Commodities

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

The exit of a big metals hedge funds tells you that making money in this game is tough. Trafigura announced this week it will wind down its Galena Metals Fund "in view of difficult conditions prevailing in commodities markets."

As Bloomberg Gadfly columnist David Fickling pointed out in a recent article, weak demand and new supply are a toxic brew for industrial metals prices. Even the smartest traders, be they at Galena or battered giant Glencore, struggle to deal with that.

What is different this time (yes, really) is that the past decade witnessed a big influx of retail money directly into metals, mainly through exchange traded funds. After the tech bubble popped in 2000, commodities were pushed hard by Wall Street as an asset class providing exposure to the next growth story -- China -- and money began flowing into commodity-linked ETFs.

If the thought of mom and pop getting into markets that have long been the preserve of secretive trading houses nestled in the Alpine valleys imparts a vague sense of dread, then your instincts remain sound. The truth is that metals, and commodities in general, have been pretty lousy buy-and-hold investments.

For simplicity’s sake, compare the total return of the Bloomberg Commodity Index, its industrial metals sub-index, and the S&P 500. It is important to look at total return rather than just price, as commodities don’t yield anything and, indeed, the futures backing many ETFs can have negative yields due to positions having to be rolled forward as contracts expire. Assuming you bought your position at the end of any year starting with 1995 and held it to now, stocks were the better option by a long way.

Metal Fatigue
Total returns on metals and commodities in general haven't come close to matching stocks over time
Source: Bloomberg
Note: As of Nov. 30th, 2015

For example, if you bought metals at the end of 1995, your total return to the end of last month was 45 percent, versus almost 400 percent for the S&P 500. If you bought at the end of 2004, as the commodities supercycle was really ramping up, your total return on metals is 22 percent, versus 140 percent for the S&P 500.

This isn’t to say that stocks have been consistently better over the past couple of decades. Look at the chart below and you can see the supercycle headlines weren’t just hot air.

Spot the Cycle
Source: Bloomberg

But if you look at annual returns to make sense of all those ups and downs, it turns out the truly super bit of this cycle didn’t actually last that long.

The Golden Copper Age
Industrial metals enjoyed a brief period of relative outperformance against the S&P 500
Source: Bloomberg

The golden period of industrial metals essentially boiled down to the five years between 2002 and 2006, when total returns consistently beat the S&P 500 by a wide margin, with a coda in 2009 as China splurged on infrastructure spending to fend off the ravages of the financial crisis. The record for the broader commodities index is even spottier.

So, as was ever the case, investing successfully in industrial metals means trading in and out of them, something most people are ill-equipped to do.

Looking at net flows of money into European industrial metals ETFs, ETF Securities data show that by far the biggest years for inflows were 2009, 2010 and 2012. As the chart above shows, the first of those years was a banner one for industrial metals, so if you traded in and out, you did well. The others were less spectacular, and anyone who bought in those years and hung on has paid dearly, especially relative to stocks. Since then, net outflows have been the order of the day, apart from an ill-timed inflow in 2014.

The exit of retail money precisely as underlying metals prices have come down is another familiar aspect of an investing fad winding down. That even the smart money is now finding metals, and commodities in general, a tough market to trade is the clearest signal yet that the super bit of the supercycle is done.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net