The changing face of commodities

Investing in commodities has changed in recent years, says Morgan Stanley economist Stephen Roach. They have started to take on the trappings of financial assets. And that's beginning to cause problems.

In a low-return world, high-yielding commodities have become the siren song of the asset-liability mismatch. Well supported by seemingly powerful fundamentals on both the demand (i.e., globalization) and the supply sides (i.e., capacity shortages) of the macro equation, investors have stampeded into commodity-related assets in recent years. Once a pure play as a physical asset, commodities have now increasingly taken on the trappings of financial assets. That leaves them just as prone to excesses as stocks, bonds, and currencies. This is one of those times.

Previously, I argued that Chinese and US demand were both likely to surprise on the downside - outcomes that would challenge the optimistic fundamentals still embedded in commodity markets (see my 15 September dispatch, "Whither Commodities?"). I also hinted that the asset play could well reinforce this development - largely because commodities have now come of age as a legitimate asset class in world financial markets. This companion note develops the asset-driven adjustments that could well lie ahead in commodity markets.

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