Coffee Isn't All That's Perking In The Pits

For much of the year, the price of copper has been on a relentless rise. With a global economic recovery stimulating demand and available supplies dwindling, futures contracts on the industrial metal soared 37% since December, to nearly $1.14 a pound on June 20. Then fears developed that speculative fever had pushed the market too far, and prices beat a quick retreat, dropping below $1.06 on June 28.

It's the same story across a wide swath of commodities, from grains to energy to "soft" commodities such as sugar, cocoa, and cotton. With the exception of coffee and aluminum, most commodity prices have fallen from recent peaks, leaving investors to wonder if the bull market of the past few months has passed them by.

Don't bet on it. Most analysts believe prices will continue to rise over the remainder of the year--and quite possibly for some time beyond that. What's going on in many futures markets is the flip side of what's happening in the bond market--the perception that inflation is around the corner. Traders and investors fleeing bonds and stocks are looking around for inflation-friendly plays, and they're finding them in commodities. Trading volume in commodity futures contracts was up 26% in the first five months of 1994. "Commodities are coming up on the radar screen," declares Richard L. Sandor, who heads Centre Financial Products Ltd. in New York.

HEDGE-FUND MOVES. Money is streaming into the markets from some unlikely sources. Futures pros believe that hedge funds, the secretive private investment partnerships that usually invest in financial assets, are now throwing some of their cash into commodities. Even certain U.S. pension funds are joining in with tiny stakes in diversified futures portfolios.

While most mutual funds don't buy commodity futures, some are joining the game anyhow by investing in financially engineered securities whose yield is tied to the price of a single commodity or even to a commodities index. For example, the most recent report from the Fidelity Asset Manager Fund shows nearly $400 million in 21 structured securities whose interest payments are linked to different commodities ranging from aluminum to zinc.

A hefty chunk of the new money is looking for higher prices--and thus going long. Some futures traders believe that a few of the big hedge funds have shifted as much as 10% of their assets into commodity futures.

Investors hoping to capitalize on the bullish sentiment should appreciate that the commodity markets are a lot trickier than they seem. Take the Commodity Research Bureau Futures Price Index. The CRB has become one of the most closely watched indexes around. Unfortunately, even one relatively insignificant commodity can distort the index. Take coffee: After soaring 94% from the 1993 low, coffee prices pulled back 13% amid fears that higher prices would encourage producers to liquidate stockpiles. But frost in Brazil changed the supply picture overnight, sending coffee prices soaring 27% on June 27.

Much of coffee's action has had more to do with Mother Nature than with macroeconomic trends. That's also true of soybean and corn prices, which ran up amid a dry spring but fell when summer rains arrived in the Grain Belt. Yet each agricultural commodity has the same impact on the CRB as oil, which is far more important to the economy and to


The money gushing into commodity futures, further, could swamp the markets, making prices more erratic. Compared with stocks and bonds, these markets are small. If all U.S. pension-fund managers allocated just 1.9% of their assets to commodities, their investment would equal the entire open interest--the amount of outstanding contracts--in the major futures markets. "It only takes a small drop of that kind of money to be a big flood in the futures market," explains Jack D. Schwager, director of futures research at Prudential Securities Inc.

CAVEAT INVESTOR. Many institutional investors are making their move through "managed futures"--the futures industry's answer to mutual funds. Sabre Asset Management in London, for instance, has drawn $50 million from European institutions for a fund that will take long positions in up to 20 different commodities. In the first quarter, the latest available data, futures funds did best in energy and agricultural trading, up 3.5% and 1.6%, respectively, according to the Barclay Trading Group Ltd. Managed funds commanded $23 billion at yearend.

But the investor should beware. The current wave of bullish sentiment is likely to push prices higher for a time. But if the underlying macroeconomic conditions don't reinforce that sentiment, going long could turn out to be a sucker's bet.