prices fell by 50%
  • While leverage boosts risk, bearish momentum bets paying off

The biggest collapse in commodity prices in a generation is giving some investors the best returns of any asset class.

Over the past 12 months, eight of the 10 best-performing U.S. exchange-traded funds were securities that benefited from declines in raw-material prices, with five more than doubling their money, according to data tracked by Bloomberg on more than 1,600 ETFs across asset classes, including equities, fixed income and mixed allocation.

With commodity prices languishing near a 16-year low because of excess supplies, money has been flowing out of funds linked to metals, crops and energy. But for the investors that took on more risk with leveraged short bets, the payoff has been big. The VelocityShares Daily 3x Inverse Crude ETN, by far the top gainer, surged 241 percent over the 12 months through Wednesday as oil prices tumbled 50 percent in New York.

“It’s been good because we’ve been short all year,” said Jay Feuerstein, who oversees $2 billion as managing director of Alternative Strategies for
Chicago-based Manning & Napier, which bets on price declines for heating oil, gas oil, natural gas and crude. “Commodity markets have been trending pretty consistently” he said. “They have this downward momentum.”

Banks from Goldman Sachs Group Inc. to Morgan Stanley are forecasting more declines for raw materials. The Bloomberg Commodity Index, a measure of returns for 22 components, is on pace for a fifth annual loss, the longest streak since the data begins in 1991. China’s slowest expansion in decades is cutting demand just as farmers, miners and oil drillers expanded supplies, encouraged by prices that were at record highs in 2008.

Investors willing to go short are reaping rewards. In the two months through Wednesday, funds shorting oil and gas producers and a broad basket of commodities posted gains of at least 19 percent.

Volatility Risk

The bets aren’t without risk because the funds that provided the biggest profits are those that are highly leveraged. Volatility can also detract from profits. The VelocityShares Daily 3x Inverse Crude ETN fell 17 percent this year to Sept. 16, even though crude prices also declined. Oil futures lost 11 percent to settle Wednesday at $47.15 a barrel. The ETF’s prospectus states that the security is designed to achieve daily returns against the drop in energy, but “may not be suitable for investors who plan to hold them for a period other than one day.”

“In the long run, there’s far more risk to being a leveraged short,” said George Zivic, a New York-based portfolio manager at OppenheimerFunds Inc., which oversees $220 billion. “The market can reverse very, very quickly. And by the time a retail investor is able to log on to his personal account or call his broker and sell that, it’s probably too late.”

Not everyone has the stomach to face the risks associated with shorting commodities. Even as ProShares UltraShort Bloomberg Crude Oil, the third-best performing ETF in the year to Sept. 16, jumped 175 percent, investors pulled $175.7 million from it, data compiled by Bloomberg show. By contrast, the long-only United States Oil Fund attracted $2.75 billion in new cash, the most of any commodity-linked ETF. The fund lost more than half of its value in the past year.

Direxion Gold Miners Index Bear 3X Shares, an ETF that bets against the NYSE Arca Gold Miners’ Index, rose 9.8 percent in the two months through Wednesday. Still, it has seen investors pull $9.56 million in the past week.

Open Interest

While few investors are willing to short commodities, there’s not much to encourage the bulls. Just 2.6 percent of the money in ETFs as of Sept. 16 was tied to raw materials, compared with about 10 percent at the end of 2011. A combined measure of net-long positions across 18 commodities has declined in six of the past eight weeks, U.S. government data show. Open interest is near the lowest since January.

The commodities bear market may last for many years, with oil dropping as low as $35 a barrel, because production cuts haven’t been sufficient to wipe out the global surplus, said Ruchir Sharma, who helps manage $25 billion as the head of emerging markets at Morgan Stanley Investment Management in New York. Goldman says the price could slump to $20, less than half what it is today. A glut could keep prices low for the next 15 years, Jeffrey Currie, head of commodities research at the bank, said Wednesday in an interview.

“Unless we start seeing an uptick in demand, it is really hard to envision a scenario where commodities rally anytime soon,” said Lara Magnusen, a La Jolla, California-based portfolio manager at Altegris Investments Inc., which oversees about $2.6 billion. Altegris Investments’ $470 million Futures Evolution Strategy Fund is shorting crude oil and gold. “Supplies are fairly ample, and demand is under pressure. And when you have that kind of scenario, generally the outlook for commodities isn’t very good.”

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