How Things Change aka Cycles
Back in 2005 a colleague asked me if I had noticed the hedge funds trading energy commodities. The fact was I had no idea what a hedge fund was nor why they would be trading energy. However, that question resulted in a number of initiatives that included the then Energy Hedge Fund Center and the book – Energy & Environmental Hedge Funds: The New Investment Paradigm (Wiley Finance, 2006) both in partnership with the man who asked me the question – Peter C. Fusaro. Over the next several years, we watched as hedge fund after hedge fund entered commodities one way or another, we tracked multiple strategies employed by those funds from debt, through equities to actively trading physical commodities. We saw the huge returns the early players experienced.
Of course, the interest was propagated by a number of factors of which tight supply/demand was probably the biggest. There were the peak oilers and other pundits who argued that natural resources would become increasingly difficult to obtain as we simply ran out of supplies. On the other hand, the economies of India and China amongst others, were experiencing phenomenal growth and consuming as much natural resource as they could obtain. To compound the problem, there were infrastructure issues, too little refining capacity, too few pipelines, transportation bottlenecks etc. Of course, I have simplified the arguments but in essence I am describing what came to be known as the Commodities Supercycle.
I recall writing articles arguing that peak oil was a none sense that made no account of human ingenuity especially as prices rose making extraction methods and other plays economic. I recall writing articles talking about easy money and how most of the funds were doing nothing special and were all long or long-biased and sooner or later, they would take a bath. I recall writing articles about how investors should approach managers and take care over their due diligence as a result. Of course, it was mostly overlooked. Like my views on man made CO2 and global warming, I am viewed often as a contrarian or even as a maverick by some. Fact is, I (we) were right on every count – and I will bet real money I will be right about the CO2 story too eventually.
No, I’m not writing this to sing my own praises nor Peter Fusaro’s. I am simply observing how everything is cyclical and how bubbles always burst. By all accounts, the supercycle may have met its demise. China and India’s growth is not so stellar anymore, oil and gas are in plentiful supply and will be for decades to come, new refineries have been built close to the supply and designed for the sour crudes, a lot of hedge funds went belly up,investors pulled their money and now it seems difficult to find money for commodity funds. We are in an era of oversight and scrutiny. Regulations are being enacted and its all getting more complex, more risky and less attractive.
The funny thing is though, now may just well be the time to invest. Good and seasoned managers who can no longer work at the banks are creating funds with good strategies. New fund starts are increasing. There is still opportunity but it has to be worked at as the easy money has more or less gone. Despite the regulatory issues, the commodities markets are more robust, broader-based, more mature and there is a wider choice of instruments and strategies to deploy. Despite the supply/demand story easing, the fact is that global population growth continues unabated and therefore commodities will face periods of tightness going forward.
Its all about cycles. Now may be the time to get back in.
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