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Konstantin Inozemtsev

Commodity traders waiting for a fresh onset of institutional investment with the dawning of the second quarter may be in for disappointment.

Two years of steady allocations into raw material, energy and agricultural markets may stall for the time being, with several weeks of moribund activity extended by deep uncertainties in the Middle East, Japan and eurozone.

As if that weren't enough, investors must now squarely confront the ending of the super-easy monetary policy cycle and the tricky act of raising rates without upending an economic recovery that remains fragile at best.

Investors reckon this spells "hold" for commodities, many of which have lost momentum during a first quarter in which many new post-2008 highs were swiftly followed by deep correction.

In the last two weeks, daily volume in energy, metals and grains was off 30 per cent or more versus the 30-day average, underscoring traders' indecision.

That, some say, could affect the momentum of the long money that had been flowing into commodities - meaning the record high sums tracked since December by the Commodity Futures Trading Commission may slow from March.

"You can bet most commodity-related investors were fairly near full-invested approaching the quarter-end," said Oliver Pursche, president at Gary Goldberg Financial Services, a firm in Suffern, New York, which manages $500-million of assets, including a commodities mutual fund.

"Now, everything is pointing to stay the course, don't do anything and if you get new capital coming in, don't rush to commit it."

Net investment into U.S. commodity indices peaked for a third month in a row in February, with long positions that bet on price gains crossing $300-billion the first time, government data showed this week.

The value of holdings by institutional investors and others who buy into baskets of commodity futures that represent such indices surged more than $45-billion over those three months.

Rising prices was one reason: U.S. crude oil rose 16.8 per cent on the quarter, and the Reuters-Jefferies CRB commodities index 8 per cent for a third straight quarterly gain.


Liquidity in commodities could also dry up quickly if the U.S. Federal Reserve embarks on monetary tightening for any reason, despite all promises in the past that it wouldn't.

Since the financial crisis, the U.S. central bank has approved one stimulus package after another to boost the economy and the latest - a $600-billion bond purchase program known in market lingo as Quantitative Easing II, or QE II - will end in June. While there is no word yet of a QE III, some senior Fed officials have been calling for the current package itself to be cut by $100-billion.

Others have suggested an outright rate hike soon, like Minneapolis Fed President Narayana Kocherlakota who said rates could rise by three-quarters of a percentage point by the end of 2011 - faster than markets expect.

"Stimulus money has been one of the biggest drivers of commodities and any attempt to choke this lifeblood is likely to be greeted by investor panic," said the managing partner of a New York hedge fund that manages $70-million in commodities.

Trading volumes in oil shrunk after investors began to worry about how long the market will be able to capitalize just on the freeze in Libyan oil exports and unrest in other oil-producing Arab countries.

Crude futures in New York defied high U.S. oil stockpiles to rise $15 during the quarter to a 2-1/2 year high above $106 per barrel. Traders say prices could dive if Libyan rebels locked in fierce fighting with Muammar Gaddafi's troops succeed in taking key oil-producing towns to resume exports.

Even so, no one really wants to bet on the direction in oil now.

"Generally speaking, our stance on the energy sector and oil in particular is going short right now doesn't make sense and adding to the long position doesn't make a lot of sense either," said Mr. Pursche of Gary Goldberg Financial. "So, it's a hold, and that obviously impacts trading volumes."

Don Steinbrugge, managing partner of Agecroft Partners in Richmond, Virginia, concurs with that.

"The average institutional investor thinks there's more downside than upside in the oil market if this whole situation in Libya is resolved in the next couple of weeks," said Mr. Steinbrugge, a hedge fund consultant who also gives advice on portfolio building to big investors like pensions.

"That said, I think it's a lot easier to predict long-term trends in commodity prices based on projections of global GDP, and what demand will be for various components of the market, than to forecast supply shocks."


Copper prices have fallen almost 10 per cent since hitting record highs of nearly $10,200 a tonne in mid-February. Trading volumes in copper - a key economic bellwether - have dwindled too on fear that the post-earthquake nuclear radiation leaks in Japan and the eurozone's debt woes would get worse before getting better.

Japan remains one of the world's largest economies although it is not as big a commodities consumer as China. The huge sovereign debt of countries such as Greece and Portugal have dragged on market sentiment for more than a year, taking a fresh blow after credit rating downgrades this week.

Despite the run-up in oil, the average energy hedge fund is down nearly 3 per cent year-to-date, according to data tracked by Chicago-based Hedge Fund Research.

Unless the market overcomes its trading inertia, returns could remain dismal, putting pressure on fund managers.

"As investors, we want the best risk-adjusted returns," said Mike Hennessy, managing director at Morgan Creek Capital, a $10-billion fund-of-funds in Chapel Hill, North Carolina, that invests with managers specializing amongst others in energy and commodity portfolios.

"We download all capital to managers and expect them to have a view and navigate those markets on a short-term basis."