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Commodity prices are heading for their sixth drop in seven years. But commodity markets have never been bigger.
Open interest – the number of open commodity contracts – has exploded on futures exchanges this year. From crude oil to soybean oil, market sizes increased by nearly 1.4 million contracts in the first nine months of 2017, the most in seven years.
This week alone, open interest in US crude futures reached a new record of more than 2.4 million contracts on the New York Mercantile Exchange. In London, low sulfur gas oil futures topped 1 million contracts for the first time. Total open interest in contracts tracked by the benchmark Bloomberg Commodity Index is 14.3 million, the highest on record, according to Bloomberg Intelligence.
The increase may seem confusing, given the status of commodities as one of the worst performing asset classes of the decade. The Bloomberg Index has lost 38% of investors since 2010, compared to a total return of 164% for the S&P 500 stock index. Volatility has also been subdued, denying fund managers the opportunity to make big profits.
Some believe that a higher open interest rate shows that investors are flirting with commodities again. Assets under management in commodities recently surpassed $ 400 billion for the first time in more than a year, according to Aakash Doshi, analyst at Citigroup. While the Bloomberg Index is down for the year, it gained 2.9% in the quarter ending this week.
âIf you look around, bonds had a good run, stocks had a good run. Commodities are one of the few asset classes that have been squashed, âsaid Tim Atwill, head of investment strategy at Parametric, a Seattle-based asset manager with $ 3 billion in funds. raw materials. âPeople say, ‘Well, maybe that isn’t a bad entry point. ”
The arithmetic suggests that the fall in prices themselves might have spurred open interest. One hundred dollars can now buy for about two barrels of U.S. crude oil, which was trading at $ 52.55 a barrel on Thursday, compared to one when it was still trading above $ 100.
The low volatility in today’s financial markets is also a factor, says Greg Sharenow, commodities portfolio manager at fund manager Pimco. Lower price movements mean that exchange clearinghouses typically require less margin, or collateral, to be held against open futures positions. This allows fund managers to make bigger bets.
âThe increase in open interest has been a function of both lower volatility as well as lower prices. For a dollar at risk to be in the market, you end up with higher amounts of contracts at stake, âhe says.
Mr Sharenow also points to the growing prevalence of systematic investment strategies that follow price trends or trade commodities for other asset classes. Managed term funds, a type of investor in this category, have received $ 5 billion in new investments during the year to date, bringing their assets under management to $ 126 billion, according to eVestment.
Companies that typically use futures markets to hedge price risks have also stepped up their activities in some commodity markets. U.S. shale oil producers have unleashed a wave of futures selling to block a recent rise in crude oil prices, deals that are rippling through the futures market.
Derek Sammann, global head of commodities and options at CME Group, the Chicago-based futures exchange operator, says that at a time when commodity prices are relatively stable, “it may seem against -intuitive to see an increase in open interest “. The CME lists commodities such as corn, gold, and US crude oil on four exchanges, including Nymex and the Chicago Board of Trade.
He questions the idea that investment funds have sparked a growth in open interest, arguing that business ventures such as miners, oil companies or farmers usually come first.
Indeed, a number of the largest commodity exchange-traded funds, such as the $ 2 billion PowerShares DB Commodity Index Tracking Fund or the $ 2.3 billion United States Oil Fund, have experienced cash outflows. funds this year, according to ETF.com.
Over the past three years, CME has “put the end-user business participant at the center of all of our sales and new customer engagement strategies.” If traders come, “financial players tend to follow,” says Sammann.
Open interest has not increased uniformly on all futures contracts. In US oil futures on Nymex, the sum plunged so that the contracts were delivered in years. One reason is that Wall Street banks take less risk in illiquid markets. Another, Sammann says, is that the shale industry that transformed U.S. oil production operates on much shorter timescales than megaprojects, reducing their need for hedging in the distant future.
Investors who return to commodities tend to hold contracts for delivery in the near future, where open interest is highest, pulling them together into new contracts when they expire. Mr Atwill calls commodities “a very liquid asset class which, to say the least, is not as overvalued as everything else.”