HSBC anticipates near-term correction in soft commodities

HSBC Investments – an early bull in the soft commodities rally – has turned short-term bear in anticipation that the asset class will cool further in coming months.

Charlie Morris, manager of HSBC Investments’ Absolute Return Service, a managed portfolio service with US$2.5 billion assets under management, has sold all remaining exposure to soft commodities (including grains, coffee, sugar and cotton). Morris has used the proceeds from this trade to increase exposure to industrial metals.

Morris said: “While the longer term-supply and demand imbalance remains a key driver for agricultural commodities, the recent price movements have been overwhelmed by extreme levels of financial speculation. Although the long-term strength may well continue, the sector needs to cool before this is likely to happen and some further price consolidation over coming months is now likely.”

The portfolio now holds zero exposure to soft commodities, down from its peak of 8% in January 2008 (held via an exchange traded fund). Overall commodity exposure in the portfolio is also down to 5.7%, from its peak of 15% in January 2008.

Morris said commodity prices were clearly over extended in most areas. Over the past nine years (to 6 March 2008), an equally weighted commodity basket (as defined by the Continuous Commodity Index ) has risen 209%, similar to the 235% rise over a nine-year period in the 1970s (1971 to 1980), another period of dollar weakness.

Within HSBC Investments’ Absolute Return Service, soft commodity exposure has been replaced with a small holding in industrial metals, also via an ETF. This basket comprises 38% aluminium, 32% copper, 15% zinc and 15% nickel.

Morris said industrial metals have traded in a consolidated range for nearly two years (peaking in April 2007). This means there are low levels of speculative capital when compared to energy, precious metals or agriculture.

“Although industrial metals typically fall during times of economic stress, we do not expect this to happen now despite current weakness in the economy. It is likely that demand will remain strong as investors will pay a premium for real assets as an inflation hedge and safe haven status from credit markets.”

The core remaining commodities position within the Absolute Return Service is in natural gas, through the purchase in January 2008 of an ETF that tracks the three month forward prices of gas.

Morris said: “Oil and gas have historically traded in step until the Amaranth hedge fund crisis led to the artificial inflation of the gas price and subsequent bust that has taken 18 months to recover. Since the collapse, the oil price has nearly doubled whilst natural gas has remained broadly flat. This is an anomaly, and in recent months, natural gas has never been so cheap relative to oil. The gas price however has started to gain strength, a trend we expect to continue.”