Commodities supercycle? Pensions loath to commit

Even if commodities are on the verge of another powerful rally, few institutional investors have plans to increase allocations to the sector due to high volatility and losses they incurred in the last two years.

Pensions and mutual funds that invested in oil, metals and other commodities during the last boom from 2003-2008 had planned to invest at least 5 percent of their multibillion dollar assets in the sector on expectations booming emerging markets would boost demand for basic resources.

Now, key indicators such as the Reuters-Jefferies CRB Index .CRB, the S&P Goldman Sachs Commodities Index .SPGSCI and the Dow Jones UBS Commodity Index .DJUBS are at their highest levels since October 2008, when prices were collapsing during the financial crisis. Some traders are even talking about a new multi-year rally in commodities or "super cycle."

Goldman Sachs (GS.N), the largest investment bank in commodities that predicted the oil-price spike that reached almost $150 a barrel in 2008, now believes crude could rally by 25 percent next year while copper prices could rise by a third.

Yet, some of the largest investors -- including the $1 trillion U.S. bonds manager Pimco and California's $200 billion pensions fund Calpers -- are keeping less than 2 percent of their money in the asset class, with no revisions in sight.

And the $130 billion retirement fund for Canada's Quebec region, Caisse de Depot et Placement du Quebec has even closed its commodities portfolio entirely.

"To me....(this) is not what long-term investors look for," Roland Lescure, chief investment officer for the Caisse, said, referring to the sharp price moves in commodities that often overwhelmed conservative investors such as pension funds.

The Caisse's C$131.6 billion ($127.8 billion) fund had as much as C$2.5 billion in commodities between 2004 and 2009, or just below 2 percent of assets. It exited commodities at the start of 2010, eventually closing out the remaining C$1.2 billion position, following two years of bruising losses.

Cautious Diversification

Long-term investors typically see commodities as a way of hedging against inflation and an opportunity to diversify their funds away from stocks and bonds.

Many big funds track commodity indexes that roll monthly contracts as they expire. The strategy worked well until the financial crisis saw equity and commodity markets start to move in sync, denying investors the diversification they were looking for.

Pricing aberrations in oil futures have also made index rolls unprofitable, with some analysts and funds arguing that the market itself was distorted by the same influx of billions of dollars from long-term investors.

The California State Teachers Retirement System (Calstrs) made headlines last month when strategists at the $132 billion fund recommended a $2.5 billion commodities allocation, one of the largest proposed by an institutional investor.

But Calstrs spokesman Ricardo Duran later told Reuters in an e-mail he expected a smaller sum to eventually be approved.

One of the reasons for that is the contango structure in many commodity markets -- when spot prices fall below the price of contracts for delivery in the future.

The Calstrs strategists cautioned that selling expiring contracts every month only to replace their positions with more expensive ones -- commonly referred to as rolling contracts -- has resulted in negative returns in every commodity sector from 1991 through September 2009.

Olivier Jakob, trading adviser at Petromatrix in Zug, Switzerland, said pensions had been losing as much as 30 percent of their commodities portfolio values a year on roll costs, eating into any price appreciation.

"The problem is that pension funds have learned the hard way the passive economics of the contango and are increasingly questioning what should be their proper exposure to commodities," Jakob said.

"(Hedging) with oil futures against a few points of inflation in an economy where a central bank has the duty to control inflation is just a very bad trade."

These losses have made existing large investors in commodities cautious about raising their exposure even as gold spot prices are hitting record highs and oil and copper have risen to multi-month peaks.

The California Public Employees Retirement System (Calpers), the largest pension fund in the United States, lost 10 percent on its commodities portfolio in the second quarter, and the fund said it had no plans to increase its allocation.

"It's been going sideways, pretty much, and we haven't done much about it," Calpers spokesman Clark McKinley said of the portfolio, which makes up less than half a percent of the fund's $200 billion. Calpers is allowed to invest up to 3 percent.

The Teacher Retirement System of Texas is another pension fund that isn't raising its commodities allocation, which stands at about $1.8 billion or below 2 percent of assets. The fund's rules say it can invest up to 7 percent in the sector.

Even bond manager Pimco, whose $18 billion commodities mutual fund often beats the market, isn't getting more aggressive on the sector.

Pimco, or Pacific Investment Management Co, is up about 13 percent for the year on its commodities mutual fund, while the DJ-UBS index it tracks shows a 5 percent gain. Pimco says the fund has been enhanced by inflation-protected securities, but it has no plans to widen the portfolio, which accounts for less than 2 percent of the $1.1 trillion it manages.

Caution Could Cost

But advocates for commodities say such caution could cause investors to miss out on the next big rally.

"As the market tightens, we'd expect that to lift oil prices up to the $85-$90 range by the end of this year," said Goldman oil analyst David Greely, adding oil will likely return to $100 a barrel in 2011.

"Demand for copper is also exceptionally high, and coupled with supply constraints, we could see prices rise to as much as $11,000 a tonne next year," Greely said.

Oil prices are currently just above $80 per barrel while copper is trading at around $8,300 a tonne.

Others, such as Lecure of the Caisse, said pension funds should get exposure to any commodities boom through direct investments in oil and mining companies, though the losses suffered by many large investors in BP (BP.L) after the Gulf Of Mexico disaster may give pause for thought.

And the Caisse may be an exception, rather than the norm.

Away from pension and mutual funds, the largest university endowments remain relatively large investors in "real assets", which include real estate, timber as well as commodities such as crude oil. Harvard University has about 14 percent of its near $28 billion endowment in such real assets, though it has no plans to expand on that.

Data from consultants Cambridge Associates suggests the average investment in oil, gas, timber and other commodities has steadily risen for universities to 3.5 percent of total assets this year from 2.1 percent in 2005.

Gustavo Soares, commodities strategist at Bank of America-Merrill Lynch (BAC.N), said while institutional interest in commodities may have slowed, he still expected it to rise long-term.

"The case for commodities has been very strong in recent years - and I think that is even more true now than before," Saores said.

"Some of the sleeping giants - the very largest institutional investors - may still come into commodities, if only as they see their peers' allocations and they don't want to be left behind."

[Source: By Barani Krishnan and David Sheppard, Reuters, New York, 13Oct10]

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